Years ago, a colleague in money management displayed a book in his office that he authored called “Everything I Know About the Stock Market.” As I recall, it was a hefty book, attractively bound with a feel of quality. However, after opening up the tome, every page was blank.  For financial types, this was quite funny because you quickly appreciated the joke.

John Kenneth Galbraith had a similar but somewhat different take. He said, “The only function of economic forecasting  is to make astrology look respectable.”

Now, forecasting the economy and the stock market are in fact two different things, but both are quite difficult to do. And while they are not directly connected, they are not unrelated. The economy and the stock market rarely can go in opposite directions for long. Earnings are the mother’s milk of corporate income and plentiful earnings cannot be found in a contracting economy. Maybe the turn in the stock market is predicting a turn in the economy?

So while both tasks are fraught with difficulty, we have to have some idea of what phase the economy and the market are in to make allocation judgments. However, we admit there is a school of thought that says the whole effort is useless and the only method that succeeds is to buy and hold “for the long term.”

We will finish our game of quoting by noting Mike Tyson’s famous observation to the effect that everyone has a plan until they are hit in the face. There is nothing like a bear market to shake the faith of a buy-and-hold investor. And, many of us older investors don’t have a lot of time, and recovery from deep bear markets can take 20 years. Buying and holding can be more difficult than you think.

Last year was a mild bear market of about 20%, and evidence is building at least for some, that the bear market is now over and a new bull market has been born.

On June 8, 2023, on the front page of the Wall Street Journal,  it was announced that “S&P Enters New Bull Market as Big Tech Lifts Indexes.”

Their sister publication Barrons followed several days later with a cover story “This Market Has Legs”, replete with the picture of the bull as the cover art.

Yahoo Finance agrees as well, and apparently, the analysts at Bank of America/Merrill Lynch. So, the “new bull market theme” has some significant support and that support is growing.

These institutions and publications may well be right, but such bullishness historically has been more indicative of a top, than the beginning of a major, prolonged advance (a bull market.)

The heart of their argument is the S&P has risen 20%, and at 248 days of decline, this long bear market has to be over. According to Jason Goepfert at SentimentTrader.com, the Dow Jones Industrial Average is on its longest losing streak in 122 years.  That certainly is an extreme reading and suggests a turn would not be out of the historical experience.

However, while the bear market has been a long one, it has not been a particularly deep one. Usually, great enduring bull markets do not begin until excesses in speculation, valuation, and public sentiment get washed out of the system. In fact, usually bear markets go even further than necessary and swing to a point of pessimism just as irrational as the frothy top.

To be sure, the market did hit some kind of a bottom last October and the S&P has risen back about 20%. But to be fair, other indices have not done nearly as well. The capital-weighted S&P has beaten the equal-weighted S&P by more than 10%. This problem of “breadth”, where a handful of big tech stocks have done well, but the vast majority of other stocks have drifted sideways, usually resolves itself in two ways.  Either the market peaks out and resumes its decline, or the breadth problems clear up by spreading participation to other lagging sectors.

There is some evidence of the latter, but the data is still a bit weak. However, the mind has to be open that increasing participation will occur.

Great bull markets are normally born with two conditions prevailing. Usually, the market cycle begins after values have fallen substantially and market metrics are cheap. And usually, the market finds a bottom on very deep pessimism.

The market is being led upward by a handful of companies that are selling at astounding multiples to earnings (very expensive) and enthusiasm for all things “artificial intelligence” reminds one of the dot com bubble. Nvidia, the darling of the group is selling at over 200 times trailing earnings. That means it would take 200 years of current earnings to be equal to today’s price. The average for the market is around 13 times earnings. Yes, the internet did change the world, and likely so will AI, but that does not mean a lot of mania can’t cause excruciating financial pain at some point.

We are not saying the bullish prognosticators are wrong. This cycle is so unusual because of unprecedented government meddling and money printing that anything is possible. However, the market never reached a profoundly cheap level, nor has pessimism been that deep either. In fact, the market has held up rather well, because bad news was considered good news. The worse the economy looked, the better because it will force the FED to pivot, cease increasing interest rates, and get back to cheap money to fuel the market advance. And gobs of cheap money can stimulate markets, even if the underlying economy is not that good, at least for a while.

It is also hoped that AI will save immensely on labor costs, which are likely to continue higher due to poor demographics.

Technical types put their emphasis on price action because they contend that everything that is knowable is in the price. From that perspective, things indeed are looking brighter.

But if you look at the underlying economy, most indicators look soft, even though employment remains strong.

The yield curve remains inverted (short rates above long rates), the 30-year mortgage is back to 7%, housing is soft, commodity prices are mostly soft, the leading economic indicators are weak and have been down for a year, the money supply is contracting, and the World Bank estimates the economies of Europe, Japan, and the US will grow by a meager .7%, which considering inflation, is hardly growth at all. How will such a slow economy produce a new bull market in stocks?

The bulls argue that rising stocks discount a recovery in the economy. We will avoid a recession and the FED will get its highly sought-after “soft landing.” Stocks will go up first and a year later, so will the economy.

That assumes the two are connected, and as we previously noted, they are in the longer term, but not in the short term. In the short term, liquidity: the availability of a lot of money at a cheaper price, can stimulate markets higher. However, we no longer live in an environment of TINA (there is no alternative) to the stock market.

Higher rates are beginning to make bond and CD alternatives look more attractive.  Indeed, there is a lot of money still sloshing around out there. While the FED has tightened, rates only recently have interest rates gotten close to the rate of inflation. In real inflation-adjusted terms, borrowing is still pretty cheap and the FED is not yet all that tight.  So while liquidity is ample, there is no guarantee all of it will flow to the stock market. The Treasury can now begin to borrow in earnest since the debt ceiling issues have been solved.  How much money will financing this bloated government soak up? How about a lot!

Meanwhile, inflation has proven to be anything but “transitory”, a statement that will go down in history as one of the biggest lies ever told by a central bank.  That was a pretty bad call considering that they have more than 300 Ph. Ds working for them. A cynic might suggest it is because of them.

Markets right now expect the FED to “pause”  or skip an increase at the next meeting (June 14) but perhaps move rates once again higher in July( 25-26th). We are not so sure. Both central banks of Canada and Australia just raised their rates once again. And will inflation likely retreat in just the next six weeks?

This is still a market dominated by the FED. Offer treats, and the puppies will jump.  Scold them, and they will cower.

We would add one other historical observation. Generally, the biggest and final part of a bear market comes after the FED has quit tightening.

We recognize the markets are acting better, but the narrowness of recent performance has to get cleaned up. If the vast bulk of stocks start moving, that is a signal that will be hard to ignore. Until then, caution is warranted and we now have safer alternatives with at least reasonable returns.