Laszlo Birinyi is very confident the S&P has bottomed. Alright, he is correct that the market is up in the face of a steady drumbeat of terrible news since November. Much of that has been attributable to the performance of beaten down sectors like housing, financials, retail, and metals.

Meanwhile, sectors that should be less economically sensitive – utilities, telecom, consumer staples, and pharma – have underperformed.

In the Barron’s article, Birinyi cites several indicators (both quantitative and qualitative) to back up his opinion; one in particular is the number of S&P stocks down 50% or more from their peak, which Birinyi interprets as a sign of an oversold market. Although it sounds like a good rule of thumb, it’s essentially a mean-reversion bet, and unbounded mean reversion bets are dangerous. For an analogous method, look at the two graphs below displaying the percentage of stocks trading above their 50-day and 200-day moving averages. There were levels these indicators were not supposed to fall below that were shattered in the midst of the fall sell-off, but there was no reason for those levels to hold, other than they had in the past. With a company you can bring net tangible assets into account at a point, and feel some margin of safety, but not so when simply comparing historical prices.

Note also: the recovery.

While it’s fully possible (even probable) the markets could meander along and eventually go higher without making new lows, I side with Jeremy Grantham’s thesis that markets will overcorrect – so while stocks might be cheap now by many metrics, bear markets do not end easily or rationally.
That this rally has been led by some of the worst sectors is not encouraging either. There have been plenty of bear market rallies on the way down, and with my own money I cannot justify the idea of putting money into something opaque, only to have it blow up sooner than later. Opaqueness might be based on depth of understanding, but only to an extent – there are aspects of a company that only insiders can be fully aware of, and these hidden risks are what keep me on edge. If my largest position ever reaches my estimate of fair value (based on the present cash available at the holding company level), I will happily give up the option value and move to almost all cash.

A primary concern continues to be the inflation/deflation threat; and while Cam Hui’s barbell strategy to hedge that bet is the most prudent and conservative choice, I feel that having a view favoring one or the other is an essential starting framework to have a handle of what is going on in the markets. Judging from the bits of data and research, my intuition leans in favor of high inflation. Still, there are no guideposts down this path of government interventionism, so who is to say when the side effects of our present policies manifest down the road – or the best way to profit? This will require further hashing out…

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