Market Risk to the Bears by Comstock Partners, Inc. Thursday, October 13, 2005
Catalyst to Resumption of Secular Bear Market
We have been discussing for most of this year what we thought was the risk to stock market bears. We concluded that if the stock market was in the secular bear market that started in 2000, the market should NOT break out of the peak area reached this year of about 1240-1245. This was also approximately the level where the breakout took place in late 1998 that led to the blow off of the late financial mania of the late 1990s reaching 1550 on the S&P in early 2000. In fact if you draw a line from that break-out level to present, it is very close to this level. The 1240-1245 level also represents about a 55% back up from the lows reached in 2002. And if we are in the secular bear market we have been writing about, the retracement from the lows should not rally much more than that. The multiple percent retracements of the Japanese Nikkei Average in their13 year bear market were also all about 50-55%.
The market has declined sharply over the past few days with the press citing the hawkish comments of the Fed presidents and governors. They are concerned that inflation could be our next problem. We aren’t sure of what the catalyst will be for the continuation of the secular bear market, but we are on record (on our web site "special report") as believing the highest probability would be a decline in housing prices and real estate in general . The latest declines just happen to begin with an article in the New York Times the first week of October detailing a falloff in housing prices in the hottest markets. The article detailed how most real estate in the “hottest” markets are remaining on the market longer as inventories of homes for sale are building. These conditions have preceded market declines in the past and have led to declines in prices. The article also detailed many areas where the prices have already started declining. Today there was another article in the Wall Street Journal outlining titled “Era of Low Rates around the Globe may Soon be Over”. The area most vulnerable to worldwide rate increases is obviously real estate.
We have seen and heard many pundits claim that this potential decline in real estate will be good for the stock market, since the “hot money” would move from real estate to stocks. We disagree with this wholeheartedly. We believe the wealth effect of declining real estate (especially one’s own home) will exacerbate and accelerate the stock market decline that has already started. Homeowners were able to extract over $600 billion from their homes in 2004 (and more this year) in order to sustain their consumption. Since the individual consumer represents about 70% of GDP, this represented much of the growth of GDP over the past 2 years. The healthy way economically for individuals to consume should be out of the savings from their earnings---not borrowing from an appreciating asset.
If we are correct that real estate in general and housing specifically have peaked, we wouldn’t be surprised if the stock market dropped by 40-50% over the next year to 18 months. This would take the S&P 500 down to the 600-700 level and even if the earnings of $70 per share actually do hold up (which we doubt -see comment of Sept 29th) the market would drop to the normal bear market trough level of 10 times earnings or less.
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