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Saturday, April 12, 2014

Knocking Down Jim Cramer's Bear Case

Jim Cramer just published “The Bear Case in 10 Easy Lessons”, which lays out the arguments for lower stock prices.  He throws these “lessons” out not as an argument but as discussion items, a sort of straw man. Here is his case and my observations:


1. Something is very wrong with the market when we get strong news out of the economy and interest rates plummet. That's a fear of an unknown unknown. What's the point of buying when there is something lurking?
Interest rates are falling because inflation is falling while the Fed is tapering. Low bond yields support low earnings yields (high PE ratios).


2. When interest rates plummet, the banks plummet, particularly now that the short rates aren't going higher. Banks are the linchpin of all big rallies, and we have lost them.
There is no doubt that banks are hurt by a low and flat yield curve which makes retail deposits expensive and compresses margins. Bank earnings are under pressure. But the current ERP is a result of low interest rates, and doesn’t depend on robust earnings by banks or corporates. And also, low interest rates may hurt banks but they help corporates.


3. There is no price where the insiders won't sell these extended techs with no dividends or earnings.
Tech goes its own way and is always hard to value using conventional tools. The valuation of blue chips is not so hard, and is poorly correlated with tech. If a tech selloff pushes down blue chips, buy them.


4. We have had a big run from the bottom, almost a triple, so it has to be out of gas and extended. It was just high-multiple stocks. Now it is every stock.
Distance from the bottom is not a useful index of valuation. Stocks were severely undervalued in 2009, when earnings were cyclically depressed. The fact that they are higher today contains no information about value.


5. We've seen this movie before in 2000. In fact, it was this week to the week that we were really beginning to thrash with the really awful dot-coms crashing daily and the insiders still selling no matter what the case.
The 2000 movie was of a classic equity valuation bubble, when the broad market equity risk premium was at an all-time low. That is not the case today; the ERP is at the high side of its normal range suggesting value.


6. Japan's a disaster.
Japan has been a disaster since 1991 and it has never had any impact on the US equity market. As a result of Shinzo Abe’s reflationary policies, Japan is finally beginning to recover, and now has higher inflation than the US.


7. China's a disaster.
China is not anything like a disaster. China remains the best performing economy in the world, although it slowing a bit as the PBoC reins in credit growth (which is a good thing). China prints its own money and has $3.5 trillion in external reserves.


8. The world's being kept afloat by central bank fiddling.
Global inflation is lower than it has been in 50 years. Global money growth is in the single-digits (almost zero in Europe). The IMF is warning about deflation. The world is kept afloat despite central bank incompetence.


9. The initial public offering flow doesn't stop.
IPO volume is suggestive of frothy sentiment and is a warning light. However, other measures suggest that we are not in an equity bubble comparable to prior episodes such as 1999. If equity prices fall from their current levels, market valuations will become more compelling.

10. Earnings will be terrible.
Future top-line and bottom-line growth are limited by anemic nominal GDP growth and by potential capacity constraints. However, from a valuation perspective, weak earnings growth is fully offset by low bond yields (i.e., a low discount rate for future cashflows). The current price-earnings ratio for 10-year governments is 38x with zero potential earnings growth, while the S&P ratio is half of that at 18x with potential (albeit weak) earnings growth.








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