The good news is that I can answer yes to the question of whether stocks have put in a bottom in this bear market. And I can answer yes to the question of whether the financial sector is out of crisis.
The bad news is: There's a but.
Have stocks bottomed? Yes, but it's nothing to get excited about. Sure, it's better than if there were still new lows ahead. I suppose considering the alternative, it's downright terrific that the S&P 500 doesn't have to go any lower than the Biblically ominous 666 level where it traded on March 6 (yes! March 6! how's that for ominous?).
But let's not get too proud of this idea that the downside is now limited. The amount stocks have fallen since their prior highs is greater than the hit they took from the highs in the Great Depression, the same number of days into the two bear markets.
I could make my case for a durable bottom just based on the idea that, using the Depression bear market as a benchmark, this year stocks clearly got way, way oversold. But I can make a more principled fundamentals-based argument, too.
I believe that in early March the market was in free-fall because the political process was like a runaway train. It looked then like a very ambitious agenda of antibusiness economic policy was about to get enacted, all at once. The momentum of a popular new president and a strong one-party grip on Congress seemed irresistible. As I wrote at the time , it was too much change, too fast. The already-destabilized economy just couldn't take it.
Since then, I think the political class realized what was going on it realized that it was pushing the economy over the edge, and it wisely decided to stop pushing. Issues like the cap-and-trade carbon tax, mortgage cramdown, unionization card-check, and the cap on the tax deduction for charitable contributions have all started to be questioned, even by Democrats.
It's a great relief for the stock market to learn that there are limits to the damage that Washington will do to promote its agenda. What's more, as time goes by, and the economic crisis eases, Washington can less and less claim that all the policies they've wanted to implement for years anyway must be implemented now in the name of emergency.
With the runaway train of change slowed down, and a demonstration that the political class knows it's playing with dynamite and intends to be cautious about it, a gigantic risk factor is moved to the sidelines. I think that draws a line under stocks for this bear market.
But the train is only slowed down. It's not stopped. As soon as the politicians feel safe again, they'll start pushing the same agenda. That's going to keep a lid on stocks for the foreseeable future. In a nutshell, yes the bottom is in, but the upside doesn't look so great.
Is the financial sector out of crisis? With the S&P 500 financial sector up 80% since early March, yes. As I wrote last week , with a great earnings report from Wells Fargo (WFC)
But that doesn't mean that some big banks aren't still in big trouble. Sure, we know the government isn't going to let one of them fail and drag all the others down with it. It's now a new world, where we can think of banks one at a time, winners and losers, not a single leaky lifeboat where everyone on board is destined to drown together. Still, the problems of a few big banks that are still in trouble can't help but make life harder even for the winners.
For example, right now Congress is considering legislation that would allow judges to use their discretion to reduce principle and interest on mortgage debt owed by people in bankruptcy. In the political parlance, it's called mortgage cramdown. Trillions of dollars of mortgages exist today, and every one of them was created under the established law that mortgage debt could not be adjusted in bankruptcy. Now Congress wants to change the rules of the game, after the game has already been played.
It's not fair, and it sends a message to businesses of all kinds that commitments they make in the marketplace are subject to sudden and arbitrary revision by politicians. More immediately, the new risk of cramdown means the mortgage interest rates will simply have to be higher than they otherwise would be, because if the new law is enacted, mortgage lenders will be at more risk.
Here's the issue. Citibank, the big bank that's still most in trouble, and the one that is most beholden to the government because of the multiple rounds of aid it has had to accept, has come out publically in favor of cramdown -- even though the banking industry, in general, of course opposes it. What happens if a couple other weak banks take Citi's position on the issue? Without the whole industry taking a unified position against it, some version of cramdown is likely to be enacted. It will happen because the weak banks couldn't say no but it will punish all banks, including the strong ones like Wells Fargo.
And the same thing will play out over and over again with other issues of financial regulation that are certain to be on the agenda over the coming years. So just like the broad market, the bottom is in for bank stocks. And just like the broad market, the upside is limited.
If you're like most investors, your perceptions and expectations for the stock market were formed by your experience of the 1980s and the 1990s. Unless you've been around as long as I have in this game, that's all you know. Anything else just comes from history books.
But the stock market isn't always like it was in those two wonderful decades. In those years it made sense to buy and hold and invest in stocks for the long run and all that jazz. It was so easy to believe in the religion of equities when stocks pretty much always went up, and when they went down, recovered to new highs before long.
Yes, but. Those days are gone. It's back the 1960s and 1970s where stocks were stuck in an endless trading range, with value relentlessly eaten up by inflation. You can make money by trading. But you might as well forget about the idea of investing.