The Case for Bearishness

by | Jul 7, 2003

Even my old friends have turned against me! As the angry emails continue to pour in from bearish readers who are furious at me for my last couple of bullish columns, my old friend Fred Goodman — the master technical analyst — has issued a major sell signal. I don’t care how much nasty mail […]

Even my old friends have turned against me!

As the angry emails continue to pour in from bearish readers who are furious at me for my last couple of bullish columns, my old friend Fred Goodman — the master technical analyst — has issued a major sell signal.

I don’t care how much nasty mail I get. I’m bullish because I know that the fundamentals for economic recovery are in place and because, according to my model, stocks are underpriced. And whether I’m bullish or bearish, I’m always going to call ’em as I see ’em. Over time I’ve been right a lot more often than I’ve been wrong. So there!

But if it helps to prove that my bullish position is a well-considered one, today I’m going to talk about Fred’s sell signal, and discuss all the negative factors that I see. I still think the positives outweigh the negatives, and that’s how I’m placing my bets. But I’m not starry-eyed about it, and I’m happy to share with my readers all of the things that worry me.

First, let’s talk about Fred Goodman’s sell signal. Whatever you think about technical analysis (I’m a fundamental kind of guy, myself), this sell signal is a clear reflection of the fact that the market has come very far, very fast. And I’ve been warning you that the sell signal was coming for weeks. In last Friday’s column I said it would likely come that very day, and indeed it did. That puts an end to the buy signal Fred issued on Feb. 24, which I also told you about here.

That buy signal was the most profitable in the history of Fred’s “Summary Index” — the super-indicator that brings together all of the esoteric technical tools that Fred looks at every day. If you’d bought Standard & Poor’s Depositary Receipts at the opening the morning after the Feb. 24 buy signal, you’d have paid $82.95. If you’d sold last Monday morning after Friday’s sell signal, you’d have sold at $99.45, for a gain of 19.9%, not including dividends. If you want to learn more about Fred’s Summary Index, I’ve posted a simple description of it on my Web site.

Fred was delighted by the market’s weakness immediately following his sell signal (in that ghoulish way that bears have of being delighted when the world goes to hell — some of the nastiest emails this week were like that). But this week has paid its respects to the bulls as well as the bears, and Fred cautions that “one swallow does not make a spring.” He thinks professional fund managers will do everything they can to gun the market leading up to the June 30 midyear performance reporting date — and then look out below.

So far, breadth indicators have led the decline — advances/declines, %-up/%-down, up-volume/down-volume, and Fred’s proprietary Breadth-Volume Oscillator and Thrust Oscillator. Fred says the too-often-ignored new-highs/new-lows statistics called last week’s top perfectly, while the popular ARMS Index was “useless because it flipped back and forth between buy and sell almost daily.”

The Summary Index is falling rapidly now, and Fred says the sell signal might be brief, suggesting a short, sharp correction of perhaps as little as a month. He thinks a sensible price target for the pullback would be in the area of 892 on the S&P 500, about where the 200-day moving average is.

OK, so the technical picture is, at least for the short term, troubling. How about the fundamentals? As I’ve written here in the last two columns, I think the overall picture is very good — the economy looks very much like what it always looks like when it’s still struggling to pull out of a recession. It’s getting there, and there are some very positive new dynamics (most important, Bush’s tax cuts), but all the evidence isn’t in yet, so most people still don’t believe it. (Of course, when everyone does believe it, it will be too late to buy stocks.)

So let’s look at the risks. The most important one is monetary policy, highlighted by the controversy over the Federal Reserve’s lowering of interest rates this week to 1.00%. I’m worried about the Fed’s new obsession with deflation — not deflation itself, but the fact that the Fed is so obsessed by it.

I’ve been writing about deflation for years, long before it was fashionable, when all anyone wanted to hear about was inflation. At this point the problem is solved. The rise over the last couple of years in the price of gold and other commodities, and the sharp drop in the foreign exchange value of dollar, all indicate that deflation is no longer a threat. But the Fed has a way of always “fighting the last war.” If they keep rates too low for too long — and we’re close to that right now — then they’ll inadvertently trigger a new bout of inflation.

If signs of incipient inflation start to emerge, that won’t be good for markets. And the red-hot long-term Treasury market is going to get the stuffing knocked out of it. Actually, Treasurys stand to lose here almost no matter what. Even if the Fed manages to avoid triggering new inflationary dynamics with its ultra-low interest rates, a recovering economy is going to trigger higher long-term interest rates no matter what the Fed does, as businesses clamor for more long-term financing.

Another risk is political instability. President Bush’s approval ratings in the polls jumped when the U.S.-led coalition invaded Iraq, but now they’ve fallen back to pretty much the same levels as when Bush first took office in 2001, after the divisive “hanging chad” election. That means Bush no longer has the political effectiveness that permitted him to shove enormous pro-growth tax cuts through a balky Senate. Some Republican strategists may crow about more new tax cuts every year, but they aren’t going to happen at Bush’s current levels of political popularity.

At these approval levels, Bush has no choice but to go along with popular but expensive spending programs like the Medicare prescription-drug benefit now under consideration. Spending burdens like that hold the economy back precisely when the tax cuts are trying to help the economy grow. But the alternative is for Bush to lose ground to Democratic challengers like Howard Dean who are explicitly campaigning on rolling back Bush’s 2001 and 2003 tax cuts.

Those two factors — monetary risk and political risk — are why I’ve been telling my institutional clients to be 75% invested in stocks, not 100%, even though overall I’m quite bullish. The picture is very, very good — but it’s not perfect.

Again, when it finally becomes perfect, it’ll be too late to buy. But that’s why sensible investors don’t see a commitment to the stock market as a black-or-white decision. You don’t have to be all in, and you don’t have to be all out. In the end, that’s what’s so silly about the angry mail I’ve been getting. There seems to be an assumption that I’m telling people to sell granny’s ranch and buy stocks — and they’d rather sell all their stocks and hide the money in a fallout shelter.

Surely the truth is somewhere in between. The only real question is where in between. For me, while there are still risks, the weight of the evidence is compellingly bullish.

Originally appeared on, where Luskin is a Contributing Editor.

Don Luskin is Chief Investment Officer for Trend Macrolytics, an economics research and consulting service providing exclusive market-focused, real-time analysis to the institutional investment community. You can visit the weblog of his forthcoming book ‘The Conspiracy to Keep You Poor and Stupid’ at He is also a contributing writer to

The views expressed above represent those of the author and do not necessarily represent the views of the editors and publishers of Capitalism Magazine. Capitalism Magazine sometimes publishes articles we disagree with because we think the article provides information, or a contrasting point of view, that may be of value to our readers.

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