Now They Say We’reClimbing The Wall Of Worry

Inflexibility makes for bad forecasting. The best forecasters possess an ability to change their minds on a dime, the moment it looks like they’ve made a mistake, and to re-formulate their assumptions. The worst forecasters maintain their initial forecast even as its reasons disappear, thinking that the market should have done what they predicted and that, therefore, it will get in step any day now.

Five weeks ago, I changed from cautious to bullish. It was a controversial move, attacked on several fronts for its “carelessness” and “ignorance of systemic issues.” I was told personally that I had no “regard for the hard-earned savings” of my subscribers. One person told me to “wake up.”

As one week of solid returns became two, then four, and now five, the tone of criticism has changed. Instead of re-visiting the initial call, some competing forecasters are just re-forecasting from now as if we’re starting fresh, slate clean, forget about what happened five weeks ago. “What’s going to happen from here?” they ask, and then re-state their market fears as though they hadn’t been wrong for more than month, or more than several years in some cases. It’s a clever change of subject and comprises the modus operandi of most in the forecasting business for a simple reason: they’re usually wrong.

Typical is the weekend note sent by EquiTrend’s John McClure, which always ends with the sign-off “Working for your wealth.” Last weekend, it was titled “We Are Climbing The Wall Of Worry” and contained these excerpts:

It was back to a bad news, good action week for the most part as investors chose to look at the data through rose-colored glasses. . . . Dow Theory states that for a trend to be confirmed, both the Dow Transports and Dow Industrials must be trending in the same direction. Although the Industrials have recovered all the territory lost since the July melt, the Transports have struggled. This week the Transports lost ground while the Industrials ended slightly higher. Until they both are heading in the same direction, the trend is in question.

And after falling since September 14, the Market Volatility Index (VIX) jumped this week to 17.73 from 16.91 last week as volatility (and fear) crept back into the market. . .

There are clouds growing on the horizon.

Given that a number of indexes are at or above their 2 standard-deviation trend channel top lines, the next correction could come at any time. Volumes also remain low and there has yet to be the flood of new buyers entering the market that normally accompanies — and confirms — a sustained rally.

Mr. McClure is hardly alone when it comes to this type of forecasting. Those who look for sustained rallies are by definition leaving themselves out of the early parts of the rally. That makes their eventual bullish calls risky because they come closer to the day of reckoning, when the market reverses course and heads lower. Then, such forecasters keep their readers invested as the market goes down, down, down until they can confirm that it’s a “sustained” bear market.

I wrote about Marc Faber and Enzio von Pfeil on September 25. Mr. Faber said that the U.S. economy is heading toward recession and that the bull market will end. Mr. Von Pfeil wrote, “We are now on ‘red alert’ for the current month of October.”

Mr. Faber has been bearish this entire year. He told Barron’s in January, “This economy is in the greatest bubble ever.” He then outlined various reasons that the bubble would burst.

In his Oct. 10 article, Mr. Von Pfeil wrote:

Here are some more market chillers protruding from Wall Street:

  • This year, 10,000 guys lose their jobs on Wall Street.
  • Industrial production rose by an annual 6% last September; this August, it rose by 1.7%, i.e. by less than one third. Adieu, turnover.
  • Retail sales peaked at an annual growth rate of 9.2% in 5/06; by this August, they were limping along at 3.9% , i.e. by less than half. Adieu, turnover.
  • Unit labour costs rose by an annual 2.4% in March, 2005; by this July, they were rising by 5.1% — or by over twice that rate. Goodbye margins.
  • Profits, unsurprisingly, are cooling. Having risen by an annual 6.6% in 1Q05, by 2Q07 they were sputtering at 4.7%, which represents a slow down of nearly 30%.

So how can profits rise if The Economic Time is worsening? We keep sensing that stagflation is on the way.

It’s not hard to see the wall of worry. It’s also not hard to see who builds it brick by brick.

Nevertheless, the Dow is up 13% this year. Portfolios from The Kelly Letter are up much more than that, as usual:

  • +42% The Dow One
  • +24% Double The Dow
  • +22% Maximum Midcap

The cover of last weekend’s Barron’s read “Black Monday” and made comparisons with October 19, 1987 when the Dow lost 23% in a day. I already wrote about that in the October issue of The Kelly Letter, from which this is taken:

Where 1987 and today differ is in the valuation of the market. Heading into October 1987, the S&P; 500 had a P/E of 22. Today it’s just 18.

More damning for 1987, though, were performances. In August 1987, the S&P; 500 was up 45% year-to-date and Treasury yields went from 7% to 9%. Those were major warning flags. This year, the S&P; 500 topped out at a gain of 10% and Treasury yields never moved beyond 5%. The market is not wildly overvalued.

Don’t fear a calamity in October. If we get a sell-off, it’ll be a good time for late-comers to join the party that will see stocks higher in the medium term.

That’s all it will be.

The solid returns of the past five weeks have not dulled my enthusiasm for stocks. I expect 3Q earnings growth and forecasts of good 4Q earnings to keep this rally going.

We have yet to see strong individual investor participation, which is usually what brings the blow-off top to a bull market. That top is where lots of gains are made. You need to be in ahead of it, not after it’s gone on for a while and there’s reason to believe it’s sustainable.

The market will decline again someday. We can all agree on that. For the time being, though, it’s better to own stocks than avoid them.

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