How (and Why) to Be a Bull Now

Last week, Tim Melvin asked how anyone can be a bull, and didn't want to hear about technicals or "oil for the lamps of China" answers. Here is a two-step plan for feeling more bullish:

1. Don't anchor on the March low -- float with risk premiums. The proximate cause of last week's breakout was Fed chief Ben Bernanke's public assertion that he has an exit strategy and still has room to be "accommodative ... for an extended period." Bernanke is telling us that he intends to keep the punch bowl out and drive down the price of risk. This makes stocks relatively attractive as an asset class, because low risk premiums make for high P/Es.

The most credible bear out there (beside our more nuanced Doug Kass) is David Rosenberg, but I was disappointed last week when he offered a version of the "quite a run" thesis as his bearish argument. He pointed out that a 15% surge in the S&P 500 typically implies large GDP growth in the following quarters. He argued that, based on the history of big index moves, the market is now pricing in 5.5% GDP growth. We aren't going to get that kind of growth, so therefore, the market is overextended.

But Mr. Rosenberg didn't seem to account for the sharp drop in prices (increase in risk premiums) that preceded the rally, or the reduction in risk premiums that has accompanied the rally. The change in the price of risk is more important to stock prices than how far we have moved from some arbitrary low.

2. Don't be bullish on the index, be bullish on a playbook. I am not targeting a specific number for the index, instead I'm bullish on the relative outperformance of some sectors. Jim Cramer did me an immeasurable service over the years by using these pages to talk about the playbook, because while I am a stock-picker, half of your gains usually come from being in the right sector. I'd love to hear more about what playbook other contributors are using to guide their current stock exposure to various sectors. Here is what I consider to be the classic playbook:

Cycles -- Economic vs. Stock Market
chart
Source: S&P (from 2000)

While it is going to be a muted recovery, we are headed toward a trough in the economic cycle, and the playbook says you want to be overweight transportation and financials. It also says that it is too late to buy consumer cyclicals, and I am underweight/short them.

While in my first point above I am arguing that the "P" in the P/E ratio can go higher as risk premiums are reduced, we still need the "E" to come through. But with financials that trade below a 10 P/E, I don't have to hope for too many miracles from earnings.


Know what you own: Haefele mentions financials. Companies in the industry include Citigroup (C), Wells Fargo (WFC), Bank of America (BAC), Goldman Sachs (GS), Morgan Stanley (MS), JPMorgan (JPM) and U.S. Bancorp (USB).

Mark Haefele serves as co-manager for a Boston-based hedge fund. Haefele focuses on using bottom-up research to locate misvalued stocks and build a long-short equity portfolio. He holds a bachelor's degree from Princeton University; a master's degree from the Australian National University, where he was a Fulbright scholar; and master's and Ph.D. degrees from Harvard University.

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