New bear market, or just a correction?
After a hellish couple of weeks, some perspective on the recent stock market decline.
It's been a tough couple of weeks for stocks. From its April high, the S&P 500 lost more than 13.4% as it dropped into Friday's low. The index also sliced through its 200-day moving average -- which is seen as the demarcation line between bull and bear markets.
So, was that it? Will the European debt crisis, financial regulatory reform, and the oil slicked Gulf of Mexico all combine in some king of unholy alliance to detail the global economic recovery and send stocks careening into the abyss?
It's tempting to get caught up in the excitement and emotion of the dramatic stock market selloff we've just witnessed. And it's easy to throw your hands up and declare the end of the bull market that started last March. But has all the recent volatility really marked the birth of a new bear cycle for stocks? I don't think so. And here's why.
Although the price action has certainly been weak, with the broad market indices taking out important moving averages, long-term breadth, earnings, global economic growth, and interest rates all suggest that higher highs are ahead for stocks. Also, there is historical precedent for a correction of this magnitude coming within the context of a long-term bull market.
According to the team at Lowry Research, there has been six bull market corrections of 10% or more since 1960. The average decline was just over 12%. Given that the rally out of the March '09 low was stronger than normal, a big scary decline was needed to clear out excessive speculation.
There are also good fundamental reasons to stay confident. In a note to clients this morning, UBS strategist Larry Hatheway listed four reasons why the current slump isn't likely to mark the initiation of a new bear market.
The first is global growth, which continues to strengthen. The ISM Manufacturing Index, which reflects the strength of the industrial production in America's factories, has yet to peak thanks to strong exports, capital investment by businesses, and inventory restocking.
And there are few signs that the European debt problems will kill the recovery by jacking up credit costs or undermining consumer and business confidence. Interbank lending rates remain very low, for instance. While this could change, for now there is no sign of trouble.
Second, corporate earnings are still benefiting from operating leverage as revenue growth supports very large jumps in earnings -- which continue to be underestimated by analysts. This will help support corporate credits and prevent European debt contagion from infecting the bond market.
Third, central banks are likely to keep rates low. Inflation just moved to a 44-year low thanks to tons of spare capacity -- both in terms of extra available workers and idled factories.
And given the fragility of the situation, the European Central Bank (one of the most hawkish) will likely keep policy rates low for a while. UBS doesn't expect the first rate hike in Europe until 2011. This will provide cover for the Fed, the Bank of England, and the Bank of Japan to keep rates near zero.
And finally, valuations are very attractive. The S&P 500 is only trading at 10.7 times UBS' $100 2011 earnings per share forecast -- which is more than 28% below the long term average price-to-earnings multiple of 15x.
Remember that the 2003 to 2007 bull market featured multiple excursions below the 200-day moving average for the S&P 500 -- and each was a buying opportunity. Given the evidence, I think the same playbook applies. This is a bull market. And dips are supposed to be bought.
Copyright © 2014 Microsoft. All rights reserved.
The apparel chain takes a hard hit after blaming the weather for its quarterly sales decline. But cold temperatures don't explain the drop in full-year sales as well.
VIDEO ON MSN MONEY
Top Stocks provides analysis about the most noteworthy stocks in the market each day, combining some of the best content from around the MSN Money site and the rest of the Web.
Contributors include professional investors and journalists affiliated with MSN Money.
Follow us on Twitter @topstocksmsn.