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How Much Longer Can This Bear Market Rally Last?


Markets tend to reach exhaustion on good news, not bad.

How long, O Lord, how long? It's always good to remember that the stock market is not the economy. Every day I come into the office to find literally dozens of emails complaining that the market is ignoring the relentlessly bearish news flow. But that doesn't bother me. What will bother me is when we start getting good news. Markets tend to reach exhaustion on good news, not bad. And these days it's hard to discern between what's merely bad and what's actually disastrous. So, let's take a look at what the difference between the two really is, and what it means going forward.

A recently released Societe Generale report outlined a "Worst-Case Debt Scenario," one which they believe is a very low probability. Their central scenario assumes a slow global recovery, with private debt being transferred to governments. Fair enough. We're well on our way there.

Comparing US and Japan, albeit from SocGen's more sanguine standpoint, there's some reason to believe the US could feasibly accommodate a Japan-esque 200% of GDP debt burden, which would essentially double 2010's projected 100% of GDP debt burden. The reason this might not collapse the dollar is because there are no attractive alternatives. Government debt is a global problem, and when you look at the US government debt on a comparative basis, the figures, while high, aren't extraordinary -- at least within that context. More on this momentarily.

As a brief digression, I don't believe that all government debt is bad by definition. Some are dogmatic on that point. While I do find a framework for understanding economics through the Austrian school, the reality is that no one is going to be able to squeeze pure, free-market toothpaste back into the tube. In fact, Ron Paul's quixotic quest to end the Federal Reserve could actually succeed... only I can promise you it would soon be replaced by a similar central bank mechanism with a different name, slightly altered agenda, and new cast members. In other words, more of the same; let's be realistic.

Also, remember that governments worldwide have a long history of supporting failed industries only to turn around and re-privatize them at a later date. It's the government version of the private-equity game (buy 'em, repackage 'em, sell 'em, repeat), only the coffers are ours and the beneficiaries aren't us. But the US didn't invent this shell game, and it's naive to think that it won't continue for as long as people wake up in the morning coveting their neighbor's greener grass.

But back to the report. One thing I find disturbing in the SocGen report, which I believe is a point of view fairly representative of the consensus in global finance, is this nugget, frequently cited as a key element of global crisis causality: "A massive increase in defaults by sub-prime households led to a global decrease in house prices and therefore bank collateral, prompting a deterioration in bank balance sheets and a necessary deleveraging by these institutions to contain the damage."

That assertion is troubling. In fact, I'd say it's false. This version of crisis causality is like a doctor saying that "your cancer was caused by cancerous cells." There's absolutely no information in that statement. It's attributing a symptom to a symptom. If that's the viewpoint of policymakers -- and I believe it is -- then the real risk is that a government debt bubble that reflects the private debt bubble, and which will be proportionately many times larger, is being triggered.

Where this meets public policy and social mood is at the point where it becomes apparent that purposeful inflationary policies are being pursued even though these policies will severely punish savers (read: risk-averse baby boomers heading into retirement years, with high savings incentives after a decade of lost or stagnant stock-market returns) and consumers with high debt burdens and painful debt servicing costs.

As someone who's a natural contrarian and who has a natural bent toward the bearish case, one thing I'm conscious of is that it's always easier to make a successful bearish case versus an optimistic bullish case because optimism, by definition, requires a belief in unseeable occurrences that will somehow "work out."

There's some evidence, but it requires far more belief, that innovation could be a path out of high government debt. Innovation in alternative-energy sector, for example, could unlock revenue streams for government that make it possible to reverse course over the next decade and re-privatize industries that are now being supported. That's one example.

What prevented a lockup last year was the ability of governments to lever up. But it could take a decade or more for this next bubble to fully inflate, and in the meantime, we'll likely see the ping pong back and forth between deleveraging on the private side and increased leverage on the government side within a choppy and superficial bull market in nominal asset prices.

The long-term bearish scenario is that we don't find a way to deleverage based on innovation or some unseeable future, and instead, reach the point where a global systemic failure occurs. But the point I want to make is that this is unlikely to be this decade's business.

Even when considering the possibility that a government attempt to lever up and reflate fails, and factoring in a truly "worst-case" scenario into DeMark studies, I simply cannot make a case for the S&P 500 to be much below 600 or so, and certainly not much below that level for very long.

For perspective, keep in mind that from present levels, a decline to the 800 would be quite frightening; that despite the fact that since we first crossed the 800 level in 1997 -- 12 years ago -- we have, over that span, spent less than four months below it.

Again, that's a pretty good sideways bear market over the past 10 years with little net gain, but many tremendous sell-offs and rallies. Some of the more extreme collapse scenarios forecast stocks to decline to around 40 or so on the S&P 500 -- there's no zero missing... 40. If that happens, then the level of the S&P 500 at that point will be the least of anyone's concerns.

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