Markets

Michael P. Regan is a Bloomberg Gadfly columnist covering equities and financial services. He has covered stocks for Bloomberg News as a columnist and editor since 2007. He previously worked for the Associated Press.

The pessimism is piling up fast.

Some of the headlines circulating on Monday included the chief investment officer who oversees $240 billion at Guggenheim Partners warning that the Nasdaq Composite Index could slide an additional 13 percent. Another article describes how seven of the 21 Wall Street strategists tracked by Bloomberg have already lowered their year-end forecasts for the S&P 500, reducing the average estimate for the first time this early in a year since 2003.

It may be tempting to look at all this negativity and take the contrarian stance, concluding that so much pessimism abounds that the market action can't get much uglier. That could very well prove to be a smart move, but there's also a good case to be made to pull a double contrarian and land right back into the realm of the pessimists.

For investors who have maintained a list of positives and negatives throughout the last few years, the negative column has been pretty well populated all along: Europe's debt crisis, the end of quantitative easing and record low interest rates, various geopolitical flash points. The problem is the positive column, which contains the ropes and pulleys and carabiners needed to climb that wall of worry, is looking a little thin.

Whether the overall economy avoids contraction, it's clear that the recession in corporate profits could very well linger through the first half of the year. Analysts in aggregate are calling for a 6.3 percent drop in S&P 500 earnings in the current quarter and a 1 percent decline in the second quarter, with only a slim 2 percent increase expected excluding energy companies in the second quarter, according to estimates compiled by Bloomberg.

Valuations have come down, but with the S&P 500 at 15 times forecast adjusted earnings for the next 12 months, they're not at no-brainer-buy levels yet, especially if those profit estimates continue to trend lower.

Perhaps what's most conspicuously absent from the positive column are the high-flying stocks from last year. Amazon.com and Netflix are both down about 28 percent in 2016 after more than doubling last year. Alphabet is off 11 percent and Facebook is down almost 5 percent.

Low Fliers
High-flying stocks from last year have been largely grounded.
Source: Bloomberg

What the market is experiencing, according to JPMorgan Chase's sagacious strategist Marko Kolanovic, is the popping of a "macro momentum bubble" that is being accompanied by, and will continue to be accompanied by, a changing tide that will lift value stocks in contrast to recent history. In recent years, as he put it, "the most successful managers would be those that replace fundamental valuation with a simple rule: buy what went up yesterday and sell what went down … It is hard to imagine this makes economic sense long term, but it is close to what equity markets experienced over the past several years." 

Another missing component from the positives column is simply the energy and vibrancy of youth. Even though the S&P 500 hasn't set a new record in almost nine months and is down about 13 percent from its last peak in May, this is still technically a bull market until the drop extends to 20 percent and the bear label is slapped on it. The bull will celebrate its seventh birthday in March, if the bear doesn't crash the party by then.

Ragin', Agin' Bull
The number of days the S&P 500 moves at least 1 percent increases as bull markets age.
Source: Sam Stovall, S&P
Counts bull markets since 1945

And bull markets are like humans, S&P's Sam Stovall pointed out on Monday. In other words, they can get a little cranky and unstable as they age. In the seventh year of bull markets since 1945, the S&P 500 recorded an average of 55 days with moves of more than 1 percent on a closing basis, Stovall wrote in a note, up from 43 in the sixth year. The number of 1 percent or bigger moves jumps to 85 days in the eighth year and 95 days in the ninth year. Not to mention, the beginning of a Fed tightening cycle has doubled the number of days with moves of 1 percent or more, he added.

At this point, the S&P 500 is closer to notching a 20 percent decline than it is to setting another record. It's time to at least come to terms with the notion of a possible bear market. This may be more alarming than it needs to be because of recent memory. The last two bears -- during the financial crisis and the dot-com bubble -- were both epic, with the first 20 percent drop only the start of the pain.

With any luck, this could be what Doug Ramsey of Leuthold Weeden Capital Management and others have described as a "garden variety" bear market, where the drop may only be something like 20 percent to 25 percent.   

In a sea of pessimism, that's about as much optimism as we can muster.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Michael P. Regan in New York at mregan12@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net