A Test of Wills on Wall Street

Is the October rally strictly for suckers, or will it last? Former bear Barton Biggs is among the pros who now say it's time to invest

By Gene Marcial

The big tug-of-war between the bulls and the bears still centers on the duration of the current stock market rally: Will the recent advance of stock prices flame out sometime soon, or will it be a long-lasting upside parade? Or worse for the bears, is it the start of a new bull market?

Wall Street has no shortage of doomsayers who see the October runup as a sucker's rally -- and the downward moves of the major indexes on Oct. 29 in reaction to a collapse in the latest consumer confidence readings gives them more ammo. But to the bulls, that's a positive signal. They argue that such forebodings will only keep more money on the sidelines which, at some point, will have to join what they expect will be lengthy upswing.

A number of investment managers, including global money pros who provide equity strategy for major institutional investors worldwide, have turned bullish. At the same time, though, some bears have become even more negative. They argue that the market's advance in the past few weeks has made it overvalued.


  "Time is running out for the bulls," says Mark Lebovit, who provides market-timing advice at Flkexible Plan Investments and through an online newsletter via VRTrader.com. But he concedes that more technical confirmation besides overbought conditions is needed to forecast the timing and severity of the market's next down leg.

Among the bulls is Abhijit Chakraborti, who heads the Global Equity Strategy team of J.P. Morgan in London. "We remain positive on equities relative to bonds," he says, citing the significant rise of stocks vs. U.S. Treasury yields since Oct. 9. He concedes that the equities runup has eroded some of the previous favorable valuation of stocks relative to bonds. But "we believe equities will further outperform over the next six months," argues Chakraborti.

Within that time period, he says, "we expect global equities to rise a further 10%, and Treasury yields to continue to back up to about 4.5% in the second quarter of next year." This rally, says Chakraborti, "has all the characteristics of a growth rally, with bonds selling off significantly and cyclicals leading equity performance."


  Also bullish about the October rally is Morgan Stanley's Barton Biggs, a widely followed macro-market strategist and a one-time unrelenting bear. In a recent missive to clients on global strategy, Biggs said this rally will carry further and last longer than most expect -- "provided that the U.S. economy perks up, as I think it will."

How far can the rally go? Biggs thinks the S&P 500-stock index could reach 1050 or even 1100. And he believes that other markets around the world will follow. Advises Biggs: "This is a rally that, as a professional investor, you can't afford to miss." But it's also a rally, he says, that you'll probably have to sell at some point.

Indeed, Biggs doesn't think that this is the beginning of a bull market. Why? Equities aren't undervalued enough, he says, and earnings growth over the next five years is unlikely to be strong enough to support substantial appreciation from these levels. Too many bubbles still have to burst, he thinks, adding that there's too much excess capacity of everything, from labor to network routers, and too many imbalances in the world ecnomy.


  Moreover, "terrorism is a menace to growth," he says. So Biggs expects a period of three to five years of "relatively slow growth almost everywhere around the world."

But here are some reasons why Biggs believes the current rally "will carry further and last longer":

Sentiment is still incredibly depressed, as gleaned from the "unmitigated gloom and doom" reports in the media, namely in recent issues of BusinessWeek, Fortune, and Barron's. The public continues to redeem equity mutual funds at a high rate, he notes. "And the strategists who visit us are still uniformly negative. And the TV business-media talking heads are skeptical about the rally. All good signs!"

Another positive: The early October bottom had most of the technical characteristics of an important low. And third, the U.S. economy, after stalling in the first and second quarters, "could be on the brink of a period of better growth," says Biggs. The bears, he notes, are convinced that recession and deflation are at the economy's doorstep.


  The dollar's decline, Biggs believes, will help U.S. growth by making exports more competitive and imports pricier. And if the market's rally continues, it would be a big boon to the economy, helping to restore the badly battered confidence of both consumers and businesses. Biggs says as the economy recovers, low inventories will be rebuilt and profits will rise, especially because they've been so depressed and costs have been aggressively reduced.

Where to invest in such a scenario? Biggs thinks investors should concentrate on banks, financial services, insurance, retailing, technology, media, and industrial materials. On the other hand, investors should cut back on the defensive groups, particularly consumer staples, as well as energy.

With the Dow Jones industrial average trading at midday on Oct. 29 around 8,240 and the S&P 500 at 871, the bears can claim that the market is showing some "toppiness," as Andrew Addison of Addison Investment noted on Monday, Oct. 28. The S&P 500 hit an intraday high of 907 on Monday, Oct. 28, and the Dow climbed to an intraday high of 8,558 on Oct. 24.

But the bulls point out that the indexes are up considerably from their lows when this rally started: The Dow landed at 7197 on Oct. 10, the same day the S&P 500 sank to its low of 768. So they think the indexes are now pausing for a well-deserved rest. Clearly, the bull-and-bear tug of war has no winner yet.

Marcial is BusinessWeek's Inside Wall Street columnist

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