Some former bears salivate in aftermath of market tumble

Huge sell-off has brought stocks down to bargain levels, they say

Oct 26, 2008 @ 12:01 am

By Dan Jamieson

Some longtime bearish market gurus have turned bullish. While the public remains panicked and some financial advisers have moved more assets into cash, several market watchers who have been warning about a severe decline now say that the violent sell-off this month has created valuations low enough to produce solid equity returns. "After the October declines, stocks are at a fairly attractive level," said Ed Easterling, president of Crestmont Holdings LLC, a Dallas-based investment firm that manages and advises hedge fund portfolios. Mr. Easterling, an author who also studies market cycles, is in the same camp as other longtime pessimists who think the market is probably in a long-term bear market phase.
But "now is not a good time to sell, and for those who are still in the accumulation phase, it's a good time [to be investing]," he said. "Stocks are now undervalued," John Hussman, portfolio manager of the Hussman Strategic Growth Fund and the Hussman Strategic Total Return Fund, wrote in an update on his website last week. He is also chairman of Hussman Econometrics Advisors Inc. of Ellicott City, Md., the adviser to the Hussman funds. "I realize how unusual that might sound given my persistent assertions during the past decade that stocks were strenuously overvalued," Mr. Hussman wrote. But the 40% market drop since the peak last fall "completely changes the game," he wrote. With a peak-earnings multiple of about 11, the Standard & Poor's 500 stock index has room for some upside, Mr. Hussman wrote. The average valuation has been about 14. Investors can "comfortably expect 8% to 10% total returns" over the next 10 years, even without a material increase in price-earnings multiples, Mr. Hussman wrote. As of Oct. 22, Mr. Easterling's own measure of the S&P 500 index's multiple was 14.7, using adjusted earnings based on economic-growth assumptions. With continued low inflation, he said, the market can sport a P/E in the low 20s. Based on a five-year normalized earnings projection, the anticipated five-year annual compounded return on the S&P 500 could come out to about 13%. Likewise, some previously cautious advisers are also feeling more positive about the market.

"To get [multiples] this low when inflation is this low is truly an anomaly," said David Waddell, chief executive of Waddell & Associates Inc. of Memphis, Tenn., which manages about $500 million.

Since last fall, he has been bearish. Mr. Waddell lowered clients' exposure and hedged with gold.

"We've got our hedges off now," he said.

"Finally, I'm semi-bullish, simply because prices are lower now," said Lou Stanasolovich, chief executive and president of Pittsburgh-based Legend Financial Advisors Inc., which manages $340 million for clients.

He had been using commodity exposure and exchange traded funds that short the market for client accounts, but he has since sold the ETFs.

"We should have a better opportunity for appreciation coming out of this downturn than we did in the last downturn," which ended in 2002, Mr. Stanasolovich said.

The market bottom in 2002 was not low enough to get rid of the overvaluation from the 1990s bubble, he added.

Citing analysis by Mr. Hussman and The Leuthold Group LLC of Minneapolis, Mr. Stanasolovich said that the market's current valuation implies returns in the "low single digits to low-double-digit area for the next 10 years."

"That's not real exciting but much, much better than 2002," Mr. Stanasolovich said.


Although the market may be cheap, newly minted bulls warn that it could still fall further.

"One would generally expect that a decline of the magnitude we've observed would be followed several months later by a secondary decline," Mr. Hussman wrote last week.

A serious bout of inflation or deflation, though, could cause investors even more pain.

Market multiples fall under either scenario, Mr. Easterling said. With bad economic conditions that reduce price stability and shrink multiples, secular bear markets typically end with a P/E of about 10.

So with bad economic conditions and price instability, Mr. Easterling figures that the S&P 500 could drop another 30% or more to about 600, which would take its multiple down to 10 times earnings, from its current level of 16.

The secular-bear period that ended in 1981 finished with a market multiple of 7, according to Crestmont.

Nevertheless, Mr. Easterling is generally positive.

The expected recession won't throw a wrench into the works, he said.

"Recessions are natural events. We get one about every 10 years, and we were due for one," Mr. Easterling said.

"Under the vast majority of economic outcomes," including a severe slowdown short of an outright depression, stocks are still attractively priced, he said.

Mr. Waddell, in surveying all the negative headlines along with the market crash, doesn't see too much more that could go wrong.

"The economic picture and the earnings picture may not be fundamentally great, but it's probably better than expectations," he said.

"The reality is that [the economy] doesn't have to be that good," Mr. Waddell added. "As long as you clear the expectation bar," the market can go higher, he said.

E-mail Dan Jamieson at


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