Comstock Partners, Inc.August 11, 2011
Lengthy Bullet Points on our Bear Case Regardless of Interim Rallys
1. Eleven years ago we experienced the strongest secular bull market in U.S. history covering the period from 1982 to 2000 (interrupted only by the 1987 crash). This secular bull market ended with the most outrageous valuations in history. In fact, the P/E and px to cash flow and every other metric you wish to use were more than double the prior peaks over the past 100 years. The NASDAQ valuations metrics were off the charts and NASDAQ hasn't come close to this high since. All this was accompanied by extreme debt increases over the prior 20 years. This was clearly (in our humble opinion) the start of the present secular bear market which should surpass the secular bear from 1966 to 1982 by a large margin. And in fact, the market did decline sharply for the next 3 years. However, the politicians and the Fed could not handle the pain that it would take to wipe out the overvaluations and excess debt that took place during the bull market. Instead, the Fed lowered the Fed Funds rate from 6.25% to 1% and kept it there for and extended period causing a second bout of "irrational exuberance" revolving around a housing bubble and a secondary stock market bubble from 2003 to 2007.
2. Wall Street and Washington wanted to push everyone possible into a home even if they were not close to being able to afford one. Washington worked with banking institutions to get them in homes they couldn't afford and then Wall Street packaged these loans, got AAA ratings and sold them to their clients. We discussed the insanity of these processes for the entire period and felt confident that when this bubble finally burst it would be extremely painful.
3. Although many on Wall Street believe the market is currently undervalued we disagree. The market expected the S&P 500 to earn $108 in early May of 2008 but due to the bursting of the bubble the earnings came in at $50 for operating earnings (excludes write-offs) and $15 for reported earnings (GAAP). The analysts that are using $100 this year and more next year for the S&P 500 and a P/E of 15 to magically come up with 1500 on the index are guilty of faulty reasoning. We believe we will trade at below 10 times depressed earnings which should take us down to the lows of 2009 or below. It is clear to us that there will have to be a global slowdown in the second half of this year and next. The reasoning for the slowdown is again the debt, but not just the sovereign debt, the private debt is even worse than the public debt. The total debt in this country is over $52 trillion and the public debt is around $9 trillion ($14.5 trillion if you count the debt used in funds that were raided by the government like Social Security).
4. The Household Debt (H/H) is by far the most extreme and will be the debt that will be the cause of the "double dip" in our opinion. The H/H debt was almost always about 50% of GDP and 65% of Personal Disposable Income (PDI) but started rising during the past 20 years as the consumers went on a spending binge where they bought everything they could on credit (especially homes) and even used their homes as an ATM machine. This took the debt from about $5-$6 trillion to $14.5 trillion at the peak in 2008. They are now cutting back and saving more and the debt has shrunk to about $13.5 trillion. We expect this debt to decline below $10 trillion (possibly $8 trillion) and will drive the U.S. into a "double dip" and affect the global economy as well, since the U.S. is three times the size of every other country-- and consumption is 70% of our economy. The latest revisions downward in the GDP for the first half of 2011 confirm our long held belief in the "double dip."
5. The "Tea Party" could have been good for the country, if they were elected before the consumption binge and outrageous spending by the government took place. However, now we are prisoners to all the debt accumulated during the past 20 years (especially the last 10 years) as we entered two wars without paying for them and promised the elderly much more than we could deliver. Cutting spending now that we are being strangled to death by the debt is a formula for disaster-since, if we don't generate growth now the deficits will explode.
6. Believe it or not, Europe is in worse shape economically than the U.S., and since we sell close to one quarter or our exports to Europe, the contagion over there only makes the U.S. debt situation worse. And with Japan's demographics, which are much worse than the U.S. ( a much more aging population), they are not any better. China will also have a very difficult time engineering a soft landing after an incredible planned economic expansion based almost completely on construction of homes and office buildings.