May 11, 2009 @ 02:33 pm
The Great Reflation has begun.
All of the massive fiscal and monetary stimuli start to hit the markets. They're starting to hit the economy too, although to a much lesser extent. And the bulls are off and running. It's the Great Reflation.
During times like these, investors who are willing to set aside rising unemployment, problematic bank balance sheets, mortgage problems, unintended consequences of government regulation, etc. and take what the market gives them will do exceptionally well for the next few months – possibly through the end of the year.
We're not the only ones seeing it though. One of the world's greatest investors is on board too.
In the next few moments we'll go through it all. We'll look into why the market still hasn't run too far too fast. We'll look into how the market could climb another 30% from here. Most importantly though, we'll try to identify the early warning signs to watch for to ensure we get out in time because, like all bear market rallies in the past, it will come to an end. And the end will come when everyone least expects it – which is likely a long ways off.
S&P 500 to Climb Another 30%!?!
Over the past few weeks we've focused on the different stages of bear market rallies, investor psychology, and how it will all play out over the next few months. After all, psychology is what is really driving the markets recently. Now, one of the world's most successful and reasoned investors agrees.
Earlier this week Jeremy Grantham released his quarterly letter to shareholders (a must read for any investor: follow this link to access it). Grantham, whose name should be familiar to Prosperity Dispatch readers, manages $85 billion at Grantham, Mayo, Van Otterloo. He is one of the most devout students of stock market history. More importantly, he is one of the best at applying the lessons of history to portfolio management.
In short, Grantham is someone worth listening too. So a few days ago when he proposed the S&P 500 would continue its climb, it's definitely worth delving into why.
To start at the beginning, Grantham wrote:
“My guess is that the S&P 500 is quite likely to run for a while, way beyond fair value (880 on our revised data), to the 1000-1100 level or so before the end of the year.”
Is he basing this on a full blown economic recovery – the rare “V-shaped” recovery? Will the catalyst be a surge in profits and cash flows for companies increasing the fair value of their shares? Or will it be strong growth from emerging markets leading us out of this?
Well, he's not betting on any of them. He's merely expecting history to rhyme.
The Greatest Stock Market Rally Ever
In his rationale for an extended rally he details what happened during the bear market of the 1930's. The part which really stands out is one of the greatest bear market rallies in history. The rally was quick, strong, and unexpected.
Grantham stated:
In June 1932 market players saw illusory light at the end of the tunnel. In two months, the market rose almost vertically, climbing 110%!
For four more months it held the gain and then, confronted with continued unrelieved bad news, sank steadily for six months so that one year after the rally began it was up only 35%.
But this is the key: by then – a year later – there really was light at the end of the tunnel and the market rose again, 130% in eight months. And this time it did not give it back.
Think about that for a second. The market climbed 110% in two months. It makes what happened in the past two months look like nothing. The important part of that rally though, just like this one, is that it was fueled by expectations of a sharp and quick economic recovery.
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