The Long Road to Nowhere

With markets stuck in the mud of late, investors are wondering what's next. Well, the answer may lie in the Zen saying: "This is it. Nothing happens next." After a love-hate relationship, the dominant emotion of investors toward stocks is likely to be one of indifference. Expect major global indices to remain anchored more or less where they are now, because emotions and stock prices are sufficiently depressed to form some sort of a bottom, while deteriorating economic and earnings growth put a lid on any meaningful rally.

Past bear-market regimes have often witnessed a period of high volatility giving way to one in which stock prices remain anchored within a broad range. The evidence that markets have established a current bottom is that, at its low in mid-November, the U.S. market had more than given up the entire gains of the 2003–07 bull run. The last time such a reversal happened was in the 1973-74 bear market and then also during the Great Depression: the U.S. stock market fell 89 percent on a peak-to-trough basis from 1929 to 1932, wiping out 110 percent of the 1921–29 rally. That's a lot steeper than the current 52 percent decline in the U.S. market, but the run-up this time was also less dramatic than in the 1920s. Futhermore, as was the case with previous bear market lows, today more than half of U.S. stocks are trading on a price-to-earnings—or PE—ratio in the single digits.

While it's hard to call an exact bottom, the benchmark S&P index does seem to have strong support in the 700–800 area. Those levels are also consistent with past bear-market troughs. Also, numerous lifelines thrown by policymakers will likely succeed in at least arresting the panic, eventually providing support to the markets. Indeed, the credit markets are showing some signs of thawing.

The good news unfortunately ends there. The fundamental big picture then comes into play. U.S. policymakers may succeed in preventing a Great Depression redux, but they cannot engineer a new growth cycle. There is a certain inevitability about what follows a debt binge with total credit as a share of the economy at a record 350 percent in the United States. The United States is probably going down the Japan way, where economic pain was amortized over time, but meaningful economic growth is yet to return.

The implication of the Japanese parallel for markets is that the S&P index treads water too, oscillating between a wide trading band just as the Nikkei did in the 1990s. So if the bottom of the trading range is somewhere in the 700–800 area, what's the top? A very firm long-term cap is most likely 1200—the level that prevailed before the world changed in mid-September when Lehman Brothers went bankrupt. That episode marked the definitive end of the 2003–07 credit bubble and the hard reality is that the world is not going back to the pre-Lehman days. In technical terms too, support levels from a bull-market era often end up being resistance points in the ensuing bear market.

The emerging markets will obviously take their cue from the U.S. trading pattern. That would involve the benchmark MSCI Emerging Markets Index swinging between a low of 450 on Oct. 24 this year and again on Nov. 20, and the late-September readings of 650–700.