Bears: Exit Stage Left

Today's über-bears are making the same mistake in reverse. They may be right about the challenges the world economy is facing—shaky banks, weak consumption, deleveraging, the flu pandemic, etc.—but they are paying insufficient attention to the prices that companies are trading at in the stock market. That is why they missed the sharp recovery of the past few months and are now desperate to label it a bear-market rally.

Since March, when the growling of the bears was loudest, the S&P index of Asia's 50 largest stocks has risen by 45 percent, and the Dow Jones Asian small-cap index by 57 percent. The move is much more intense than in the spring of 2003, when the last bear market bottomed.

Another bubble? Hardly. In the first quarter of this year, the entire Japanese stock market was trading below its book value, and the Korean, Taiwanese, and Thai markets were not far behind. In all four countries, the market index expressed in dollars was back at 1980s levels.

Even at the peak in 2007, global stock markets were not in bubble territory, meaning at absurdly high valuations, with the exception of China and a handful of emerging markets. There was indeed a financial bubble, but it was restricted to credit and the areas that feed off it, such as real estate and private equity. By contrast, stock markets had already been in a bear phase—if we define a bear phase as a period when stock prices fall relative to earnings—since the turn of the century. The credit crisis, in particular the astonishing policy blunders surrounding the unmanaged collapse of Lehman Brothers, accelerated the process dramatically.

At the start of this year in many countries, stock markets were trading at the lowest levels in a generation. In several European and Asian markets, stock dividend yields had fallen well below government bond yields; effectively, investors were pricing in a long deflationary slump. Common sense suggests that such an outcome would be tremendously destabilizing to our societies. Political leaders everywhere, once aware of the risks, will stop at nothing to avert it. In an era when central banks are using every trick in the book to get money flowing again, deficits are ballooning, and bailouts have become routine, it is government bonds, not corporate stocks, that seem out of kilter with reality.

So what next? According to another great investor, Sir John Templeton, bull markets are born in despair, grow amid skepticism, mature in optimism, and die amid euphoria. Nobody can blame the über-bears for enjoying their moment in the sun; they've earned it fair and square. And if in doing so they set the stage for the birth of the next bull market, we'll have something else to thank them for.

Tasker is an analyst at Arcus Research in Tokyo.

© 2009