Louise Yamada: 2000s Uncanny Resemblance to 1930s; David Rosenberg: Worst to First Unsustainable

When last we checked in with technical analyst supreme Louise Yamada, we were 4 weeks into a monstrous bounce... she was cautious [Apr 9, 2009: Did this Rally Turn Louise Yamada Into a Bull?] and not changing her tune. It's been 6 weeks, and thousands of green shoots later and we've only suffered one serious weekly setback. Barron's has a piece with her latest thoughts. If you are not familiar with her, in November 2008 [Nov 21, 2008: Fear Louise Yamada] she suggested S&P 600 (with downside to 400). We were at S&P 800 at the time, and the index fell to 750 in the days to come, before rallying for about 7 weeks on Obama / Geithner green shoots... to S&P 950. Then proceeded to crash to S&P 666. She did not back off from those calls when we last looked in early March [Mar 2, 2009: Louise Yamada - Sheeeee's Back]

The latest...

• So, why the attraction of green shoots? One can only speculate that they must be in some ways intoxicating. Perhaps not the shoots exactly, or the stems or seeds, but the leaves of a certain plant. Those might be smoked or otherwise ingested to bring about a euphoric effect. From what I've read, the current crop is far more potent than the commodity available in years past. How else to explain the mind-bending notion that an economy that is declining less quickly is somehow improving?
• Market historians have been pointing to 1938 as an antecedent for this year's action, as Mike Santoli has noted in his Streetwise column. So, too, has Louise Yamada, the doyenne of technical analysts, who now counsels clients via her LY Advisors after her long career at Smith Barney.
• "It is almost uncanny the degree to which 2002-08 has tracked 1932-38," Yamada writes in her latest note to clients. She has posited in her so-called Alternate Hypothesis that the structural bear market would be less like its most recent predecessor, from 1966-82, and more like 1929-42.
• So the dot-com collapse parallels the Great Crash and its aftermath, followed by a rather nice recovery in 2003-07, similar to 1933-37. The parallels continue, with the collapse from late last year into this March tracing a similar, sickening trajectory to late 1937-38, as illustrated in Louise's chart nearby. That drop led to a strong reaction rally, not unlike the current one, for a total gain of 60%. But that was broken into three segments: an initial rally of 46%, similar to the move from the March lows. Then we saw a 10% pullback, not unusual in a rally, then another gain of 22%.

I do believe history rhymes if not repeats... but frankly if we pulled back 10% and then reversed and gained 20%ish from there... that would be quite amazing.

• From there comes the hard part. Starting in November 1938, there was a 22% drop, qualifying for the 20% rule-of-thumb definition of a bear market; then a rally of 26%, fitting the definition of a bull market, into the fateful month of September 1939, the start of World War II.
• Then came a series of bull and bear trades -- down 28%, up 23%, down 16%, up 13%, and the final decline into 1942 of 29%. After this nauseating roller-coaster ride, the market was down 41% from the 1938 highs (analogous to where we are now) to the 1942 lows.

I do believe we will trade in a quite large range, and as we entered 2009 I stated as much... the ping pong between hope and reality. We've already has a multitude of "technical" bull and bear markets (mindlessly set as a +/- 20% move) just in the past 18 months.

• The positive aspect of this, writes Yamada, is that the arduous process permitted individual stock consolidations to develop over years ultimately provided the base for a bull market in 1942.
• But, she emphasizes, that means investors probably face years of frustration if they think a new, sustained bull market has begun. Structural bear markets typically last 13 to 16 years. Given the declines that have been suffered so far -- topped only by 1929-32 -- the structural bear has several years to go to complete the repair process.

So if this indeed somehow play out in parallel we are in 1938 and the next bull begins 2013. That would fit into the 1938 = now, and 1942 = 2013. And would put us in the front end of the 13-16 year bear market theory. Probably works well with what some of the Elliott Wave guys forecast but I don't know enough about that art to comment. [Robert Prechter of Elliott Still Extremely Bearish] Now with that said, there are so few statistical comparisons to this type of era, that it takes some leaps of faith ...

• As for the current rebound, it is rather like a bungee jump, with an elastic snap-back after a terrifying plunge. And it has been a kind of worst-to-first move. David Rosenberg, ensconced at Gluskin Sheff in Toronto after years of distinguished duty as Merrill Lynch's North American chief economist, observes that the best performers have been the lowest-quality stocks or those with biggest short interest. "In other words, this was a rally built largely on short-covering, pension-fund rebalancing and the emergence of hope wrapped up in 'green shoot' data points," he contends. That makes its sustainability in doubt.

Boy, we've lived and breathed that... shorting "worst" has been a painful experience for the past 10 weeks.

• WHAT IS LIKELY TO DISAPPOINT THE BULLS is the pace of recovery in corporate profits, according to the perspicacious Smithers & Co. of London. Earnings per share -- the sustenance of equity investors -- will be hampered by punk economic growth ahead and the need to repair corporate balance sheets.
• Deleveraging means share issuance rather than buybacks -- a reversal of the trend of recent years that worked to the benefit of corporate chieftains' bonuses. "The growth rate of earnings per share is thus likely to be worse than that indicated by profit margins alone," his report logically infers.
• Investors had come to regard the record profit margins of recent years as the new norm. Last year's were above average, despite the general perception they were squeezed. With U.S. growth likely to stabilize at only 1% into 2010, the outlook for earnings is apt to be, in a word, lousy.

This is also my theory. The "new normal" will be a very different situation but if American consumers rebuild their balance sheets over the next 3-4 years, they can forget the lessons we've just gone through .....and return to their proliferate ways. Right around 2013.

It's all coming together splendidly.