"Echoing the forecast he made at this year's Barron's Roundtable ('Rocky Road,' Jan. 19), Felix (Zulauf), the founder of Zulauf Asset Management in Zug, Switzerland, still believes the S&P 500 will bottom in 2011 in the 400s, down from last week's 680 and a 2007 high of 1,565. But, first, he asserts, stocks are poised for a bear-market bounce from a low this month. It could last two to four months, and boost the S&P 25% to 40%, to roughly 900. (The corresponding level of the Dow industrials would be about 8,750.) Felix sees numerous signs of an impending rally: Sentiment is deeply pessimistic. The rate of change on (most) down days is declining, even as prices fall. And, there's lots of money around. But this rally will be for nimble traders only, affording 'those with too much in stocks to sleep well an opportunity to lighten up.' In anticipation of a move up, Felix has closed out his short positions -- for now ... After the rally, alas, the market could be cut in half, Zulauf says. 'Policymakers and investors still don't understand the process at work in the world economy'" ... Assuming a current book value of about $500, the S&P trades for 1.4 times book -- admittedly, down from 5 times at its peak. The market historically has bottomed at an average of 0.9 times book value. 'Secular bear markets usually last 10 to 15 years, and this one started in 2000,' he adds. 'The market has a chance to make an ultimate low within the next two years. If it does so at 90% of book, that low would be in the 400s.' Bottom line, the money manager says: 'People need to understand it is a different world today. We will not go back to the world as we knew it.'"
(Barron's � 3/9/09 issue)
Schaeffer's addendum: The italics in the above quote are mine, as they illustrate what may be a potentially disturbing sequence of events for the bulls � short covering by those who had correctly established bearish positions as they now anticipate either a market bottom or (as with Mr. Zulauf) a sharp bear-market rally. Mr. Zulauf joins Steven Leuthold, who on Wednesday of last week (according to Bloomberg) told investors to keep money out of his bearish Grizzly fund after it rose 74% in 2008, and Bill Fleckenstein, who shut a 13-year-old bearish fund in December. In addition, such prominent and respected (and erstwhile bearish) market analysts and money managers as Marc Faber, Doug Kass, and Bob Prechter in recent weeks announced they were covering their short positions.
The concern for the bulls does not relate to a knee-jerk contrarian reaction to the sudden conversion to the bullish case (at least for the short term) by such a large number of prominent bearish players, though the temptation is great. But one should proceed with caution on this front, not only because these gentlemen have proven to be very savvy navigators of this bear market, but because there are certainly a number of technical indicators that point to at least an oversold rally that could produce one of those "1,000 points in 1,000 minutes" bounces.
No, the biggest concern for the bulls is the fact that short covering is almost always a major factor driving bear-market rallies (including those that transition into bull markets), and if the short positions of such prominent players have already been covered, and this is also reflective of action being taken by others who had been short the market, then bullish short-covering firepower has already been seriously depleted. Worse yet, this covering has occurred in the context of a market that just can't stop making new lows, despite the urgent bid that automatically results when short positions are covered. Some redeployment of sideline money could certainly trigger a rally, but without sufficient fuel from short covering, the potential magnitude and duration of such a counter-trend move this deep into a bear market would have to be suspect.
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