Why Three Bears Turned Bullish

With the broad market up 27% in the month after its March 9 bottom, the bullish case for stocks doesn't seem so outlandish. But the market is sure to be buffeted yet by disappointments on the corporate-earnings front. And, despite some good housing numbers recently and a new detox plan for banks that hold bad assets, economic setbacks are a given. So the debate continues about whether the March-April advance represents a new bull market or is just another bear-market rally.

But such conversations completely miss the point, according to the bulls. Whether a new low is coming or not, they say, the bigger risk now is being out of the market and missing what might be the best buying opportunity in decades.

Jim Stack, a money manager and publisher of a newsletter called InvesTech Research Market Analyst, was one of the most vocal bears of 2008. Briefly optimistic at the start of 2009, Stack went into hibernation again but suggested in March that the market was approaching the buying opportunity of a lifetime. "Calling the turn in the market is like trying to catch a falling pitchfork -- it can be painful if you miss," says Stack, who operates out of Whitefish, Mont. "That's not the objective. It's to recognize that many indicators in the market are at extreme levels -- beyond levels at which bear markets bottom."

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Stack says some bullish signs cropped up in late winter. One was a record level of bearishness among investors, a contrarian indicator that typically heralds a turnaround. Another gauge, comparing cumulative price gains over a period of time to cumulative losses, indicated selling so extreme it was hard to justify.

Fake-out rallies in which stocks gain 20% or more within a bear market aren't unheard of, but they are rare, Stack told clients in his April letter. Unlike previous feints, however, the spring rally has been marked by steady gains in a wide swath of sectors and industries. And surveys of consumer confidence are starting to show some optimism.

Coming into 2008, Stack had just 45% of the assets he manages in stocks; now he's bumped the allocation to 60%. And if he sees further evidence that the market has bottomed for good -- meaning more weeks with no new market lows -- he'll ratchet up that percentage. Stack says he's splitting his purchases between defensive stocks and the economy-sensitive sectors that do well in new bull markets. Among the holdings he's added to recently are Intel (symbol INTC), Johnson & Johnson (JNJ) and Walgreen (WAG).

Relying on history. Forgive the folks at the Leuthold Group, in Minneapolis, if they feel slightly whipsawed. Leuthold turned bullish last August -- clearly early. When the market refused to comply with the firm's rosy outlook, a fail-safe mechanism triggered by mounting losses pushed stock allocations from 63% of assets to 50% on February 23. A mid-March letter to subscribers said stock holdings would not be reduced further, and a few days later, the stake was back up to 65% of assets (for Leuthold, 70% counts as fully invested in stocks). "Now is not the time to be cautious toward the stock market," Steve Leuthold wrote in a memo to clients.

His advice to individuals who are invested in reputable funds, close to retirement and fretting over sizable losses: Hang in there. You could recover half or more of your 2008-09 losses over the next two years. Leuthold says investors ten years or more from retirement should increase stock holdings "NOW!"

He cites history to buttress his rationale. Following per-iods of dismal performance, he notes, the stock market tends to rack up impressive gains. This year alone, Leuthold anticipates that Standard & Poor's 500-stock index will hit 1100, representing a 63% gain from the March 9 closing low and a 28% increase from April 9. Leuthold worries, however, that by late 2010, stocks and the economy could be vulnerable to a resurgence of inflation. The new bull market, he fears, may not carry the indexes beyond their October 2007 peaks.

But for now, it almost doesn't matter what you buy, says Leuthold portfolio manager Jim Floyd. "The trick is to get back in." In the bargain-oriented portfolio he manages, he's loading up on stocks that do well in anticipation of an economic rebound: tech, telecom, basic materials, energy, precious metals and homebuilders. The firm also sees opportunity overseas, particularly in Asia (especially China), where there are fewer banking problems, cheaper stocks and faster-growing economies.

Don't be too late. Many investors are understandably reticent about jumping into stocks. To overcome paralysis, draw up a battle plan and stick to it, says Jeremy Grantham, chairman of GMO, a Boston money-management firm. Once called a "perma-bear," Grantham's newfound bullishness is noteworthy. The firm made a "large reinvestment" in stocks in October and another in March. Its traditional global balanced portfolio is within a few percentage points of the 65% allocation to stocks that represents a neutral weighting.

GMO isn't guaranteeing we've seen the bottom; in fact, if the pattern plays out the way it has in other post-bubble markets or through bad recessions, stocks could become even cheaper. But it's better to be early than too late. "Really cheap markets are capable of doubling really fast," says Ben Inker, GMO's asset-allocation chief. "Just as the money you lose in buying an overpriced asset is lost forever, if you fail to buy a cheap asset when it goes back up, you won't get another chance to make that money."

GMO figures that the S&P 500 would be fairly valued at 900 -- up 33% from its low and up another 5% from its close on April 9. Over the next seven years, as the market reverts to more-normal levels from its oversold, post-bubble extremes, investors can expect annualized returns of 8% to 11%, after inflation, GMO predicts. "This is the best opportunity that investors have had since 1982," Inker says. GMO favors big, stable blue chips, which have a good shot at surviving hard times in a still-dicey economy. And despite recent rallies, there's no need to rush in all at once. "Put some money in every month," says Inker, "and if the market goes back down, speed that up."