By Laszlo Birinyi

The S&P 500 has been perilously close to a 20 per cent decline in recent weeks which would, by definition, terminate the bull market which began in March 2009. Given the economic circumstances and the continuing political turmoil on both sides of the Atlantic, most commentators believe it is only a matter of time before such a landmark is reached.

Having been bullish, I am – as expected – disappointed but not undaunted. I remain bullish if only now with a lower case “b”. Some months ago I conceded that making market forecasts was increasingly difficult as they entailed an understanding of American politics, Chinese monetary and financial policy, Greek and Italian attitudes, German elections in addition to the usual economics, corporate developments and actions and comments by the Federal Reserve Board.

I contend that as much as five percentage points of the recent sharp correction has been a result of fund liquidations. It was curious that there were a number of stories regarding the sharp losses and redemptions at some significant hedge funds and at quarter’s end there was accelerated selling. I think it unlikely that declines in stocks such as Ralph Lauren, Wynn Casinos, Chipotle Mexican and other strong performers is related to corporate developments or fundamentals.

That does not, of course, mitigate the pain of seeing those and other stocks fall but going forward it suggests the pressure was more likely temporary than enduring

I am willing to concede that the sun is shining on the other side of the fence but I continue to find the negatives only somewhat persuasive. Yes, global economies are shaky and political paralysis exists, but stock market concerns are too often based on opinion. The bears contend that corporate earnings are too high. Perhaps, but we recently calculated that analysts’ expectations for the third quarter on a company by company basis – which are down 2 per cent from three months ago – have actually been increased by 1.5 per cent for the fourth quarter. And even a casual perusal of the past finds that bears always think earnings expectations err on the side of optimism

Thus, the bears rationalise the reality that the S&P is trading at 11 times forward earnings. I submit that many individual names are, by definition and history, attractive. IBM, for one, is trading at a discount to the market which is not the norm for declining markets.

The bearish retort has been that stocks are expensive and should be sold, using the ten year, inflation-adjusted price-to- earnings measure by academic Robert Shiller. My response is “sell what?” His measure suggests stocks are attractive in the six to eight times P/E level. But the market last ventured into that neighbourhood in the late summer of 1982. As a money manager, using this rule would have meant I missed out on the two subsequent 100 per cent plus rallies.

I am also encouraged by the chartists. Based on painful experience, I have never found them to be of value. Several months ago 1,400 was a virtual given but on September 12th and 13th no less than six technicians were suggesting much lower levels. Perhaps, but our files included a prominent article from April 26, 2010: “Technical analysts see room to roll”. The market was then in the third day of what was to be a 17 per cent decline. On July 5, 2010, that year’s S&P low, we had: “Technicians await the bear”. Buy high sell low?

There is, of course, the possibility that the bears will prevail, a double dip will occur and the market will retreat. Even then I would not follow the convention to take a defensive posture. Those who suggest that course always begin with utilities but some historical analysis undermines that idea.

Our study of market cycles found that in bad times utilities are not a panacea. During the bear market that began in late 2007 and ended in the first quarter of 2009, the S&P lost 56 per cent and utilities 46 per cent. Dividends helped some but they are usually taxed. In the 2000 decline the broad market lost 46 per cent and utilities were down 45 per cent.

I think the bearish case is short of substance, the defensive thesis suspect and that selling has been overdone. There are some attractive – if not cheap stocks available. We are reviewing and pruning weaker positions and stocks as well as being more judicious in our purchases. Being bullish on stocks is probably a step down from being bullish on the market but, as economist John Maynard Keynes once said, when things change, I change my mind. What do you do?

I don’t know how and when this will all end. One clue might be to look for significant and prominent negative reports. On March 9, 2009, at the absolute bottom, the Wall Street Journal’s Money section headlined: “Dow 5,000? A bearish possibility”.

And one of the longest market stories in last year’s New York Times – again at the absolute bottom for markets that year – was subtitled: “Wall Street tallies new losses with a bear market in mind”.

Laszlo Birinyi is the founder and president of Birinyi Associates