By Tyler Durden | 26 August 2010
Equity investors are in for a rude shock. The global economy is sliding back into recession and they are still not even aware that these events will trigger another leg down in valuations, the third major bear market since the equity valuation bubble burst.
This lack of awareness reminds me of reports this week that a 35 year old Polish man hadn't noticed for five years that he had a bullet lodged in his head. Like the equity market in 2000, the Polish man had been partying too hard to notice that he had been shot. The BBC report the police as saying "He told us he remembered having a sore head, but that he wasn't really one for going to the doctor."
As the equity bloodbath of the last decade enters its final, [perhaps] bloodiest phase, investors continued optimism also reminds me of the Black Knight in Monty Python & the Holy Grail. Despite being obviously grievously wounded by King Arthur, the Black Knight makes light of his injuries which he dismisses as "merely a flesh wound". The vast bulk of the investment industry fails to appreciate that we are locked in a structural bear market and about to enter Act III.
This year has already seen a dramatic flip-flop in sentiment as the market has begun to acknowledge it is sinking into the deflationary quicksand. For this year outperformance of bonds over equities in the US, for example, is over 20 percentage points (see chart below).
So far the equity market has shrugged off much of the weaker data that abounds, and has not joined the bond market in its perceptive move. The equity market will crumble though, like the house of cards it is, when the nationwide manufacturing ISM slides below 50 into recession territory in coming months. Indeed, the new orders data for August, already reported by the regional ISMs suggests that the equity market is going to get some sentiment crushing data in the very near term. "But, never mind," the last standing optimist will tell us, "it is only a flesh wound!"
The structural bear market has not reached the end. We have long said that the de-bubbling process would end only when equities became very cheap and revulsion in equities as an asset class hangs in the air like a fog. The problem remains more of excess valuation within the US rather than Europe, but that will not prevent the bear market hurting other cheaper markets as much. We will return to the valuation nadir last seen in 1982 with the S&P bottoming around 450 (see chart below).
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