Yes folks you read that right I have become a bull, but in bear’s clothing mind you. On May 18, I became a Bear in Bull’s Clothing. On July 13, 2007 I said that the market had reached its high water mark. And on December 3, 2007 I became a bear. I am very optimistic, even though I should not be. I am looking at my portfolio and right now I am staring at 0.35% returns since the beginning of this year. Until the beginning of this week my returns were around 6.8%. This week I was completely walloped. But I am completely optimistic, because after seeing this week I feel like singing Pat Benetar’s “Hit Me With Your Best Shot!”

Yesterday Meredith Whitney talked on CNBC and said that there might be yet another write down. She said the biggest problem is that nobody knows what is going on and that we are only 40% through this. Then she said, there might be another 50% drop in the stock price. Saying 50% is interesting and one wonders how one arrived at that number. Well, I think I might have found out. Look at the following two charts.

nasdaq citi

If you were to compare the highest point and pullback point of the left hand chart with that of the right hand chart you could make the argument that 24.31 is still too high and to match you would need to look at 13. Notice how 24 is about double 13, and that would support Meredith’s argument. What is the chart on the right? It is the chart of Citigroup. So my question is, is Meredith thinking that the financial bubble is like the Internet bubble? I personally don’t think it is the same. As Mark Twains once said, “history does not repeat itself, it just rhymes.”

Let’s look at another issue of the financial bubble, is Meredith right in that it is like a finding Waldo situation? I would prefer another analogy, its like the drunk that came home, sobered up and found a very expensive drinking tab in their pant pockets and wondering what happened. We are at the stage where we accept that we got piss drunk, but need to figure out how to pay for everything. I feel we are seeing the bottom. We know what the risks are and we know that we need to confront the issues.

I am a bull in bears clothing because I am seeing an end to the misery. So to see how much further things will go I decided to do some Monte Carlo simulations on the S&P (they include some of my own magic sauce).

Let’s start with a worst case scenario. I call this the year 2000 melt down, and is illustrated as follows.

scenarioyear2000

In this scenario we get spring earnings and it shows that things are ok, not great, but ok. As a result we have some rallies to 1400, but then in the summer something happens. Maybe it is a world event, maybe it is a complete melt down of the market. The end result is that the S&P drops down to around 1100, maybe 1050 and then around the winter, late autumn we begin our rally.

I don’t see this happening, but I threw it in because I wanted to highlight what could happen if SOMETHING happened to get into the way of the market around the summer.

Now let’s look at a best case scenario.

scenariogood2

In the best case scenario we get earnings see that things are not that bad, and decide that things are slowing down, but the world will recover. As a result we have a rally late summer, early fall and rally to around 1600 on the S&P before doing another pullback. In this scenario we touch, maybe slightly break through the 1300 barrier and move on. I don’t see this scenario happening either. It is too darn optimistic.

Here is the scenario that I see as being most likely.

scenariorealistic

We go into earnings being optimistic, then get beaten up a bit more. But then we see that things are not that bad, and people are feeling pretty good about themselves and start the rally in late summer early autumn. In this realistic scenario there will probably be another rally before a sell off that breaks 1300. Whether or not we break 1250 and touch 1200 I don’t know. I am thinking though we will not break 1200, as that just seems too unlikely. Though you never know.

Here is what I think is going to be crucial to see which scenario plays out:

  1. Earnings in April. How good or bad are they? Have we priced in everything?
  2. What about the summer? Will people be optimistic or pessimistic?

What also has me thinking, and this was said by an economist at the World Economic forum, is that even if the world slows down by quite a bit it will not matter. The world is still growing. Things will slow down, yes, but think about this, imagine if a billion people consumed an additional 50 USD per year. That 50 USD is trivial for us, but not for the developing world. Including the multiplier effect this is an incredible amount of money. We are not going to have a dramatic rebound, and there will still probably be hardship. What it means is that you should begin investing.

So how would I invest?

  1. Buy stocks that are bargains or cheap on valuation. Don’t buy stocks that have dropped by a huge amount because that was a good thing.
  2. I don’t buy the cyclical and defensive stock argument. Take for example Nestle, defensive stock, great results and an increasing stock price, but compared to its historical earnings it is priced in the upper levels of valuation. For a market that is going to slow down that is not a good position.
  3. Look at the past PE valuation of a stock and make sure it is cheap on that measure as well.
  4. Buy what you know.

I am so optimistic, that I even bought Apple shares. Yes the individual who is so critical of Apple bought Apple. Do I like Apple? No! I am not trying to pull a “Jerry Yang” who puts emotions in front of business. I am pricing in for more drops but at these levels nibbling at Apple might not be so bad.