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What a two weeks it’s been… 
 
During the course of the past 12 sessions, the S&P 500 has fallen 16.8%. U.S. debt has been downgraded by Standard & Poor’s for the first time since 1917, when Moody’s started the whole ratings game. And this was topped off by the S&P 500’s dizzying 6.66% drop yesterday. 
 
As someone who manages money — and not just writes about it — it is a challenging time. Unlike when I was a mutual fund manager and my job was to be "fully invested" through thick and thin, I am forced to make decisions on whether to ride out these sharp corrections — or to put a big chunk of my clients’ assets in cash.
 
On the one hand, my clients are understandably worried. 
 
On the other, it is astonishing how little objective data is causing the recent decline. 
 
So, I am going to go out on a limb here:
 
I think the current sell-off is massively overdone.
 
And I think when you look back in three months as we enter a Q4 rally, this week will be the buying opportunity of the year.

 

The S&P Downgrade in Perspective 

 
Yes, Standard and Poor’s downgraded the U.S. government’s credit rating to AA+. 
 
But Moody’s and Fitch both affirmed the U.S. government’s credit rating at AAA. With at least two of the three major rating agencies keeping the United States at triple-A — from a legal perspective — the country still is rated AAA. Investors won’t be dumping U.S. Treasuries en masse. 
 
Nor does the world come to an end after a downgrade. A decade after Japan lost its triple-A rating, 10-year Japanese government bond yields are still only 1% and the yen is as strong as ever. 
 
U.S. Treasuries remain the world’s least ugly safe asset. 
 
A lot of the noise from China and elsewhere is as much about Schadenfreude — joy about the U.S. government’s comeuppance — as it is about economic fundamentals. Last week, Russia’s Vladimir Putin commented that the United States "is living like a parasite off the global economy." Parasite or not, your pension fund is unlikely to be moving your retirement assets to Moscow or Shanghai anytime soon. 
 
That explains why yesterday’s jump in risk aversion saw Treasury yields fall rather than rise on the very day the U.S. government’s debt rating was downgraded. 

 

The Bullish Case — The Fundamentals 

 
You don’t need me to tell you about the bearish case for global financial markets. You can find that anywhere. 
 
But here are three more reasons to be bullish, which you won’t find in a media that reports 13 negative stories for every positive one. 
 
First, U.S. corporate profits are very strong. Almost 75% of companies beat analysts’ second-quarter estimates. By some measures, corporate profits have risen faster since the 2008 recession than at any time in the past 100 years. U.S. companies now have over $2 trillion on their balance sheets. 
 
Second, stocks are relatively cheap. The S&P 500 is trading at only 11.2 times 2012 earnings. That’s hardly a euphoric level that signals the onset of a crash. Recall the words of Sir John Templeton:
 
"Bull markets are born in pessimism, grow on skepticism, mature on optimism and die on euphoria."
 
If anything, we’re at the "pessimism" phase of this cycle and not at "euphoria."
 
Third, falling oil prices are their own "stimulus package" to U.S. consumers. 
 
Deutsche Bank estimates that if gas falls to $3 a gallon, the reduced pricing frees up $100 billion in annualized consumer spending from where it peaked earlier this year. Experts are predicting that the national average of $3.70 per gallon — down from $4.11 — could fall as much as 35 cents per gallon over the next month. 
 
Although the correlation between oil and gas prices is not perfect, consider that on Jan. 16, the price of a barrel of oil was $91.66 and the average price of unleaded gas per gallon in Northeast Pennsylvania was $3.15. Now consider that overnight, NYMEX light crude fell to less than $77. This was the first time prices had dropped below the $80 mark since October 2010. It looks to me that this adds up to more money in U.S. consumers’ pockets.

 

The Bullish Case — Investor Sentiment

 
I’m a big believer in the distortions caused by market psychology. 
 
Nobel-prize winning theories about "rational expectations" to the contrary, investors are anything but homo economicus — the perfectly rational actor. 
 
Financial markets are much more like Mr. Market, the metaphorical manic depressive, who was first described by Ben Graham and popularized by his student Warren Buffett. 
 
Some days, Mr. Market is euphoric. On other days, he’s very depressed. If you catch him on a euphoric day, he wants a very high price for his shares. If he’s in one of his down moods, he’s willing to sell you his shares for a pittance. Mr. Market highlights the one thing you can predict with certainty about financial markets: investors will always overreact to events — whether positive or negative. 
 
There are some terrific ways to quantify these mood swings. You can look at everything from age-old stalwarts like the AAII investor sentiment survey to the Roubini Sentiment Indicator developed by InsiderMonkey.com, which has shown that increases in market bear Nouriel Roubini’s popularity are followed by declines in the stock market.
 
Sentimentrader.com does some terrific work to quantify the unquantifiable. It points out that the recent market action is chock full of once-every-few-years kind of moves with all sorts of extremes. At times like this, the future is usually binary. You get an all-out market crash, or a hard 2-3 day rally.
 
Well, yesterday, I think we already got our "crash."
 
Here’s one of many astonishing statistics. Yesterday, market breadth on the NYSE — the number of stocks up versus down — was as negative as it’s been since, well, most likely since before you were born. With 67 declining stocks for every one that rose, you’d have to go back to May of 1940 — before Pearl Harbor — to see fewer up stocks as a percentage of total stocks as you did yesterday.
 
The bottom line? Most price- and breadth-based indicators are stretched to negative extremes that have been seen a handful of times in the past 50 years. And that means a solidly higher market over the next 1-3 months.
 
That doesn’t, of course, mean that stocks can’t continue to fall today…
 
But look for stocks to bottom sometime this week. And strap yourself in for a wild ride.
 
Sincerely,
 
Nicholas A. Vardy 
Editor, The Global Guru 
 
P.S. My colleagues and I at Eagle Publishing have been working hard over the past few months in developing a course on "How to Profit like a Hedge Fund Manager." This is the same basic approach that I’ve used in the past to manage an actual hedge fund — and it’s one that you can implement IMMEDIATELY in managing any investment in your own portfolio. I believe it’s literally the most valuable information you can have in managing your money — and that it will change the way that you look at investing forever. And the best news for you is that we’ve decided to give it away for FREE!
 
We’re still working out the details, so I can’t tell you much more at this point. But keep an eye out in your inbox for a personal message from me in the coming weeks on how you can gain access to this highly valuable course, which includes the very best of my own thinking.