Some of you may have subscribed to value-oriented stock research newsletter. One thing you may notice is that as the market enters deeper into the bear market, the number of “Buy” recommendation increases. From that perspective, these value-oriented stock research are ‘bullish.’

Before we comment on the wisdom of their recommendations, we will have to explain the philosophy of value-oriented stock research. As we explained to one of our reader’s comment in Confidence back? Beware of bear market rally,

… for long-term value investors, they follow the ?bottom-up? approach. That is, they (i.e. the value investor) invest in businesses based mainly on its individual merits (i.e. is it a good solid long-term safe businesses whose stock price is undervalued? Bear Stearns is definitely ruled out in this case) and not worry about the macroeconomic big picture, the business cycle, e.t.c. … In that sense, such value investors are neither ?bullish? or ?bearish.? Rather, they have a neutral view on the business cycle and other macroeconomic big-picture.

Here, we see a potential trap for the unwary value investor. Back in February last year, as we explained in What to avoid at the peak of the business cycle?,

One of the common mistakes that novice investors often make is to extrapolate the past earnings of cyclical stocks into the indefinite future during the turning points of the business cycle. Since the stock market always anticipates the future earnings of companies, cyclical companies will look ?cheap? (i.e. low P/E ratio) during the peak of the boom.

During the turning point of the business cycle, the P/E ratios of good quality companies in a bear market may look very enticingly cheap. But as we explained in Why accumulating stocks on the ?cheap? can be deadly to your wealth?, during such a time,

… a falling average P/E ratio does not imply that stocks in general are cheap. Yes, with careful and judicious stock picking skills, you may be able to find really cheap stocks. But do not let falling average P/E ratio fool you.

Low P/E plus the “Buy” recommendations from the value-oriented stock research may make buying stocks of good quality companies look like astute contrarian moves.

But this is where the Achilles? heel of value-oriented stock research lies. Because they hold a neutral view on the macroeconomic big picture and business cycle, they can severely underestimate the effects of a protracted downturn in the earnings of businesses. This news article, Bottom-up analysts ignore the big picture, sums it well:

“You have got a set of numbers that assumes some sort of recovery,” Macquarie’s equity strategist, Tanya Branwhite, said when releasing the report. “Unfortunately, that’s premised on the cycle we have seen in the last five to 10 years. What is facing the economy at the moment is nothing like we have seen in the last five to 10 years.”

One value-oriented stock research (which we will not name) believes that this current bear market will be like any other ‘typical’ bear market in the past- the downturn will last only 12 to 18 months. In other words, their position is that this coming recession will only be a V-shape or U-shape recession (see What type of recession is coming?). If they are wrong about that (i.e. the coming recession is an L-shape one), then their current “Buy” recommendation will be very wrong.

To illustrate this point, we will give you two examples.

After the stock market crash of 1987, the world economy did not fall into a Depression as initially feared. By 1989, stock markets had more or less recovered. If you bought into the market after the crash, you would have profited greatly.

But what if you bought into the market after the stock market crash of 1929 (see The Great Crash of 1929)? Or you bought Japanese stocks just after the bursting of the bubble in the late 1980s? The outcome will be completely different if you had done so.

In short, not all bear market purchase will turn out to be astute if the timing is way too early.