An Investor's Best Approach to the Bull vs. Bear Battle

Wasn't it just the other day that fretting over the disintegration of the eurozone was consuming Wall Street? Now, many of these growling bears have quickly turned bullish, and more upbeat notes from corporate bellwethers like FedEx(FDX) could further embolden them.

For individual investors -- who lack the luxury of betting with other people's money -- the decision to be bearish or bullish is much tougher. Legions of analysts are screaming that stocks are cheap, but the scars from a financial crisis that few saw coming remain. And since both the bulls and bears can make a compelling case, the best investment decision for smaller investors might simply be the one that lets them sleep easier at night.

The bullish camp, for now, is swelling. Institutional investors boosted their equity holdings to 68% as of July, the highest level in 15 months, Bloomberg reported. But among individual investors, the ratio of bulls to bears is now at its lowest level since July 2009, the summer when most economists believe the recession technically ended.

A Screaming Buy?

Some high-profile investors, like Barton Biggs at hedge fund Traxis Partners, who were unloading stocks earlier in the month have started to buy again. And given Biggs's track record at sensing which way the wind is blowing -- sometimes the most meaningful factor moving the market despite the reams of data that are trotted out -- it's hard not to pay attention.

To many bulls, the case for stocks is so overwhelming that investors who don't buy are missing a once-in-a-lifetime opportunity. Companies in the S&P 500, after all, are supposed to earn almost $100 a share next year, according to Wall Street forecasts. Stocks have traded at about 15 times forward earnings, with multiples hovering closer to 20 when interest rates are low, like they currently are.

Such historical valuations could put the S&P 500 index at 1,500, and even 2,000 wouldn't be outside the realm of possibility. Even if things fall short, bulls argue, stocks are a screaming buy.

"Unaware of the Hook Buried Inside"

However, bears like fund manager John Hussman, make a compelling case for why stocks are already severely overvalued, perhaps by 40%. While often bandied about, the forward operating earnings measures that Wall Street uses are just projections that exclude important charges. Analysts are merely extending the sharp rise in earnings following a recession into the future, and unrealistic profit margins -- 50% higher than historical norms -- will be needed to meet them.

"Investors who allow Wall Street to convince them that stocks are generationally cheap at current levels are like trout -- biting down on the enticing but illusory bait of operating earnings, unaware of the hook buried inside," Hussman recently wrote.

Of course, the stock market has always a feud between opposing views about the right price for shares. But such gaping differences -- where some see nothing but growing profits ahead and others are simultaneously bracing for a painful deflationary scenario -- are still rare.

Professionals who pull down big paychecks can spend all day figuring out how to balance the two forces and switch quickly, much as Biggs did. For individual investors, though, the debate should be about how much they're willing to risk in a stock market that could easily go either way.