The last several weeks have seen the markets put an unholy fear back in investors. Regardless of geography or asset class, there has been a growing sense of fear and foreboding that have caused many sleepless nights and left those less-resolute individuals feeling not unlike deer caught in headlights.
Getting directly to the point, investors need to realize – quickly – that the market is cheap. Despite the uneasiness surrounding matters of business, economics, finance, and politics, there is simply no denying the fundamentals.
The situation is this: as a result of the credit crisis and ensuing recession, the market tumbled to ten-year lows. However, a good portion of this fall was unwarranted; the market’s fall was simply exaggerated by fear – not facts.
After bottoming, stocks (as evidenced by the Dow Jones Industrial Average) rallied approximately 70%. Once again, this move was due in large part to emotion, this time at the other end of the spectrum. Rather than unnecessary fear, there was an irrational amount of excitement in the markets.
Investors, between March 2009 and April 2010, became complacent and over-confident that the worst had passed. Most of them never stopped to study market fundamentals like corporate earnings, which would have indicated to them that the market’s rally was overdone.
Since putting in a top in April, stocks have now fallen about 15% off their highs. As they have done so, the degree of panic in the market has continued to increase. Many market participants have begun booking their profits and taking money off the table. Pundits have begun preaching for the end of days, and many [formerly optimists] have begun second-guessing their previous predilections.
The single theme running rampant throughout this entire saga is emotion – the one thing that should be perpetually left out of the equation.
One of the golden lessons on Wall Street is not to get attached to a position. In the 1987 movie with same name, Gordon Gekko (Michael Douglas) famously remarked “…don’t get emotional about stocks, it clouds your judgment.”
The one problem with this insightful lesson is the lack of circumstances in which it is applied. While most apply the phrase only the investors who seem overly bullish, few consider the opposing attitude. Just as it is unwise for investors to marry a stock, it is also poor practice to adhere to baseless pessimism.
When dealing with the markets, it is necessary to be completely objective – that is to say: heartless.
Investors’ relationship with the market is simple. It has nothing to do with feelings, and everything to do with profit. Over the years many in our industry (and big business in general) have tried – quite successfully – to paint a touchy-feely veneer over a very ugly, cold-hearted business.
Business, from manufacturing to finance and the world’s markets of exchange – and advisors – exist with one sole purpose in mind: to make money. Without that aim, the singular purpose that drives capitalism day-in and day-out, the financial markets would be completely unnecessary (and I would be out of a job).
This nasty facet of business is often ignored and seldom addressed, though commonly understood by every free-market capitalist. It’s a good lesson to remember in times like these, where emotions are much more abundant than facts. Doing so encourages investors – and businesspeople in general – to re-center themselves, re-evaluate their goals, and renew their objective approach that has driven profits for centuries.
Wednesday, July 7, 2010
Wednesday, June 30, 2010
Double –Dippers Reject Reality
Despite the market’s recent behavior, it is our growing opinion that the chances of a double-dip are extremely low, and continuing to fall. This idea, as overly-optimistic as it may sound, is not without evidence. Just last week an article appeared in the Wall Street Journal stating that many corporations are beginning to spend money on capital investments (Lahart and Maher, Seeing Economic Rebound, Firms Step Up Spending).
However, this recent spending has – for the most part – not been financed by debt, but paid for in cash that companies have been hoarding since the 2008 financial crisis. In addition to investments in production, there has also been a small wave of corporate acquisitions as of late, serving as further evidence of confidence among business leaders.
Despite this recent increase in the flow of money around the US economy, broad money supply numbers have continued to slip at an alarming rate. We consider this to be mostly a flash in the pan, mostly because a great deal of this so-called ‘deflation’ is due to default rather than traditional deleveraging.
Our anticipation is that once company’s gain additional confidence that they can benefit from investing in production and expansion, the corporate appetite for debt (and risk) will likely increase. Once that happens, money will begin flowing through our economy at a quickening pace, and deflation will cease to be a concern.
In fact, quite the contrary may occur. Given the amount of new money that has been created through government stimulus programs, there is a very real possibility that inflation may become a problem, once that new money starts making its way through the economy.
Examining at the market, it is apparent that investors have become extremely negative extremely quickly in last few weeks. In fact, last week we saw multiple 90% down days, during which more than 90% of all trading volume was down (for every 100 shares of stock traded, more than 90 were at a lower price than the previous trade). Unfortunately this is hardly unusual; it’s typical of the investing public to overreact. In reality, the market is more likely close to a relative bottom rather than a top.
Stepping back to look at the market over a long-term, we can see that stocks remain trading within a range it entered in October of 2008 during the collapse. Those long-time readers may recall that this is precisely what we called for at the time.
In fact, during the fall of ’08 we said that after their precipitous decline stocks would recover, and that once they peaked they would like stay within a trading range for an extended period of time. At the time we equated this to the period from about 1975 until roughly 1982, during which time a similar trading range existed. However, we do not expect the current trading range to exist for that long.
Our anticipation is partly due to the fact that we’re now coming down to crunch time in the political world. It is our clear expectation that political profligates in Washington will likely lean on the Treasury and Fed to boost conditions of the US economy and financial market coming into election season.
After all, in mere months these grandstanders will need to be able to go back to their constituents and claim that all is well. At that time they need things to at least appear to have resumed some state of normalcy, at least in the eyes of the American public.
The last few years have been extremely volatile in the markets, and the situation today is hardly different. We live in a world of constant flux. Unfortunately, there is little that investors can do except get used to it. The fact is that there is now, always has been, and always will be a lot of uncertainty in the markets.
When it comes to the markets, there’s no such thing as a free lunch; no golden key that will unlock the secrets of the world. That’s why we spend countless hours of each and every day, week after passing week studying the markets and keeping up with its most minute developments. Hard work and perseverance are the only way to survive the maze of global markets.
However, this recent spending has – for the most part – not been financed by debt, but paid for in cash that companies have been hoarding since the 2008 financial crisis. In addition to investments in production, there has also been a small wave of corporate acquisitions as of late, serving as further evidence of confidence among business leaders.
Despite this recent increase in the flow of money around the US economy, broad money supply numbers have continued to slip at an alarming rate. We consider this to be mostly a flash in the pan, mostly because a great deal of this so-called ‘deflation’ is due to default rather than traditional deleveraging.
Our anticipation is that once company’s gain additional confidence that they can benefit from investing in production and expansion, the corporate appetite for debt (and risk) will likely increase. Once that happens, money will begin flowing through our economy at a quickening pace, and deflation will cease to be a concern.
In fact, quite the contrary may occur. Given the amount of new money that has been created through government stimulus programs, there is a very real possibility that inflation may become a problem, once that new money starts making its way through the economy.
Examining at the market, it is apparent that investors have become extremely negative extremely quickly in last few weeks. In fact, last week we saw multiple 90% down days, during which more than 90% of all trading volume was down (for every 100 shares of stock traded, more than 90 were at a lower price than the previous trade). Unfortunately this is hardly unusual; it’s typical of the investing public to overreact. In reality, the market is more likely close to a relative bottom rather than a top.
Stepping back to look at the market over a long-term, we can see that stocks remain trading within a range it entered in October of 2008 during the collapse. Those long-time readers may recall that this is precisely what we called for at the time.
In fact, during the fall of ’08 we said that after their precipitous decline stocks would recover, and that once they peaked they would like stay within a trading range for an extended period of time. At the time we equated this to the period from about 1975 until roughly 1982, during which time a similar trading range existed. However, we do not expect the current trading range to exist for that long.
Our anticipation is partly due to the fact that we’re now coming down to crunch time in the political world. It is our clear expectation that political profligates in Washington will likely lean on the Treasury and Fed to boost conditions of the US economy and financial market coming into election season.
After all, in mere months these grandstanders will need to be able to go back to their constituents and claim that all is well. At that time they need things to at least appear to have resumed some state of normalcy, at least in the eyes of the American public.
The last few years have been extremely volatile in the markets, and the situation today is hardly different. We live in a world of constant flux. Unfortunately, there is little that investors can do except get used to it. The fact is that there is now, always has been, and always will be a lot of uncertainty in the markets.
When it comes to the markets, there’s no such thing as a free lunch; no golden key that will unlock the secrets of the world. That’s why we spend countless hours of each and every day, week after passing week studying the markets and keeping up with its most minute developments. Hard work and perseverance are the only way to survive the maze of global markets.
Wednesday, June 23, 2010
Re-Emerging Markets Paint Pattern
For the last several decades, emerging markets have been the fad for business and investing. During that time, little was heard of US industry, which sat mostly on the back burner, away from the limelight. All we heard about was the new global economy and the world’s increasing flatness. American businesses began outsourcing production, then back-office administration, and even some engineering capabilities (typically considered our advantage over other, less-developed countries).
Now, after years of increasing momentum, attention, and investment, the emerging markets wave is finally coming dying down. Why? Quite simply, the world has changed. For example, while China was the long-time leader in cheap manufacturing, it recently lost that title to India and Mexico, according to a May, 2009 article from Industry Week (China Loses Low-Cost Manufacturing to India, Mexico, Agence France-Presse).
In fact, that same article cites a study from AlixPartners which revealed that, at the time, the cost of manufacturing a car in a Chinese plant was just 6% lower than its American counterpart. Moreover, recent stories abound of companies finding out the hard way that there are still difficulties in sending business overseas, and not just from a logistics standpoint.
Almost a year ago we observed that companies like Farouk Systems had to incur significant expenses month after month in their ongoing battle to prevent knock-off versions of their own products being produced in China right alongside their legitimate goods (Recovery in the Making, Danger Still Abounds). The same article reference Carlisle Wheel and Tire as one of many companies that have had major problems controlling the quality of offshore production.
What all this indicates is that the long-time trend of outsourcing is, as we’ve written before, most likely coming to an end. In fact, the flow of production may be getting ready to reverse course and actually start flowing back into the United States. This would be admittedly a very subtle, long-term trend that may not garner any significant attention for years.
The real underlying principle here is that everything in the world of business, economics, politics, et al, and hence, everything that has implications in the investment world, cycles. Some cycles are certainly longer than others. One example of a shorter term pattern comes from the old saying popular among traders, “Sell in May and go away,” which refers to the stock market’s natural tendency to slow down over the summer (which is very apparent at present) and for trading to traditionally pick back up again in the fall.
Just as market activity and trading volume cycle, so too do economics, including everything from inflation and interest rates to government spending and consumer confidence. All these things cycle, albeit with varying lengths, severities, and implications.
This idea that everything cycles is, consequently, one of our key arguments for why investors need to take an active approach to portfolio management. For those who want to do it themselves, this means the commitment of sufficient time to the study the economies and markets so that they are perpetually updating their holdings based on a changing economic environment.
For those who do not wish to dedicate the time, energy, and focus to this continual (and sometimes mundane) task, the consequence is that they need to look for (and hopefully find) an asset manager who is willing to do this work for them.
While such services certainly aren’t free, they are an absolute necessity for investors unwilling to do the legwork themselves. I’m sorry to say, but investing is no easy task. American’s access to financial markets and instruments make our country one of the greatest one the world. It’s important to understand that this does not in any way entitle us to a free lunch.
Now, after years of increasing momentum, attention, and investment, the emerging markets wave is finally coming dying down. Why? Quite simply, the world has changed. For example, while China was the long-time leader in cheap manufacturing, it recently lost that title to India and Mexico, according to a May, 2009 article from Industry Week (China Loses Low-Cost Manufacturing to India, Mexico, Agence France-Presse).
In fact, that same article cites a study from AlixPartners which revealed that, at the time, the cost of manufacturing a car in a Chinese plant was just 6% lower than its American counterpart. Moreover, recent stories abound of companies finding out the hard way that there are still difficulties in sending business overseas, and not just from a logistics standpoint.
Almost a year ago we observed that companies like Farouk Systems had to incur significant expenses month after month in their ongoing battle to prevent knock-off versions of their own products being produced in China right alongside their legitimate goods (Recovery in the Making, Danger Still Abounds). The same article reference Carlisle Wheel and Tire as one of many companies that have had major problems controlling the quality of offshore production.
What all this indicates is that the long-time trend of outsourcing is, as we’ve written before, most likely coming to an end. In fact, the flow of production may be getting ready to reverse course and actually start flowing back into the United States. This would be admittedly a very subtle, long-term trend that may not garner any significant attention for years.
The real underlying principle here is that everything in the world of business, economics, politics, et al, and hence, everything that has implications in the investment world, cycles. Some cycles are certainly longer than others. One example of a shorter term pattern comes from the old saying popular among traders, “Sell in May and go away,” which refers to the stock market’s natural tendency to slow down over the summer (which is very apparent at present) and for trading to traditionally pick back up again in the fall.
Just as market activity and trading volume cycle, so too do economics, including everything from inflation and interest rates to government spending and consumer confidence. All these things cycle, albeit with varying lengths, severities, and implications.
This idea that everything cycles is, consequently, one of our key arguments for why investors need to take an active approach to portfolio management. For those who want to do it themselves, this means the commitment of sufficient time to the study the economies and markets so that they are perpetually updating their holdings based on a changing economic environment.
For those who do not wish to dedicate the time, energy, and focus to this continual (and sometimes mundane) task, the consequence is that they need to look for (and hopefully find) an asset manager who is willing to do this work for them.
While such services certainly aren’t free, they are an absolute necessity for investors unwilling to do the legwork themselves. I’m sorry to say, but investing is no easy task. American’s access to financial markets and instruments make our country one of the greatest one the world. It’s important to understand that this does not in any way entitle us to a free lunch.
Wednesday, June 16, 2010
First Real Estate, Next Bonds: The 1-2 Punch
Risk is one of the most ambiguous terms existing in the financial world. Though its commonly accepted definition almost always includes complex mathematics, it has recently been acquiring increasing subjective meanings.
For example, the ‘risk’ inherent in bonds is, in theory, reflected the bond’s yield. If an investor adds up the separate forms of risk found in a given bond, including those risks associated with liquidity, default, reinvestment, inflation, they will supposedly arrive at the bond’s yield to maturity.
However, it is becoming increasingly apparent that investors in fixed-income securities, both corporate and government-issued, have become increasingly lax in considering various forms of associated risks. This failure to recognize risk is nearly identical to what occurred toward the end of the real estate bubble, when investors failed to recognize the possibility of property values declining, mortgages defaulting, etc.
Surveying the market today, there are countless bond issues whose prices hardly justify their investors’ risk exposure. This has led us to the leading us to the ironic conclusion that bonds, typically thought to be among the safest investments, are in fact among the most dangerous to be found in today’s market.
Consider first the risk of default that remains for bonds from both the private and public sectors. Despite the recovery in share prices that has taken place since the stock market bottomed last year, companies are hardly out of the woods. As discussed in previous articles, the economic recovery hardly justifies current high prices, nor do they reflect the difficulties still facing corporations, both in U.S. and abroad.
These difficulties include uncertainty regarding government regulation, credit that has remained tight since the financial crisis, and big businesses encounters continual criticism in the court of public opinion.
The default risk associated with bonds issued by many municipalities and sovereign nations has certainly been increasing as governments have struggled to service mounting debts. This is especially dangerous, as government bonds are typically considered the safest of the safe investments.
However, even if issuers don’t default, fixed income securities still pose a serious threat to investors’ portfolios.
As we have written several times before, interest rates are currently at generational lows. In fact, in an effort to spur the flow of money around the economy, the Bank Prime Loan rate has been pushed down to at levels not seen in more than half a century.
At one point in 2008, the market saw investors buying short term Treasury securities with NEGATIVE interest rates. These poor souls were essentially using Treasury debt like safety deposit boxes, but for larger sums. They were willing to buy these securities KNOWING that they would lose money, and were happy to control their losses.
With interest rates so low, any rational investor should be asking themselves how much lower can they possibly go. Bond yields can only fall so far before demand simply dries up. The dangerous part of this equation is what happens after interest rates bottom.
When interest rates start back up – and they WILL start back up at some point – investors who buy bonds at such low interest rates will see their principle deteriorate extremely quickly. Bondholders who sell before maturity, but after interest rates have risen, will be forced to sell at a severe discount. Those who don’t sell, but hold to maturity, will be paid the full face value of their bonds, which is nice.
However, they will likely experience a tremendous loss of purchasing power, as a result of inflation that occurs between now and then. Moreover, these investors face substantial reinvestment risk, as they will be earning a below-market return for an extended period, as they wait for their bonds to mature.
Inflation, though a near-certain problem in the economy down the road, is unlikely to be nearly as bad as Glen Beck would have you believe. Many doomsday theorists point to the recent appalling expansion of the US monetary base as a signed death sentence by inflation. However, there is a way for governments around the world to avoid the hyperinflation that many consider inescapable.
Let’s revisit, for a moment, the risk bonds pose to investors’ principle, should interest rates rise. This aspect of bonds, though typically confined to a day or two of lectures in university finances classes, may deserve a place in political science curriculum in the near future. It is our contention that, through a form of defeasance, the government can successfully refinance a large portion of its debt after interest rates rise, thereby eliminating a significant portion of the national (Treasury) debt outstanding – by shifting the cost to bond investors in the form of mounting losses.
We all know that the government expanded the US monetary base (and in grotesque fashion) after the financial crisis began tearing through the economy. However, interest rates were already low when the government issued substantial amounts of new debt to fund new emergency facilities. Looking at a Monthly Statement of the Public Debt of the United States from the end of May, we can see that the vast majority of outstanding debt has a yield under 5% (United States Treasury).
Now, when the Federal Reserve under Jimmy Carter (and to a lesser extent Ronald Reagan) increased the US monetary base by 30%, the prime rate wound up peaking at over 20% when Paul Volker finally killed inflation (St. Louis Fed). This time around, the monetary base more than doubled. However, if prime rate ends up at just 15% (a conservative estimate, in our opinion), a good deal of Treasury debt issued at low interest rates could lose 66% of its face value.
The boys in Washington, after years of trial and error, seem to have finally perfected a system of paying for massive public debts, without ever sending the American people an invoice. Without raising taxes or tariffs, the government has been able to get the American people to pay for its absurd spending through losses and inflation.
In light of these revelations, and in view of recent controversy surrounding the secrecy of the Federal Reserve, it’s important for investors to remember that old quote from Mayer Amschel Rothschild, which we have used before and will certainly use again: “Give me control of a nation’s money and I care not who makes the laws.”
For example, the ‘risk’ inherent in bonds is, in theory, reflected the bond’s yield. If an investor adds up the separate forms of risk found in a given bond, including those risks associated with liquidity, default, reinvestment, inflation, they will supposedly arrive at the bond’s yield to maturity.
However, it is becoming increasingly apparent that investors in fixed-income securities, both corporate and government-issued, have become increasingly lax in considering various forms of associated risks. This failure to recognize risk is nearly identical to what occurred toward the end of the real estate bubble, when investors failed to recognize the possibility of property values declining, mortgages defaulting, etc.
Surveying the market today, there are countless bond issues whose prices hardly justify their investors’ risk exposure. This has led us to the leading us to the ironic conclusion that bonds, typically thought to be among the safest investments, are in fact among the most dangerous to be found in today’s market.
Consider first the risk of default that remains for bonds from both the private and public sectors. Despite the recovery in share prices that has taken place since the stock market bottomed last year, companies are hardly out of the woods. As discussed in previous articles, the economic recovery hardly justifies current high prices, nor do they reflect the difficulties still facing corporations, both in U.S. and abroad.
These difficulties include uncertainty regarding government regulation, credit that has remained tight since the financial crisis, and big businesses encounters continual criticism in the court of public opinion.
The default risk associated with bonds issued by many municipalities and sovereign nations has certainly been increasing as governments have struggled to service mounting debts. This is especially dangerous, as government bonds are typically considered the safest of the safe investments.
However, even if issuers don’t default, fixed income securities still pose a serious threat to investors’ portfolios.
As we have written several times before, interest rates are currently at generational lows. In fact, in an effort to spur the flow of money around the economy, the Bank Prime Loan rate has been pushed down to at levels not seen in more than half a century.
At one point in 2008, the market saw investors buying short term Treasury securities with NEGATIVE interest rates. These poor souls were essentially using Treasury debt like safety deposit boxes, but for larger sums. They were willing to buy these securities KNOWING that they would lose money, and were happy to control their losses.
With interest rates so low, any rational investor should be asking themselves how much lower can they possibly go. Bond yields can only fall so far before demand simply dries up. The dangerous part of this equation is what happens after interest rates bottom.
When interest rates start back up – and they WILL start back up at some point – investors who buy bonds at such low interest rates will see their principle deteriorate extremely quickly. Bondholders who sell before maturity, but after interest rates have risen, will be forced to sell at a severe discount. Those who don’t sell, but hold to maturity, will be paid the full face value of their bonds, which is nice.
However, they will likely experience a tremendous loss of purchasing power, as a result of inflation that occurs between now and then. Moreover, these investors face substantial reinvestment risk, as they will be earning a below-market return for an extended period, as they wait for their bonds to mature.
Inflation, though a near-certain problem in the economy down the road, is unlikely to be nearly as bad as Glen Beck would have you believe. Many doomsday theorists point to the recent appalling expansion of the US monetary base as a signed death sentence by inflation. However, there is a way for governments around the world to avoid the hyperinflation that many consider inescapable.
Let’s revisit, for a moment, the risk bonds pose to investors’ principle, should interest rates rise. This aspect of bonds, though typically confined to a day or two of lectures in university finances classes, may deserve a place in political science curriculum in the near future. It is our contention that, through a form of defeasance, the government can successfully refinance a large portion of its debt after interest rates rise, thereby eliminating a significant portion of the national (Treasury) debt outstanding – by shifting the cost to bond investors in the form of mounting losses.
We all know that the government expanded the US monetary base (and in grotesque fashion) after the financial crisis began tearing through the economy. However, interest rates were already low when the government issued substantial amounts of new debt to fund new emergency facilities. Looking at a Monthly Statement of the Public Debt of the United States from the end of May, we can see that the vast majority of outstanding debt has a yield under 5% (United States Treasury).
Now, when the Federal Reserve under Jimmy Carter (and to a lesser extent Ronald Reagan) increased the US monetary base by 30%, the prime rate wound up peaking at over 20% when Paul Volker finally killed inflation (St. Louis Fed). This time around, the monetary base more than doubled. However, if prime rate ends up at just 15% (a conservative estimate, in our opinion), a good deal of Treasury debt issued at low interest rates could lose 66% of its face value.
The boys in Washington, after years of trial and error, seem to have finally perfected a system of paying for massive public debts, without ever sending the American people an invoice. Without raising taxes or tariffs, the government has been able to get the American people to pay for its absurd spending through losses and inflation.
In light of these revelations, and in view of recent controversy surrounding the secrecy of the Federal Reserve, it’s important for investors to remember that old quote from Mayer Amschel Rothschild, which we have used before and will certainly use again: “Give me control of a nation’s money and I care not who makes the laws.”
Wednesday, June 9, 2010
The Birth of a New Bull Market
After my articles the last few weeks, many out there probably think of me as pretty bearish on stocks. However, friends, I’d like to clarify that point. In the short term, it is still my view that the market has some tough times ahead. However, taking a longer term perspective, I don’t think it’s possible to be more bullish. In fact, in our humble opinion, we are about the witness the birth of a bull market from the ashes of a bear!
To clarify further, I am not saying that the tough times are over and investors need to rush out and buy stocks. While the market has corrected, as anticipated, we are not of the belief that the correction is over, or that the market is now fairly priced. We do, however, have a very different opinion on where the stock market is currently in its life cycle.
Many today argue that after the market’s peak in 2007 and subsequent decline, investors have another eight to twelve years of bear market to look forward to before the correction is over. Our view is substantially more optimistic.
Looking at stocks over the past fifteen years, one will notice that neither the Dow Jones Industrial, nor the S&P 500 (a much better sample) have gone anywhere in more than a decade, since 1998. In fact, an investor who bought either of these indices at that time would actually have losses – significant losses – in real terms (when inflation is considered).
This brings us to the startling realization that stocks have not been in a bear market since 2007, as many would believe, but since 1998. In other words, we are likely much, much closer to the end of this bear market than most believe.
Though we frequently cite his administration for political comparison, the current state of financial markets is not unlike the 1970s under Jimmy Carter. The market actually made a peak in 1966 under Nixon, and despite making a marginal high under Ford around ’73, the market didn’t really go anywhere until 1982, right after Carter left office.
What this amounted to was essentially a lost decade for stocks, much like the one we have just emerged from. In 2000 the stocks set new highs, after which the market basically trended sideways until setting a new all-time high, though marginally, in 2007.
Our contention is that, thanks in part to changes in technology that permit information to be disseminated more quickly, the market has accomplished in ten years what previously took fourteen: The market has undergone a prolonged and substantial correction in stock prices, in real terms, and is now poised to resume the trend of a long-term bull.
For our outlook we look once again to the past: After the bull market closed with the Carter years, Reagan took office and oversaw drastic policy changes that ushered in a new era of prosperity for companies and escalating stock prices that last for approximately twenty years.
The same shift is, in our opinion, developing in the market, and will likely take place at the end of Obama’s first (and probably only) term. Lately the economy has begun showing signs of life, from housing inventory dropping to manufacturing beginning to shift to the US, to the financial crisis abating.
Please don’t misunderstand, investors can’t simply throw caution to the wind and begin buying indiscriminately. There is still a possibility that we are in store for a slight double dip, although more so in stock prices – it has already started – than in the economy. However, this is mostly because the economy has shown improvement, but not nearly enough to justify the stock market’s recent high prices.
Nevertheless, we maintain that this correction is likely the start of a shake-out that will cause many investors to shift to traditionally “safer” investments (Treasury bonds and the like). These investors will certainly grow to regret their impatience, as we’ve written before. With bond yields at long-term lows, bondholders are going to take major losses when interest rates start creeping back up. Getting back on point, once the shake-out in equities draws to a close, which will happen much sooner than most probably think, look out for the bull coming through!
To clarify further, I am not saying that the tough times are over and investors need to rush out and buy stocks. While the market has corrected, as anticipated, we are not of the belief that the correction is over, or that the market is now fairly priced. We do, however, have a very different opinion on where the stock market is currently in its life cycle.
Many today argue that after the market’s peak in 2007 and subsequent decline, investors have another eight to twelve years of bear market to look forward to before the correction is over. Our view is substantially more optimistic.
Looking at stocks over the past fifteen years, one will notice that neither the Dow Jones Industrial, nor the S&P 500 (a much better sample) have gone anywhere in more than a decade, since 1998. In fact, an investor who bought either of these indices at that time would actually have losses – significant losses – in real terms (when inflation is considered).
This brings us to the startling realization that stocks have not been in a bear market since 2007, as many would believe, but since 1998. In other words, we are likely much, much closer to the end of this bear market than most believe.
Though we frequently cite his administration for political comparison, the current state of financial markets is not unlike the 1970s under Jimmy Carter. The market actually made a peak in 1966 under Nixon, and despite making a marginal high under Ford around ’73, the market didn’t really go anywhere until 1982, right after Carter left office.
What this amounted to was essentially a lost decade for stocks, much like the one we have just emerged from. In 2000 the stocks set new highs, after which the market basically trended sideways until setting a new all-time high, though marginally, in 2007.
Our contention is that, thanks in part to changes in technology that permit information to be disseminated more quickly, the market has accomplished in ten years what previously took fourteen: The market has undergone a prolonged and substantial correction in stock prices, in real terms, and is now poised to resume the trend of a long-term bull.
For our outlook we look once again to the past: After the bull market closed with the Carter years, Reagan took office and oversaw drastic policy changes that ushered in a new era of prosperity for companies and escalating stock prices that last for approximately twenty years.
The same shift is, in our opinion, developing in the market, and will likely take place at the end of Obama’s first (and probably only) term. Lately the economy has begun showing signs of life, from housing inventory dropping to manufacturing beginning to shift to the US, to the financial crisis abating.
Please don’t misunderstand, investors can’t simply throw caution to the wind and begin buying indiscriminately. There is still a possibility that we are in store for a slight double dip, although more so in stock prices – it has already started – than in the economy. However, this is mostly because the economy has shown improvement, but not nearly enough to justify the stock market’s recent high prices.
Nevertheless, we maintain that this correction is likely the start of a shake-out that will cause many investors to shift to traditionally “safer” investments (Treasury bonds and the like). These investors will certainly grow to regret their impatience, as we’ve written before. With bond yields at long-term lows, bondholders are going to take major losses when interest rates start creeping back up. Getting back on point, once the shake-out in equities draws to a close, which will happen much sooner than most probably think, look out for the bull coming through!
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