quinta-feira, 13 de novembro de 2008

Back at the Bottom

November 13, 2008
Jason Kelly

We're right back down at another make-or-break moment. They come frequently these days. Will the Oct. 10 bottom hold or is another waterfall crash dead ahead?

The Nasdaq already failed its Oct. 10 and Oct. 27 lows and is officially in new, cheaper territory. The S&P 500 is a whisper away from that ignominy. Same with the Midcap 400. Same with the Russell 2000.

It's been all crap all the time for so long now that people are finally just backing away. The tone of notes here at Kelly HQ has been abysmal. I'm hearing about retirement plans up in smoke, famous investors who've done poorly this year, even a suggestion that all stock markets just be closed for good. "To hell with the whole con," one man wrote.

From my publisher came interesting anecdotal evidence. When the crash began in early September all the way up until about three weeks ago, sales of stock books and other investment books went through the roof. My own stock book sold five times the volume at Amazon.com in October than it sold in average months. People sensed a bargain basement on Wall Street and wanted strategies to take advantage of it.

Those sales volumes have now gone the way of Detroit auto sales. Investment titles are selling at a pace below average. In their place, sales of poetry, love stories, and picture books have quickened. The idea of making a killing in stocks has vanished. People just want to escape.

That's supposedly when bear markets end. Once everybody has cashed out and no longer gives a rip what happens on "Fall Street", a stealth bull market begins. I'd love to call for one here but can't because I don't have any new evidence to cite.

None of our tools is working. The most honest analysts have admitted that. The others are tossing out calls for up or down and then claiming victory when the coin toss goes their way. What we know, though, is that the VIX has never before stayed this high for this long without some kind of reprieve from the downside. Breadth isn't supposed to stay this bad for this long. Oversold isn't supposed to get more, and more, and more, and more oversold and then stay there.

What we're hearing now is the same set of excuses we hear whenever markets jump the rails and keep going across the field. We dust off the old "the market can stay irrational longer than you can stay solvent" canard from Keynes, the old "it works until it doesn't" quip now seemingly in reference to the very idea of stock investing, and the old description of "hundred-year flood" and the new "black swan" to denote how odd a set of measurements faces us. It's the same kind of stuff Long-Term Capital Management said when its bulletproof model was shot to death.

I like what University of Chicago finance professor John Cochrane wrote in Wednesday's Wall Street Journal:

We are in, or headed for, a recession. Anyone whose job or business will be impacted can't take stock-market risks, and should be selling despite low prices. We are seeing lots of "deleveraging," "disintermediation" and "forced selling." As losses mount, investors or institutions that have borrowed money must sell to avoid bankruptcy. Others, such as some university endowments or defined-benefit pension funds, have backstop commitments that must be honored, and they too must "capitulate" at some point. Still others may just be less willing to take risks after suffering a huge loss, a sensible "once burned, twice shy" mentality.

All of these actors become more averse to holding risks as the market declines, so they sell. This increasing risk aversion amplifies an initial price decline -- coming from bad earnings news or the huge rise in credit spreads -- into a rout.

If this is indeed what's going on, it also means that unleveraged, long-term investors should be buying, since prospective returns are better. They must be able to suffer through further mark-to-market losses, and not have recession-sensitive jobs or businesses. They must still have some money left to invest, so they can exchange some of their valuable Treasurys for assets that the suddenly risk-averse are trying to unload. The more these investors can understand and digest slightly exotic securities being dumped by leveraged intermediaries, the better. Warren Buffett is in the news, and he should be.

But this line of thought still does not justify wild optimism. The dividend yield and S&P 500 P/E are barely back to long-term averages, and dividends and earnings will surely fall next year, justifying some of the recent price decline.

[In conclusion...] If you're less leveraged, less affected by recessions, and have a longer horizon than the average, it makes sense to buy. If you're more leveraged, more affected by recession or have a shorter horizon, it might be the time to sell, even though you might be cashing out at the bottom. If you're about the same as everyone else, do nothing and relax. If you're wrong, at least you will have excellent company.

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