Market Correction Makes Stocks More Attractive

SmartMoney.com/TrendMacrolytics ^ | July 27, 2007 | Don Luskin

[frithguild]

THE FINANCIAL MEDIA is so promiscuous in its use of negative language to describe the stock market when prices go down. Stocks "slid," "plummeted" or even "collapsed." You hear it all the time, even when nothing really happened.

So what words are left to describe a really big down day like Thursday? How about, "Stocks became a better bargain than ever!"

Isn't it true? Isn't it all a matter of perspective? If you already had all your money in stocks, then of course you're sorry to see prices fall — especially after a day like Thursday.

But if you have cash in your pocket and you'd like to buy stocks for the long run, or add to an existing portfolio, then Thursday was a home run. Your world just got a lot sweeter.

Same thing with home prices. If you're looking to buy, the so-called collapse of the so-called housing bubble is great news. Your dream home just went on sale! Attention all you Kmart shoppers.

Then again, all of this depends on an important assumption: You have to believe that the decline in prices is temporary. You have to believe that it doesn't reflect some kind of horrible permanent change in the economic environment.

For example, the stock-market crash of 1929 turned out to be no bargain. If you'd bought stocks at the end of that disastrous October, you would've had to endure terrible declines in value during the Great Depression, not making a sustainable profit on your investment until 1943, according to data from Ibbotson Associates.

But the stock-market crash of October 1987 was a very different story. The market decline then was far worse and much scarier than the one that ushered in the Depression more than half a century earlier. And, it turned out, much more of a bargain. Had you bought stocks at that month's end, you would've shown a profit after just three months.

So don't be afraid just because you see stocks slide, plummet or collapse. Not even if you see them get nuked, trash-compacted, reamed, steamed or dry-cleaned.

Don't just look at prices, and for heaven's sake don't let yourself be stampeded by the overheated language of the media. Ask yourself as objectively as possible, "Why?"

If the answer to that question is that the world really is getting a lot worse, then step aside as a buyer or consider selling before things really do get worse. But I've learned that usually the world isn't getting anywhere near as worse as the stench of panic in the air would make you believe.

Remember, even if the world is getting worse, you'd still want to be a buyer of stocks provided that their prices fell enough to more than compensate for the deteriorating backdrop.

I'm sure I'll get plenty of emails accusing me of being a perma-bull. Especially from perma-bears who've been so terribly wrong for so terribly long. A day like Thursday is a great relief for these people, who can myopically convince themselves they've been right all along.

But I'm no perma-bull. I have no stake in stocks being up or down, per se. I just want to call it right. And I never want to forget one fundamental truth about investing: No matter what, stocks always have a positive expected return.

Stop for a minute and think about that seemingly simple statement. It's actually quite profound, and it's something that most investors have never really thought about consciously.

If markets are at all efficient, then risky securities like stocks must be priced so that the people who hold them — the people who take risk — will get rewarded for that risk-taking, at least on average. If the fundamentals get worse, then stock prices will fall so that from their new low level investors will still have a positive expected return.

Yes, that's an argument for always holding stocks. But believing that argument doesn't make me a perma-bull. It just means I think that over time I'll get rewarded for taking risk.

Markets aren't always perfectly efficient, nor are they perfectly right. Sometimes the risks in the world aren't fully appreciated by markets — or at least the risks I think are out there aren't. Then I'm bearish. Sometimes the risks in the world are overemphasized — or at least the risks I think are out there are — and that's when I'm bullish.

I interpret Thursday's big drop in stocks, in combination with Tuesday's big drop as well, as simply creating a higher expected return for investors daring to buy stocks in an environment that has suddenly gotten riskier. Not really worse, just riskier and more uncertain.

In the last week the bond market has become dysfunctional. Because of losses in the subprime sector, bond investors are suddenly reappraising their willingness to bear risk. That means lots of bond issuances, including some massive ones designed to finance a couple of high-profile private equity deals, haven't been able to get done.

So right now nobody knows what deals can get done and at what prices, and what deals can't get done. That's a bad thing for markets that rely on clear, simple, liquid trading conditions. Now big plans involving many billions of dollars are disrupted. Those disruptions then disrupt other plans, and so on in a daisy-chain of escalating uncertainty.

But so what?

We're talking about a disruption in the markets, not a disruption in the real world. Markets are amazingly adaptable, and they will adapt to this uncertainty and quickly transform it into certainty.

Stocks have dropped in response to heightened uncertainty, not actual deterioration of anything in the real world outside of markets themselves. When that uncertainty is resolved, stocks prices will quickly rise, because the real world will be, and has been all along, a very good place. Earnings are improving, jobs are plentiful and the economy — other than the small portion of it devoted to housing — is accelerating.

I really think this is good news. It's scary, to be sure, but if you believe as I do that you get paid for taking risk, then take some. And get paid.

Donald Luskin is chief investment officer of Trend Macrolytics, an economics consulting firm serving institutional investors.

[WashingtonSource]

What do the numbers on the horizontal line represent?

[Biblebelter]

When two Dow components like Citigroup and J P Morgan Chase DID NOT participate in the run up from 13k to 14k, I felt that we were nearing a top as though I said last week calling tops is a fools game. This week those two took a further beating owing to bridge loans given on M and A action. When those two very significant Dow 30 stocks find some solid support, I think the market will get back to work on those historical highs.

[AndyJackson]

It really looks to me that housing is going to pull us into a recession.

Between increases in real estate taxes due to the housing boom, increases in interest rates (I have an ARM but the cap is below the current fixed term rate) and increased energy costs - there is a big segment of the economy that is not getting income from me - adding up to probably close to $800 per month. The extra would have gone to eating out, luxury food and wine, travel, new kitchen appliances, etc. Some local government bureaucrat and some arab oil sheikh has my money instead. It is a large fraction of my total income, everyone must pretty much incur the same things, and therefore it has to be having an impact on the economy.

[AndyJackson]

I felt that we were nearing a top

When despite all the "good news" and all the postive shilling that goes on, and all the efforts by the local dealers in the market to keep prices going up, it tanks this much in two days, I think we can say we have seen the top.

A bargain is not a 1% dip. A bargain is a 30% discount or more on fundamental value. I don't think we have seen real bargains in the US stockmarket since Greenspan succeeded Paul Volker.

[BrooklynGOP]

The economy and the stock market are not the same thing. The economy is in good shape, the stock market will correct itself by 8-9% by the end of the year :P

[coloradan]

It really looks to me that housing is going to pull us into a recession.

That would be totally unexpected, given the inverted yield curve earlier this year. Inverted yield curves have NEVER forecast recessions before!!

[TeddyIke]

lol. good point. I almost forgot that. How many months was that light flashing danger?

[conservatism_IS_compassion]

Interesting analysis. Anything that starts out sounding like, "No news is good news - because good news 'isn't news'" gets my attention. Because I think that is a fundamental which is difficult to keep firmly in mind "when all about you are losing their heads - and blaming it on you."

Journalism is about attracting attention and selling advertising. That is their business model. And since the construction of a house, tho good, is planned and executed gradually, it is naturally less of a "news" item than the destruction of that same house in a fire. And that explains why the Chicago Fire is much more famous than the prior construction of Chicago from scratch in a few decades in the Nineteenth Century.

Speaking of which, it is interesting to note that Chicago was the first place in which "balloon construction" was done. You have probably seen "balloon construction" - unless you are blind; that is how Americans have built houses ever since. It was called "balloon" construction because it was so light compared to the timber construction which was the norm from time immemorial. I got that information from The Americans: the National Experience, which is the second book of a trilogy by Daniel Boorstin. Fascinating book, highly recommended.

[coloradan]

6 months, I think.

[MikeHu]

Mainstream media’s “news” is not objective — but a dysfunctional perspective of life, which attracts dysfunctional personalities to the profession — that increases that mob-think. Different professions, like every subculture, attracts a certain profile of personality as their ideal — which of course eliminates the kind of real diversity which would provide them perspective and insight. Instead, they are a narrow group of narrow minded people who get more inbred every year until they cannot understand why the rest of the world has passed them by, while they insist they are leading the parade, or at least the thinking in this country — when in fact, they have self-selected so nobody can think, so as not to threaten the editors and the rigid pecking order that drives out the talent.

When the talent is locked on the outside and regarded as the “enemy,” those subcultures, even if at one time predominant, have doomed themselves to sterility and extinction. And that is the present state the mainstream media (journalism) finds itself in. Yes, they have been successful at ensuring that nobody with talent can ever bypass all the drones who think the way to get to the top is just to outlive everybody else and harass the up and coming talent, into leaving, after exploiting them as much as possible during their internship, thinking they’ll always be an unlimited supply of ambitious fools willing to prostitute themselves and demonstrate their dedication to do “anything” to get to the top.

That’s why when one sees these “writers” on television or even pictures in their byline, one then understands why such hideous people could produce such a twisted and distorted view of the world — and think that’s what the rest of society should think to be accepted as “normal” in their opinion — as though that opinion should matter.

Journalists are very prone to envy and resentment because they often interview these “famous” people, many who have no talent and ability either, and wonder why that can’t be them — because they have no insight in what is going on, and think that they are entitled to be just as famous — but for what, they don’t think is necessary to master.

So basically that’s all we see these days in the mainstream media as the “news” — everything that is not important to know, while useful information is denied, suppressed or ignored. Meanwhile, they all think they deserve to be the next media icon. So what if they are coarse, stupid, ugly people: “look at Helen Thomas” and virtually everybody else featured in the newspapers. Why these people should have any presence in the American consciousness is beyond me.

[frithguild]

Volume

[WashingtonSource]

Thanks