- Elvis Costello
The selling over the past few days smacks of panic, yet again.
Some of this melt-down is forced selling as de-leveraging continues in the realms of the Masters of the Universe. Some of this selling is due to bear raids that are specifically designed to wreck the financial stocks and force the government to come in and wipe out the equity of bank stock holders. And some is just sheer panic.
It is incredible to me that people are willing to throw out everything and run and hide in the so-called “safety” of the Treasury market while opportunity beckons across risky assets unlike anything seen in decades. As the government gets ready to run trillion dollar deficits for as far as the eye can see, investors are so cowered that they are willing to accept 2% a year for a decade.
There is this theory in finance known as “The Efficient Market Hypothesis.” This theory postulates that, to varying degrees, the market is an efficient processor of information, whether it is all information (the strong form theory) or merely all widely known information (semi-strong form theory), and that information is priced into stocks. Because stock prices are a reflection of all or all known information, the market is "efficient."
But consider what we have gone through over the past decade – The Asian Contagion, the collapse of Long-Term Capital Management, the Tech Bubble, the Credit Bubble, the Housing Bubble, and most recently government T-bills with negative yields.
The market is not a wise, all-knowing processor of information and seer of the future. The market is an idiot.
Everywhere I look, I read that it is the end of the world. All the news is bad. Everything is horrible. It is the Great Depression all over again. And so on.
Yes, the economy is bad. Yes, things are bleak. Yes, the world has changed. Who on God’s Green Earth doesn’t know this already? But is it really the end of the world?
Economic growth is driven primarily by technological progress. Advances in technology make things cheaper and lowers the cost curves of producers, freeing up resources for investment and expansion. This process is usually known as “productivity growth.” And unless the American public has become collectively lazy and stupid all of a sudden, the technological advancement and productivity growth that has made this country the richest nation the planet has ever seen will continue.
This is not to minimize the problems in the economy. We may be on the brink of a true depression, if a depression is defined as a 10% contraction in economic activity. We must continue to de-lever. We have some very serious problems we must work through.
But we are working through those problems. Many of the dominoes that had to fall have fallen. More dominoes must fall but we are nearer the end than the beginning.
This decade so far has been the worst decade for stocks. Ever. Valuations for stocks are attractive and the expected return from equities is at the highest level in decades. Credit markets are improving and governments are flooding the financial system with liquidity.
The most powerful force in asset markets is reversion to the mean and we have overshot the mean on the downside.
Can the market go lower? Of course. Markets can do anything they want.
But others can bet against reversion to the mean. I’m not.