I am reading numerous comments in the media (and by SA readers too) about the advisability of waiting for a drop in the market in order to buy stocks. Well, it is never bad to buy stocks on dips and I am not going to discourage anyone from trying to buy cheap. But some points have to be made in an attempt to save - those who are willing to be saved - from the bad advice that has been oh, so popular over most of the past 3-3 ½ years from numerous highly rated commentators whom we know well but who shall remain unnamed here. They cost many people, individual investors and professionals, including some of our clients, quite a bit of money in unrealized gains.
Reasons for being bearish are plenty: from Europe to China, to the huge debt the USA is accumulating, to fear of a double dip recession, to housing that does not recuperate and consumers who are alleged to be scared and pessimistic because their earnings are not growing and, above all, the political uncertainties that bedevil us all… and on and on.
All true but all impotent in the face of the all-mighty American economic machine which keeps churning on its natural course. This could be dismissed as cheap pep-talk but when, dear reader, you look at a few selected graphs, available to anybody but insufficiently read by most, you may just change your mind.
First let us look at the savings rate:
From a panic-driven 8.3% it is now down to 4.4%. What happens to all that "unsaved" money, may I ask you? It goes into consumption, where else? And in order to dissipate any doubt in this direction, here is a graph of the retail and food service sales:
Note the upward departure from the green trendline between 2004-2008. What happened there? It is the reflection of excessive borrowing and it is a classical manifestation of the "appearance of prosperity" which must turn into a collapse which this time has been dubbed the "Great Recession". Whatever clever names our beloved pundits come up with, we have here a text book boom-and-bust cycle. Of course, you have to read the right text books as not all would give you this very clear reversal to the trend picture.
After the bottom has been reached, the consumer started improving and is now back to the trendline. Noticed the pundits who were recently bemoaning the consumer's "loss of steam"? What they were seeing was that little wiggle at the end of the blue line which brought it back to the green trendline. That much for listening to pundits rather than trying to see the entire picture.
So how about the housing? I probably do not need to convince any serious follower of the economy that it an essential part of the US economy. The graph below gives a good feel of what's going on:
The blue line is the actual reported Case-Shiller number and the green dashed line was a somewhat daring, but simple common-sense-driven forecast that we put forward in May 2009 when a low in this time-series seemed to have been reached. No learned algorithms were used, no consensus forecasts were considered. We simply said that the real estate market "felt" the same as it did in October 1993. And, after double checking with some experienced "on-the-ground" real estate practitioners, we took the risk to assume that the development from May 2009 onward will be the same as it was after October 1993 and we simply "chain indexed" the subsequent performance (apologies for the statistical term being used).
We were met with some polite scorn by a professional economist working for a very large institution who, after a 2010 meeting in which we presented this forecast never invited us back to his office: so be it… But being simple-minded can sometimes turn out better than being too sophisticated. Here is the detail of the 3 years since we made that forecast:
Note how little the actual performance diverged from our "primitive" projection and how the blue line appears to be trending back toward the estimated dashed green line. May I stick my neck out a little further here and suggest that the explanation for the over-performance in the first part of the period was simply the effect of government stimulation to which the real world of the American economy responded with the subsequent decline. Come to think of it: this is not unlike the phenomenon reflected in the graph of the retail and food sales shown above. What this highlights is that governments can and indeed do influence the economies; but they cannot dominate the overwhelming natural trends at work. All they end up doing is to create some (misleading) volatility...which pundits pick up and sell as real trends.
So how can this be used by an investor? Just as indicated in the introduction to the article: do not let the pundits drive your investments. Their interest is to sell their paper or TV show, not to help out your portfolio. Of course, not any stock will be a good buy at these times and, should you be interested, you can read how we analyze the analysts (Part I and II) in order to come up with some reasonable selections. Doing your due diligence, by yourself or with the help of a good professional, is obligatory.
As for how long the current bullish period will last, no one can say for sure. But a fair guess would be that it will exceed a couple for years. The situation must be watched very carefully as we are dealing with human emotions rather than natural phenomena…Although the empirical data may indicate a relationship between the two. For more on the market cycle, again, if you care to read some more of our opinions, you can go here.
Graphs Copyright © Aug. 1, 2012 Clement Moore Ogden.