Crisis of Confidence

We are in a bear market caused by the excess in residential real estate, the deleveraging of the global financial system and a major credit crunch. But the issue we are faced with today is shortage of confidence, not shortage of capital.

Seeing the news headlines, clearly people are frightened. However, it is important not to ignore the good news drowned out by the juicy headlines that sell newspapers and garner ratings. To get some perspective on recent events, here are some facts that do not receive prominent exposure on the news:

• The U.S. dollar is getting meaningfully stronger vs. most currencies, especially the Euro
• Oil is off more than 50% from its peak
• Commodities prices are sharply declining
• The Consumer Price Index (CPI) had its first decline in almost two years
• Our Exports are growing
• Unemployment is near its 60 year average
• The Federal Government is engaged in an unprecedented effort to inject liquidity, provide relief and restore confidence in our financial system
• Cash (savings accounts, CD's, and money market funds) on the sidelines is at a 15 year high, much of which will likely return to the market once confidence is restored

History shows that market crises are inevitable. But painful as they may be, they are ultimately surmountable. Our capital markets are resilient. Markets overshoot occasionally, but surviving companies emerge much stronger. The U.S. economy has grown over every decade in the last century, and the market generated double-digit returns despite numerous bear markets, recessions, stock market crashes, two world wars and several other wars, the September 11th attacks, a major oil crisis, double-digit interest rates, rampant inflation, high unemployment, political scandals, the resignation of a president and the assassination or death of several presidents, and much more. I believe this time is not different in that investors focused on long-term objectives will be rewarded for their patience.

Stocks cannot be cheap and popular at the same time. A basic rule of investing is to buy them when they are unpopular and selling at bargain prices. An environment like the current one, where so many stocks in every sector are on fire sale, does not occur often and typically does not last very long (even though it can feel like an eternity while going through it).

For the market to go up from here, the news doesn't have to be good. It just has to be not as bad than what people currently expect.

Consider:

• The peak-to-trough decline in the Dow Jones Industrial Average is the second worst since the Great Depression
• The volatility of the S&P 500 is at record levels (historically a reliable predictor of bottoms)
• The Dow is 30% below its 200-day moving average, the widest spread since November 1937
• The S&P 500's dividend yield is now above the yield on 10-year Treasury notes for the first time since 1958
• Stocks are now valued at 59% of GDP, well below their long term average of 79%

Warren Buffett understands asset values and market behavior better than anyone. In 1974, at the time the worst bear market since the 1930s, he wrote a now famous Forbes article and said the time was right to buy stocks. It turned out to be the best buying opportunity in a generation. In 1999, he warned that prices were very high and future rates of return are likely to be sub-normal. And indeed, the trailing 10-year return on stocks is now negative. Mr. Buffett wrote an op-ed piece for the New York Times about a month ago, in which he said values are compelling and advised buying US stocks.

We at Wellcap partners have been listening. You should, too.

Alan Schram is the Managing Partner of Wellcap Partners, a Los Angeles based investment firm.

Comments

[JBS]

The REAL shortage is HONESTY on Wall Street.

The "market" is a swindle, and as long as it remains a swindle, no one in their right mind is going to trust their money there.

[truthforme]

"But the issue we are faced with today is shortage of confidence, not shortage of capital. "

I stopped reading after that line.

[Vickster]

From where I live, the problem seems to be that all the capital has been squeezed out of the middle class.

[jsarets]

The market overshoots, but it has never overshot by $600 trillion in worthless derivatives, it has never overshot in an environment where exponential growth in energy supply is almost certainly out of the question going forward, and it has never overshot in a globally integrated economic order.

The MBA class can lean on their crutches of historical empiricism all they want, reaching for the Great Depression and such, but the fact of the matter is that we've long since entered uncharted waters devoid of valid historical reference points.

The way you know this time is different is that in 1929, the Morgans, Rockefellers, and Aldrichs all exited the market before they began calling in the margin loans. The elites were in control. This time, the elites have egg on their faces and they're quite simply eating it. The elites are not in control -- they're running for the exits with their tails between their legs.

This was not supposed to happen. At least not so soon. The powers that be got exposed by outsiders (e.g. Meredith Whitney) before they were ready to kick the legs out from under the economy. The most appropriate historical comparison that comes to mind is not the Great Depression, it's Waterloo.

[vietveter]

Spoken like so many of

the "wise men" that have not been laid off.

RIGHT HERE, this family, right now

the problem is a lack of capital.

[republifornian]

cogitoe is correct if you didnt see this coming mid september you missed the boat, our tax advisor told us that we should sell our stock and convert it to cash and tax free muni bonds, and then we cashed in the 401k's and are doing some short selling to make up what we lost on the market, we are holding fast and wont reinvest until I know for sure what bo is going to do about capitol gains and the bush tax cuts.

[Cogitoe]

Yes, the shortage of confidence starts starts out as a symptom of the problem and then becomes the problem, but it is grossly inaccurate to say there is not also a shortage of capital as most people understand that word. There may be an unusual level of cash on the sidelines, but the amount of liquid investible capital (public stock and bond values) has decreased significantly. As for the "glass is half full" list, oil, commodities and the CPI are down becuase we are entering a deflationary environment which actually scares the Feds more than inflation. Unemployment may be a t a long run average, but it is expected to quickly rise to painful levels. I am not suggesting we panic (if you did not panic by September you missed that boat), but there is also little basis for cheerleading.

[PoliticalAnimal]

Where are the perp walks?

[movecenter]

That may apply to banks, but many individuals have big problems with capital.

[KillTheMessenger]

Nice confidence trick. Just let us all forget about the basics and invest all our money in the market. WITH CONFIDENCE.

:-)