The Dow is now down 41% since the Bush administration commenced their bailout and stimulus program in September, and down some 30% since the election.
Bailouts and stimulus produce long term uncertainty. Right now the markets are telling us that enhanced government involvement in the economy will crowd out private investment, and higher costs to finance our national debt will dampen future growth and hurt earnings prospects. The markets are telling us we can't keep bailing out every insolvent bank and backstop every bad mortgage. This desperate act to avoid pain is not a strategy and the markets see through it. If we keep digging the hole we are in, throwing good money after bad, we are going to run out of money.
There is no question the economy is heading in the wrong direction and will continue to experience substantial distress. There are three likely scenarios from here. One, if the stimulus package works and the economy recovers. This will be good for stocks. Two, if the stimulus package proves insufficient and we get a Japan style protracted period of low growth and low inflation. This will likely be good for value stock pickers, but hard on everyone else. Three, if efforts to revive the economy prove futile and a deep depression ensues, which will not be good for any equities.
I have no idea which of these is most likely, but I believe that because of policy failures of both Bush and Obama, and because of the desultory performance of the economy, the market is already expecting a depression, and stocks are priced accordingly. So if we end up not having one, the market will rally substantially.
Some people think they should wait until things clear up before they commit to stocks. But the future is never clear, and when optimism abounds, you pay a very high price for stocks. One should not equate the current uncertainty with risk. There is plenty of uncertainty now, but much less risk, because high quality stocks are available at much lower prices, and logically an investment is more attractive AND less risky if made at a lower price.
This should be obvious: Wouldn't you prefer to buy the house down the street at a lower price? Wouldn't you consider that same house to be a better investment, with bigger upside and smaller downside, at the discounted price?
The stock market anticipates future events, and bottoms well before the economy does. Historically, a small percentage of trading days has represented a large proportion of returns. Because very few people can consistently predict macroeconomic events and investors rarely foresee the big market moves, sitting on the sidelines can have large opportunity cost.
The only thing you can do is think about individual business values, and make rational judgments about them, building an investment portfolio with the odds stacked in your favor. We at Wellcap Partners believe this is the best time in many decades to buy quality businesses at what are clearly very attractive prices.
Alan Schram is the Managing Partner of Wellcap Partners, a Los Angeles based investment firm. Email at email@example.com.
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