Sunday, February 17, 2008


There is no denying the fact that the stock market continues to face some fairly substantial issues right now. Problems in the credit markets persist. The banking system has some difficulties. There is concern that the subprime slime will spread. And there is a great deal of debate about the state of the U.S. consumer and the degree to which a slowdown here in the U.S. might affect the global growth story. However, despite all the hand-wringing and teeth gnashing, we feel that it’s time for investors to choose sides in this game.

The bears argue that we have never seen a financial crisis of this magnitude. They say that the banking system is on the verge of collapse and that the U.S. consumer is starting to bury their heads in the sand. Our furry friends are also fond of suggesting that we will soon enter something that more resembles a Japanese-style depression than the slowdown in growth their opponents are purporting.

On the other side of the aisle, our heroes in horns argue that the Fed is aggressively easing interest rates, which, history shows, has usually turned both the stock market and the economy northward. The bulls are also quick to point out that the data from the retail sales report this week showed that the consumer isn’t quite dead yet. In addition, the bull camp reminds those with an open mind that there is still a debate about whether or not the economy will even enter a recession.

For those concerned that this is 2000 – 2003 all over again, the bullishly inclined point to the fact that valuations in the stock market are not excessive by any stretch of the imagination and that the cycles in play this year suggest an upturn should begin in the very near future.

However, being the stubborn creatures they are, the bear camp refuses to waver in their conviction that they will ultimately be proven right. Their thinking is that the sky will indeed crash down around our ears because the subprime defaults will spread into credit cards and auto loans. The glass-is-half-empty crowd also believes that the U.S. consumer is going to stop shopping altogether and that the growth in the burgeoning economies of the world is about to stop on a dime.

It’s Time to Choose
Getting back to reality, most of the economists I respect are looking for the economy to either “brush with recession” or experience a very mild pullback. And since stock market valuations are not sky-high right now, most experienced investors recognize that the downside is probably limited to single digits from here.

It is also important to recognize that this stock market correction is not being driven by the economic outlook. No, this is a correction caused by a financial crisis. And in the past 20 years or so, these types of corrections have proved to be far less damaging than the bear camp proposed at the time, and were relatively short.

So, with subprime having celebrated its one-year anniversary last week, we feel it is time to decide which camp you are in. You can side with a naysayer like Ron Insana (former CNBC host, now turned hedge fund manager), who likes to espouse that the financial markets and the economy are in dire trouble. Or you can side with the bulls, who argue that with the Fed and the boys and girls in Washington D.C. in their corner, nothing too terribly bad is going to come of this mess.

As you might be able to discern, we tend to favor the latter argument. While we do not, in any way, shape, or form want to downplay the severity of the hundreds of billions of dollars of stupidity that is the subprime CDO problem and we do understand that there may be another shoe or two to drop in this ongoing drama, we also recognize that it rarely pays to bet against the good ‘ol USofA.

I learned a very long time ago (1994, to be exact) that unless you make your living shorting stocks, it rarely pays to be a pessimist in this business. Sure, stocks encounter a bear market every three yeas or so. But history shows the market spends nearly three times as much time going up as it does going down. So, as a card-carrying bear, your victories may be sweet, but they are definitely few and far between.

The stock market is a self-correcting vehicle that is able to adapt to the environment on the fly. And given all of the writedowns ($150 billion and counting) and the worries about the banking system, one can argue that the market indices have actually held up fairly well. Sure, the correction has been a bit nasty at times. But remember folks, corrections are part of the game! These things are no fun at all. But, at this stage of the game, it might help to be reminded that, on average, the stock market tends to experience one of these corrective phases once a year or so.

And while I recognize that we’ve already “done the math” recently in this column, let’s not forget that since 1900, the average bull market has enjoyed gains of +85.1% while the average bear lost -31%. The point here is that since the market has already dropped a fair amount, it is probably time to begin thinking about ways to benefit from the next bull market that is bound to come along.

Time To Go The Other Way?
So in closing, we believe that it is time for individual investors to make a decision. If you believe that the U.S. will somehow muddle through this mess in the credit markets, then you need to be looking for opportunities to buy some stock here and there. Go ahead, consider picking up a few shares of your favorite names the next time the market plunges a few hundred points.

However, this is not to say that we won’t see new lows in the major averages, so it might be best to space out the purchases one plans to make. And we are NOT saying that we won’t see a recession or even a bear market on the Dow and S&P 500. But, in light of the fact that the Fed is on the case, we DO believe that the downside is limited from here. So, is now the time to be focusing on the well-worn bear case? Or is it time to start looking to the other side of the abyss?

Wishing you all the best for a profitable week ahead,



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