Posted on 03/17/2007 9:21:47 AM PDT by frithguild
THREE WEEKS AGO in this column I wrote that my valuation model made stocks look attractive for the long term — but it was also saying that a short-term correction was due. My model sure was right about that correction.
The model is based on just three factors: stock prices, corporate earnings and interest rates. Over the last three turbulent weeks prices are lower, earnings are higher, and interest rates are lower. All three factors have moved in the direction that makes stocks look like a better value.
I don't have a firm conviction about whether stocks have literally hit bottom in this correction. It wouldn't surprise me if they had to probe a bit lower. But it wouldn't surprise me if this Wednesday's intraday low was the turning point. From here it doesn't matter — the difference between those two possibilities is just a couple percent.
What matters are the larger questions: Is this really just a correction? Or is it the beginning of a new bear market?
If it's just a correction, we could be back to the old highs within a couple months. But if it's a new bear market, then a value-based rally coming up here will itself just be a correction, and we'll eventually slip to much lower lows.
For me, the bear case is all political. I'm neither a Democrat nor a Republican (I'm a registered Libertarian, if you must know) — so I don't really care which of the two major parties is in control. That said, I know that the agenda being pushed right now by the Democrats, if it succeeds, will be very damaging to growth, and ultimately to stocks.
As I wrote here two weeks ago, the Democrats' obsession with stopping so-called "global warming" could end up putting all kinds of useless but costly restrictions on business. And their plan to implement the largest tax increase in history, by letting the low rates put in place in 2003 expire, would crush the economy and the markets.
But the Democrats control only a slim majority, and they don't control the White House. And the 2008 elections are an eternity away, in political terms. Those risks are real risks, but they are just risks.
Here and now we're facing other imminent negatives, most notably the collapse of the subprime mortgage-lending business. At this point, we need to ask ourselves whether the economy is poised for recession whether or not the Democrats ever end up making it any worse. I've come to the conclusion that the subprime panic is just that — only a panic.
I'm not saying that there isn't a problem in the subprime sector. Delinquencies and defaults are up significantly, and some firms that specialize in subprime lending are in real trouble, and may never recover.
But just because there's a problem, that doesn't mean the economy is headed into recession because of it. Think back to a year and a half ago when two back-to-back hurricanes wiped out a major American city and destroyed a large fraction of the nation's oil and gas production and refining capacity.
That was a real problem, indeed a tragedy. But it didn't cause a recession or anything remotely like one. And the subprime problem won't either.
If subprime were a real threat to the overall economy, we'd be seeing signs that we're just not seeing. For example, we'd be seeing the credit crunch in subprime spilling over into the whole mortgage market. And we're just not seeing anything like that.
If anything, we're seeing the opposite. Today conventional fixed-rate and one-year adjustable-rate mortgages are cheaper for consumers than they were just six weeks ago, before the subprime market blew up.
That's partially because interest rates overall have come down, and mortgage rates have come down with them. But we haven't seen any significant increase in the spread between mortgage rates and Treasury yields. In fact, mortgage spreads are lower today than they were for most of last year, back before anyone even started thinking about subprime.
My general optimism that stocks will eventually recover from this correction is not just based on the idea that subprime problems won't trigger a recession. There's more to it than the absence of serious negatives. We should remember the positives, too.
Interest rates are low. Inflation is low. Tax rates are low. All of those things may change for the worse, and there's a good chance they will — but that's over the horizon at the moment. Right now those are all strong positives for growth.
And don't forget the tremendous benefits the U.S. economy is getting from globalization. I know, mostly when you hear that word it's in connection with the trade deficit, and the idea that we're losing jobs to places like China and India.
But here's the reality on that. For all the chatter about the trade deficit, did you know that U.S. exports are at all-time highs? It's true — they were almost $127 billion in January. And they've been growing at double-digit rates for most of the last four years.
Stocks are cheap again. The proximate threats to the economy are not overwhelming. And the really big threats are over the horizon, and it's still possible to mitigate those risks.
So I'm operating on the assumption that the stock market decline of the last several weeks is just a correction, and that we can expect to recover from it. I'm not ready to say we've seen the lows, but I'm starting to gear up to call a bottom at some point here.
Bear markets always arrive unexpectedly. So do bull markets.
So if the signs point one way, or another, don't believe them.
Economy, Financial Markets and Investment Ping List (PCP)
Profit Center Ping
Inflation is low?....what planet does this guy live on?
Adam Hamilton of Zeal is predicting dow 7000 by end of 08.
Thanks. :)
I just had another thought. Some of the topics and discussions you mentioned may not have specific articles related to it. You may consider starting an ongoing thread, and ping people to the latest post where some new topic of discussion is starting. And if the thread will go on and successful, as I expect it to be, it could be a regular "Daily Thread" and have a spot on the Front Page of FR, along with "The Threat Matrix" and other threads.
Look at the list of "Daily Threads" on the left side of the FR front page.
The Threat Matrix started kind of the way you are starting the PCP (Profit Center Ping), but we had the same issue that we will have here, that not everything we want to discuss is in an article, to be posted. There is a new Threat Matrix posted every month, and the posts just go on, but people ping people to new posts and have a discussion. That model may work well for the PCP.
And since there are quite a variety of "Daily Threads", I think if you send a note to Jim Robinson, that you would like to start a "Profit Center" daily thread along the lines of the Threat Matrix, you probably would get permission.
I think it will be quite exciting to be able to go to one thread to find out the latest discussions and opinions.
I am also going to FReepmail this to you, to make sure you don't miss it.
I think your idea and willingness to do this is great and could lead to interesting and robust business/financial/markets, etc. --i.e. "Profit Center" discussions. :)
One more suggestion, if you don't mind:
When you ping people, you might want to add the words "PCP", and "profit center" to the key word list, so people can find all the articles under those key words.
Also -- re. the "daily thread" idea -- that wouldn't preclude pinging to individual articles, just give us another specific forum, in addition.
I also think that if interest rates stay low, we'll be OK, but that's an IF.
"As I wrote here two weeks ago, the Democrats' obsession with stopping so-called "global warming" could end up putting all kinds of useless but costly restrictions on business. And their plan to implement the largest tax increase in history, by letting the low rates put in place in 2003 expire, would crush the economy and the markets. "
I certainly agree with this.
Mortgage rates have dipped down about 1/4% because of the "flight to quality" where investors here and overseas are buying treasuries. As the demand for treasuries increase so does their price and thereby lowering their yield as price and yield move inversely.
That said, I disagree with the author's view of where the market is headed over the next two years. Froth in the housing market will not work it's way through the system any time soon. Then there is China's banking system which poses a whole other dynamic.
The correction will overcorrect and then the market will return to its present level or higher before it goes straight to %$#@ by Thanksgiving.
Yes, the open money inflation is low. The inflation of the black money system is 20%.
That is a system where nobody knows how much money is in circulation.
save
The public should invest in the stock market.Let the pros trade it,they're the only ones who consistently do so successfully.Buy solid companies with most of your investment funds,and use a small percentage to speculate if you absolutely must be a player.
The question is, "Where is all the excess cash coming from"?
Does is come from the US vs Asia trade imbalance?
Does it come from the "Carry Trade" with the Bank of Japan?
Seems that the whole subprime crises is a result of too much cash seeking a parking place?
Also seems to me that the excess capital has to "dry up" at some point?
Just thoughts from me, no answers?
North Korean printing presses?
I guess three weeks from now he'll be relying on this vague statement for chest-beating over his awesome powers of prediction. He'll just need to cut and paste the first paragraph of this article and edit it a little.
Another question I have sometimes is where the money goes when the DJIA drops 250 points in a single session. *POOF* it's gone from the universe. Possibly money can appear *FOOP* just as easily since we don't even use paper much anymore.
And in this corner...
When Carol Venzin needed a loan to fund her hair salon business, the bank was happy to help -- provided she pledged her home as collateral.
Venzin, who owns a Fantastic Sams salon in Pittsburgh, Pennsylvania, and three more in Harrisburg, had ample equity in her house to back the loan, but as the housing market slumps, some other small-business owners may face a credit shock.
"It's difficult to get a loan without putting up your home as collateral," Venzin said, noting that consolidation in the financial services industry has left fewer of the community banks that have traditionally lent to small entrepreneurs.
Many banks have already tightened standards for residential loans...
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