It is Time to Get Greedy in the Stock Market


by

29 September,2011

Difficult as it may seem to imagine but this will turn out to be a great time to buy stocks.

Being a contrarian tends to pay off really well long term. Buy low and sell high seems obvious enough but it is a difficult idea to really put in practice, specially when the market falls down the precipice such as it did the day after Bernanke’s Operation Twist. Investor behavior may be rational in the long term, but the short term is more like a stampede.

The Stock Market will Recover

At this time I believe that we are close to, or already have, seen the bottom in the stock market. The pessimism is all pervading, triggered by the despair about Fed’s inability to impact the economy in any meaningful way. But precisely due to the fact that there is not much any one in the government can do to fix the economy, I think it is going to get better from this point on. Allow me to explain.

Businesses will Stop worrying About Government Actions and Re Focus

There is a big reason why the banks are hoarding their cash and not lending it out. Or that many of the large technology companies are sitting on mountains of cash and not doing what they would have normally done: acquisitions, new launches, new plants, hire workers, etc. The reason is that the businesses today are not really sure what new policies or regulatory changes they might see in the future and so they are hedging their risk by not spending. Now that it is evident that the Fed has no more ammunition left in affecting the monetary policy in the country (such as artificially keeping interest rates low) a great deal of uncertainty has been lifted. Now market dynamics again take precedence and that is something businesses are able to model and react to.

Looming Elections

Other ambiguity in the market centered around all the anti business initiatives the current administration has taken so far. National healthcare, raising taxes, etc’ all has the effect of raising costs for the businesses and it slows down the business activity. With the elections looming in 2012, it is unlikely that the current President will embark on any new “reforms” as radical as these for two reasons.

  1. The focus of the government is slowing shifting towards elections away from the national issues, and
  2. There is every incentive for both parties to stick to their platforms to strengthen their electoral prospects

A stand-still government is preferred as the business community knows what to expect and what not to expect and they can then adapt.

Parallels to the Great Depression

The Great Depression was prolonged by Herbert Hoover’s desire to actively get involved in the economy and try to steer it. The fact is that governments do not really create economic value. All they can do is to take resources from one part of the economy and channel it to other parts. This reallocation of resources invariably destroys value as there are costs of doing so in a top down manner. The markets are the most efficient way to distribute resources where they can create the most value.

At this point in time, I believe that the stock market has digested the shock of Quantitative Easing 3 and now understands that there is not much the government can do to fix the economy. Therefore the market mechanisms must and will take over and the economy will now find its footing.

In this tide of bad news, it is easy to overlook some of the positives that did come out in the last few weeks. Foreclosures are slowly and surely declining and the inventory of foreclosures is getting smaller as investors are now jumping in. Most companies are still profitable, and some are more profitable than ever before. Heck, Apple Computers now has more cash on its books than the US government. We are likely sitting at the beginning of a new bull market and this is a great time to find good stock picks to benefit from it.

Another reason to invest now? When the stocks are cheap, the risk is also at its lowest.