Tuesday, December 20, 2011

Investment Discipline Needed Now More Than Ever

Today's explosive rise in stock prices was welcome in a year with little net gain to show for nearly twelve months of often sharp moves.  Yet, while on a short-term basis stock prices seemed oversold and likely to have a rebound, today's move was lacking in confirmation by trading volume and fundamental news.  

While better demand for Spanish bonds was good news for now, unexpectedly higher housing starts in the U.S. is not necessarily positive.  With an enormous overhang of housing supply still on the market--or being withheld until conditions improve--additional housing supply is not what will give the U.S. economy a sustainable lift.  

Many people seem to think that sustainable U.S. economic growth cannot occur until the housing and banking sectors turn the corner.  That is probably true, but banks continue to conceal the extent of their impaired mortgage-related (and European?) assets.  And as I noted, the housing market needs to work through the excess supply before it can return to even moderate growth, as prior levels of high volumes of unprecedentedly large houses will probably never occur again, largely for demographic reasons.

The investment implications of this are that one should set limits for purchases and sales, while using conservative assumptions about earnings growth over the next year.  If the ECRI leading economic indicator's forecast of a recession is incorrect and growth in the U.S. leads the developed world, then the conservative assumptions used in setting reasonable valuation buying levels will simply have provided a "margin of safety," which is always a prudent approach to investing.

Steve Lehman

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