Monday, March 26, 2012

A New Era? Not Likely

I don't mean to be unsympathetic about the challenge of being a market forecaster or economist.  After all, the record of supposedly the best in the business is quite poor.  Instead, the evidence is overwhelming that a value-oriented investment approach of buying when individual stocks have cheap valuations (on book value, sales, and earnings) or the stock market overall is historically cheap produces the highest returns.  I know there are exceptions by investors who adeptly use technical analysis or momentum approaches, but value works--not in every period, but over time.  It is hard to follow because it goes against human nature and many of the behavioral biases that work against the average investor.

Though the stock market currently is still historically cheap versus quite overvalued U.S. Government bonds, it is not at all clear to me that now is a good time to make major purchases, after a rise of more than 25% since last October and a more than doubling off the historic low three years ago.  

Yet that is what Goldman, Sachs now recommends in a new report, titled "The Long Good Buy."  Goldman argues that now is the best time in a generation to invest in stocks.  One key argument is that interest rates on savings and government bond holdings are so low that there is no effective alternative to stocks.  

Reports of hedge funds capitulating and throwing money at the stock market to try to make up for trailing the market indexes this year has provided additional power to the recent rally.  This rally, led by Apple's seemingly endless runs to new highs, seems to have little risk.  

But with measures of market sentiment at elevated levels (and stocks technically overbought)  I think risk is greater than is apparent.  

I have never accepted the assumption that if bonds are expensive, one must buy stocks instead.   Cash is always an alternative (though not worth the career risk for many institutional fund managers).  Even when cash yields almost nothing, it provides valuable resources for when better investment opportunities arise.  I have long thought it unfortunate when one must be fully invested in a market selloff and is unable to buy at depressed prices without selling something else that is (similarly) depressed in price.

So, my advice continues to be to raise cash for better values later.

Steve Lehman

 S & P 500:  1400

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