Tuesday, March 16, 2010

Recognition Phase

The most significant damage done in markets often happens in the recognition phase. That moment when reality and optimism diverge. As I see the reality I can't help thinking of the apocryphal tale of General George Custer shouting above the din of battle, "Take no prisoners!" Looking across the spectrum of the economy Ben Bernanke might feel similar.

Using fundamental measures of market value, from 1929 until the late 1990's, the market has carried a higher valuation only twice. In late 1972 prior to a two year 50% decline and in summer of 1987 before the market plummeted in the autumn.

Anyone who has read Bringing Down the House, the story of the MIT blackjack "team", knows when the odds are good you pull up a seat at the table and when they are not, you walk away. If the fundamentals of valuation look iffy, what could drive the speculative values higher? The monetary stimulus of the Obama package can hardly be replicated in 2010. The consumer driven economy will be lackluster at best with high levels of unemployment and constrained consumer credit. The outsized gains in the market during 2009 have already discounted a normal recovery a couple years into the future. This is not a normal recovery and a couple years in the future, is just that, somewhere over the horizon.

The chart above shows what more than a decade of buy and hold has down for investors. What was it good for? Absolutely nothin'.

John Barnyak
Stonehouse Asset Management

"Custer,was a man of boundless confidence in himself and great faith in his lucky star."