Buttonwood prays for war

The Economist is really too much this week. Our regular reader will know that I, Baruch, would find their mock-rational stopped-clock bearishness amusing, were it not for the fact that otherwise smart people with scant knowledge of financial markets like my own dear, silent, Bento (wherefore art thou, Bento?) seem to take what they write as gospel.

How has the Economist done so far this year? Well in many ways they were early on subprime; in March Eeyore Buttonwood was warning that risk in equities was rising as subprime debt was beginning its collapse. However, in stockmarket terms “early” is another word for “wrong”. Buttonwood more or less capitulated in June and July, suggesting sometimes the press can be too bearish. In retrospect, this was clearly a signal to sell; the major indices proceeded to drop 10-15% in July-August, partly because subprime chickens came home to roost, also because of a crisis in the crowded trade of Quant investing (more on that later), and also because, well, it was time for something like that to happen.

However you look at it, this bearishness has been disastrously wrong; subprime or no, stockmarkets have been pretty good this year, the S&P500 +10% and at an all-time-high, and NASDAQ +13%, with big moves in big, popular individual stocks. US indices have broken through technical resistance and look like carrying on up for a while. I would bet on 15%-20% returns in these indices this year, if not more. My fund is already up 30% YTD, but of course, I am a genius.

It is particularly since the mid-August lows that stocks have shot upwards, propelled by Fed cuts. It is no surprise to see Buttonwood fighting this every step of the way. We are told separately: we are in a liquidity crisis, rating agencies are hopeless, US corporate profits are at risk, a “benign credit cycle” may go “dramatically into reverse”, it could be 1990 (the start of a bear market) again.

Now this week a clearly incontinent Buttonwood cautions us (with typically immaculate timing) that stocks do not always go up in the long term; indeed a bunch of academics, examining long term returns over 10 and 20 year periods in loads of different stockmarkets, have shown that they can go down sometimes in some countries. Never mind that the academics also conclude “in every country we have examined, equities have beaten bonds, bills and inflation over the long haul” and the skews in the returns they examined have been universally to the upside (their point is that equity returns are a bit lower for a bit higher risk than people think). Buttonwood concenrates on survivor bias. Imagine if you were in the pre-revolutionary Chinese or Russian stockmarkets. Yes, that’s right: don’t invest in stocks, there may be a war.

The main article in the finance section, entitled “Bad-news bulls” jumps on the stalled bandwagon too, subtitled: “Stockmarkets are breaking records again as if the credit crisis were ancient history. If only it were” (my emphasis). Like every Economist article it is an exercise in listing conventional wisdoms in an “on-the-one-hand, on-the-other-hand” format before concluding that currency turmoil, reversion to the mean in corporate profits etc could hurt stocks.

Gaah. Stocks are going up because we are in a period of moderated risks (which may or may not continue), because global growth is strong, even if the US may not be (but we don’t know that it is properly weakening yet), and finally, most of all, because the Fed is on the side of stocks and just cut rates. The credit crisis is, most probably, really behind us. Bonds are expensive, real estate is, well, shitty. People always need to save money and the only real, liquid asset class there is right now are equities, which are cheap relative to their historical multiples. Buy stocks. Buy tech stocks. Buy tech funds.

One day this will change. There will be corrections — we may even get one soon, I bought some puts the other day, a type of health insurance. But the fairly reliable indicator provided by the Economist and Buttonwood is telling us it is still OK to invest.