Tuesday, September 21, 2010
10 Reasons to be Bullish on Common Stocks
Years ago, at the end of 2001, Warren Buffett wrote an article on the outlook for the stock market in Fortune magazine.
The article was largely bullish on stocks, which turned out to be a great call. However, there was another part of the article that has stuck with me over the years.
Charles Darwin used to say that whenever he ran into something that contradicted a conclusion he cherished, he was obliged to write the new finding down within 30 minutes. Otherwise his mind would work to reject the discordant information, much as the body rejects transplants.
Man's natural inclination is to cling to his beliefs, particularly if they are reinforced by recent experience - a flaw in our makeup that bears on what happens during secular bull markets and extended periods of stagnation.
And so last night, at 3 in the morning, I woke up with a start.
Perhaps, I thought, there were a number of reasons to be bullish on the stock market, despite the steady drumbeat of negative economic news and my own innate caution.
So I got up and started writing. And much to my surprise, my notes were still legible in daylight:
1. Fed policy remains very accomodative. As this week's Economist notes, recessions are almost always the result of tight monetary policy. Most of the talk in Washington is about more Fed stimulus, not tightening;
2. With exception of the dismal unemployment rate, much of the recent economic data is actually not all that bad. True, GDP growth is has been low relative to other recoveries, but at least it is moving in the right direction;
3. The highly partisan bickering in Washington greatly reduces the chances of a major fiscal policy mistake. Yes, taxes will probably go higher, but it now seems more likely that they will simply revert back to the 2001 levels, prior to the Bush tax cuts;
4. Transportation stocks have continued to move higher, which is typically a bullish signal for the economy and the stock market;
5. Corporate cash levels remain very high, and we have seen a significant pickup in M&A activity. With top line growth muted, it is now almost an announced strategy for many companies to "buy growth" through acquistions;
6. The appetite for corporate bonds has remained strong, with no signs of worries. Even the junk bond market has been robust, and yield spread levels are back to 2007 (i.e. pre-crisis) levels;
7. Sentiment on stocks is ridiculously bearish. Domestic US stock mutual funds have seen large outflows in favor of either bonds or emerging markets. If most managers are bearish, can't most of the "bad news" be already priced into the market?;
8. September is historically the poorest month for stock market returns, yet we have actually had a pretty good up move so far. The fourth quarter, meanwhile, is historically the best;
9. Referring to point 8: volume has been low, and concentrated in just a few stocks, so a number of analysts say that the rally this month means little. On the other hand, historically good moves in stocks rarely begin with explosive volume, so perhaps the current market action is actually positive;
10. For anyone with a time horizon of longer than a few months, it is hard to get excited about investing in either bank CD's or short maturity bonds, with yields of 1% or less.
Yesterday's market action, I thought, was actually pretty encouraging, since both bond and stock prices moved higher together. There's a lot of cash on the sidelines that needs to be invested.
Finally, I would not that when Buffett wrote his article in 2001, we were just in the aftermath of 9/11, and virtually no one was bullish. Of course, his analysis was correct, and stocks moved sharply higher for the next few years.
Last week, Buffett dismissed talk of a "double-dip" recession and a stock market swoon. Just like 9 years ago, the media was fully of people dismissing his comments.
But it has rarely paid to bet against Buffett, and so perhaps we should talk about what might go right rather than all of the pitfalls that await.