Is it time to buy Equities ? #2

Another week of doom and gloom with Intel and Walmart cutting forecasts and the US government's bail out package with a somewhat surprising shift in priorities (buying back bank stocks rather than mortgage assets). We'll see what Congress's and the general public's reaction will be to that and how things eventually pan out.

The positive side of that is that prices are back down to the lows (or will be shortly) - so here's another couple of reasons why I haven't joined the "the world is coming to an end" camp.

Commodity prices as a buffer: Let's be honest. In hindsight it was truly remarkable how we could have a nice couple of years of bull market when the world's most important commodity (oil) went from sub 12 USD in '01 to almost 150 USD in July '08. Even if you take out the currency effect for the rest of the world (the USD went from 85c to the Euro to 1.6 over the same period) that's still a massive dent in consumer's real purchasing power. But that also means that now on the way down (Oil at 56 USD today) this purchasing power gets unlocked and back into the market again as oil is in almost every product (either directly or through transport). And we haven't seen that effect fully yet as prices at the pump lag oil moves quite a bit (especially on the way down..surprise). US Petrol prices have fallen an average of 40% from July while Crude is down over 60% . Europe is even worse in passing on the benefits.

Similar price declines happened to other commodities (metals and agriculture) where the impact on the consumer is less obvious but all in all recent price action will lower inflationary pressure on consumers and increase relative purchasing power which in turn should help stabilise the economy (to a certain degree) on the way down.

"Bad debt": It seems like everybody these days talks about it and how the tax payer will have to pick up the tab - cab drivers, hair stylists, journalists that usually only report on celebrity gossip have all become experts overnight (and of course it's only the bankers that are to blame - why should anyone NOT take out a mortgage if it's offered to them even if they can't afford it). Consensus is that there is a lot of it around and that it will take a while to clean up.

First of all, while this is true for the consumer, corporate balance sheets (with the exception of banks) are in solid shape. Investments in this last business cycle were one of the lowest ever relative to earnings. Lending conditions (or lack thereof) do remain a worry, but with governments around the world working hard on restoring banking business I think we've seen the worst liquidity shortages.

Secondly, let's take a look at the situation in Japan when the government stepped in and ended up buying up "bad debt". Over the period of 10 years almost 100% of the original investment could be recovered reducing the bill for the tax payer to almost zero. My bet is that the US economy is in better shape than Japan in the 90ies (demographics to start with - a growing population) and that nationalising stakes in banks at these depressed levels will yield massive profits in the next 5 to 10 years when the sector gets fully privatised again. Europe might not be participate in this as much as the potential for long term government involvement in those political environments is much higher.

So while short term there will be strain on budgets across the globe, government could find themselves awash with cash coming out of this which in turn would lead to some decent spending increases (or have you ever met a politician who wont spend a surplus) and accelerate growth.

Lessons of long term investing: In summary, I don't believe that we'll be able to avoid a full blown recession and yes, things in the stock market might get worse before they get better. But for the reasons mentioned above and my strong belief that the fundamentals of the world economy remain sound I think that the current levels in Equities are starting to look very interesting for any individual with a 5 - 10 year investment horizon. In addition to that I believe that the USD will continue to strengthen vs the European currencies so US investments, like the S&P 500, make the most sense for me. The dilemma for institutional investors at the moment is that they simply cannot be patient. The investment industry by and large gets evaluated on quarterly numbers and a quarter or two too early could be the last quarter for many funds in this environment. As a private investor one should take advantage of the luxury of being able to have a long term view. Buying at the absolute bottom and selling at the top never works.