THE FINANCIAL MEDIA
is so promiscuous in its use of negative language to describe the stock market when prices go down. Stocks "slid," "plummeted" or even "collapsed." You hear it all the time, even when nothing really happened.
So what words are left to describe a really big down day like Thursday? How about, "Stocks became a better bargain than ever!"
Isn't it true? Isn't it all a matter of perspective? If you already had all your money in stocks, then of course you're sorry to see prices fall especially after a day like Thursday.
But if you have cash in your pocket and you'd like to buy stocks for the long run, or add to an existing portfolio, then Thursday was a home run. Your world just got a lot sweeter.
Same thing with home prices. If you're looking to buy, the so-called collapse of the so-called housing bubble is great news. Your dream home just went on sale! Attention all you Kmart shoppers.
Then again, all of this depends on an important assumption: You have to believe that the decline in prices is temporary. You have to believe that it doesn't reflect some kind of horrible permanent change in the economic environment.
For example, the stock-market crash of 1929 turned out to be no bargain. If you'd bought stocks at the end of that disastrous October, you would've had to endure terrible declines in value during the Great Depression, not making a sustainable profit on your investment until 1943, according to data from Ibbotson Associates.
But the stock-market crash of October 1987 was a very different story. The market decline then was far worse and much scarier than the one that ushered in the Depression more than half a century earlier. And, it turned out, much more of a bargain. Had you bought stocks at that month's end, you would've shown a profit after just three months.
So don't be afraid just because you see stocks slide, plummet or collapse. Not even if you see them get nuked, trash-compacted, reamed, steamed or dry-cleaned.
Don't just look at prices, and for heaven's sake don't let yourself be stampeded by the overheated language of the media. Ask yourself as objectively as possible, "Why?"
If the answer to that question is that the world really is getting a lot worse, then step aside as a buyer or consider selling before things really do get worse. But I've learned that usually the world isn't getting anywhere near as worse as the stench of panic in the air would make you believe.
Remember, even if the world is getting worse, you'd still want to be a buyer of stocks provided that their prices fell enough to more than compensate for the deteriorating backdrop.
I'm sure I'll get plenty of emails accusing me of being a perma-bull. Especially from perma-bears who've been so terribly wrong for so terribly long. A day like Thursday is a great relief for these people, who can myopically convince themselves they've been right all along.
But I'm no perma-bull. I have no stake in stocks being up or down, per se. I just want to call it right. And I never want to forget one fundamental truth about investing: No matter what, stocks always have a positive expected return.
Stop for a minute and think about that seemingly simple statement. It's actually quite profound, and it's something that most investors have never really thought about consciously.
If markets are at all efficient, then risky securities like stocks must> be priced so that the people who hold them the people who take risk will get rewarded for that risk-taking, at least on average. If the fundamentals get worse, then stock prices will fall so that from their new low level investors will still have a positive expected return.
Yes, that's an argument for always holding stocks. But believing that argument doesn't make me a perma-bull. It just means I think that over time I'll get rewarded for taking risk.
Markets aren't always perfectly efficient, nor are they perfectly right. Sometimes the risks in the world aren't fully appreciated by markets or at least the risks I think are out there aren't. Then I'm bearish. Sometimes the risks in the world are overemphasized or at least the risks I think are out there are and that's when I'm bullish.
I interpret Thursday's big drop in stocks, in combination with Tuesday's big drop as well, as simply creating a higher expected return for investors daring to buy stocks in an environment that has suddenly gotten riskier. Not really worse, just riskier and more uncertain.
In the last week the bond market has become dysfunctional. Because of losses in the subprime sector, bond investors are suddenly reappraising their willingness to bear risk. That means lots of bond issuances, including some massive ones designed to finance a couple of high-profile private equity deals, haven't been able to get done.
So right now nobody knows what deals can get done and at what prices, and what deals can't get done. That's a bad thing for markets that rely on clear, simple, liquid trading conditions. Now big plans involving many billions of dollars are disrupted. Those disruptions then disrupt other plans, and so on in a daisy-chain of escalating uncertainty.
But so what?
We're talking about a disruption in the markets, not a disruption in the real world. Markets are amazingly adaptable, and they will adapt to this uncertainty and quickly transform it into certainty.
Stocks have dropped in response to heightened uncertainty, not actual deterioration of anything in the real world outside of markets themselves. When that uncertainty is resolved, stocks prices will quickly rise, because the real world will be, and has been all along, a very good place. Earnings are improving, jobs are plentiful and the economy other than the small portion of it devoted to housing is accelerating.
I really think this is good news. It's scary, to be sure, but if you believe as I do that you get paid for taking risk, then take some. And get paid.
Donald Luskin is chief investment officer of Trend Macrolytics, an economics consulting firm serving institutional investors. You may contact him at email@example.com.>