Heard in the Village: July 2010

The villagers have been hearing about Paul Krugman, a Nobel prize economist, talking of depression, John Paulson, hedge fund trader, betting on economic growth and the rest of the financial media wondering about a double dip recession. They also were listening as to why the market would be going up or down based on the speakers favorite indicators as they behaved over the last 30 years. “They’re looking at the bark on the tree while a forest fire is coming toward the watched tree and bark” was the common comment heard around the village. Many people are believing the causes for this recession are the same as the ones in recent decades but just more severe than the others. It’s what the villagers call an inventory adjusting profit and loss recession. Most are not aware that it is what the villagers call a balance sheet correction.

Balance sheet corrections are far less common than the usual inventory recessions. They happened in the1870s, the1930s and now. They are correcting excessive amounts of debt on illiquid assets and inflated asset values. They are also ignoring the correction cycle of a 25 year bull markets in interest rates and equities. The market cycle has 3 legs up and 3 legs down. We have had 1 leg down to the 6600 area and a nice big year long rally. That rally is over and we are likely to be going into the second down leg in a bear market that could last until around 2016.

The villagers remain convinced the markets will stay down or go lower because of a lower p-e attached to whatever earnings are generated. Villagers are contrary value players so when they saw the BARRON’S Bond yield/stock yield (in BARRON’’S every week) at .80, they began thinking of accumulating better quality equity income stocks more actively because they may be better valued than any time since the 1970s when it was around.70. (1 is when stocks and bonds are equal. Below 1, stocks are favored. It has been as high as 2.5 and rarely below 1 until recently)

They would buy their stock picks at p-es at 10 or less and they would consider buying more as their yields go higher. They knew euphoria and bleakness can be overcome by the market with things unseen by investors, economists and the news media.

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