Tuesday, August 9, 2011

Is the sky falling?

The US stock market has been hammered last week and yesterday, raising both micro and macro issues.  On the micro side, the most immediate question that comes up in day-to-day conversation is whether the decline will continue.  If you have not cashed out your stocks yet, should you do so now?  Or has the recent plunge in values created a great buying opportunity?

Princeton's Burt Malkiel, author of the classic A Random Walk Down Wall Street advises investors not to panic in an op-ed in yesterday's WSJ.  Malkiel thinks that stocks are now significantly undervalued, based on price/earnings ratios and dividend yields.  Sure, the recent economic news is not great, but Malkiel shares one of my all-time favorite economics quotes from Nobel laureate Paul Samuelson: "The stock market has predicted nine of the last five recessions."  Malkiel's advice:
We all need to be aware of the limits of our ability to forecast future stock prices. No one can tell you when the stock market will end its decline, but there are some things that we do know. Investors who have sold out their stocks at times when there have been very large declines in the market have invariably been wrong. We have abundant evidence that the average investor tends to put money into the market at or near the top and tends to sell out during periods of extreme decline and volatility.

Today's WSJ has a worthwhile piece on why 2011 is not likely to be a repeat of 2008.   The key factors in a nutshell: (1) 2008 -- credit bubble in real estate, 2011 -- sovereign debt crisis (brought on partially by government attempts to correct recession created by credit bubble); (2) 2008 -- key players short on liquidity, 2011 -- key players flush with cash; (3) 2008 -- governments thought they were capable of using fiscal, monetary policy options to stimulate growth, 2011 -- governments out of bullets.  Hopefully there will be a fourth difference, with 2011 being a short term stock market correction that will have no effect on consumption or investment. 

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