Going on a Buying Strike

by Chuck DiFalco | March 9, 2009

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Like so many others, I thought the November 2008 low in the S&P500 index was “the bottom.” The violence of the cascading downfall, like a tall building toppling over from an earthquake, ranked between a bear market and a crash. Some call it a panic. The volatility indexes shot up to more than double what was previously considered benchmarks of fear. Massive selling of everything, including gold mining stocks whose companies collectively are the only ones in the world that can profitably sell tangible product as fast as they can produce, looked like a classic capitulation. Hedge funds delivered. I bought some commodity stock funds on the cheap. Problem is, they got cheaper.

Those who take investing seriously have learned to buy equities when everyone else hates them. Get in when the masses are getting out, when there’s rioting in the streets, and biblical wailing and gnashing of teeth. Fall 2008 seemed just such a circumstance. Problem is, everyone else could hate stocks even more.

A “big picture” discontinuity continues to both roil the stock markets and give me pause. The economic rules are changing. The most popular example is the quasi-nationalization of banks in the US. Clearly there will be increased regulation of the financial sector at some point in time. But I don’t know what the changes will look like. Also, the US Federal Reserve is breaking precedent weekly. There is warranted fear about the haphazardness of its intervention. Finally, buried below the headlines are discussions in Washington about shifting regulations for the energy and medical industries. Everyone wants a level playing field on which to conduct business and perform and investment analysis. But the prospect of vastly different rules, regardless of whether better or worse, makes any analysis I might do become obsolete next month.

Another trend, economic nationalism, threatens to distort international trade at best, eviscerate it at worst. Although the US has been the center of fraudulent financial engineering, the rest of the world’s countries compete to be the most protectionist. For example, Ecuador just erected trade barriers against 627 types of goods. Yes, Ecuador is a small country. But what if the larger Asian countries followed the lead off this cliff? How long will this dangerous situation to play out?

This year might mark the secular low in the US stock markets. We might be headed there as I write this, with the S&P500 already down over 20% this year, on top of a larger loss than that last year. If so, it could provide a good risk/reward to buy certain investments. The secular low has proven to be a great entry point for small capitalization stocks. For example, from the secular bear market low in 1974, the Dow 30 stocks provided no profit to 1982 after subtracting inflation and taxes from capital gains and dividends. However, small stocks surged over those eight years. This time around, the small cap investing theme would necessarily involve companies from many countries, not just the U.S.

Unfortunately, making money now might not be that easy. Nimbler small companies might adapt more quickly to the current deflationary recession than behemoth corporations. However, if I’m right, all the measures small companies have taken might be not relevant if the second part of the double dip recession is an inflationary one. While getting a dose of the 1930’s now, we could be in for a whipsaw to 1970’s stagflation before the secular bear market finally ends next decade. Risk and unwise spending has been transferred to the US Federal Government. Passing the buck is not solving the problem. What happens when global investors look at Uncle Sam’s balance sheet and refuse to provide credit? For politicians, creating money from the digital void could be less horrible than defaulting on debt or hiking taxes enough to pay liabilities. I can see a strong possibility that small cap stocks will not outpace inflation over the next several years.

So, let’s summarize my current equity buying opportunities. Not large capitalization stocks, not small caps, not international companies. I can rationalize up to a 20% sector weighting in commodity related companies in case increasing material prices overcomes more regulation, economic nationalism, and recession. But I already have that allocation. I also have enough funds highly correlated to global equity indexes as well. Even my formerly conservative balanced fund looks unattractive. It’s too late to sell to raise cash. I will just go on a stock market buying strike. My 401k deduction is currently going to inflation protected bonds and money market funds. And I’m putting in only enough in to capture the match. So what if US stock prices relative to 10 year average trailing earnings are low? What about the global economic framework over the next 10 years will be the same as the past 10? Despite lower prices, I don’t find value in stocks now.

What the economic landscape might look like next year, let alone in a few years, is changing faster than the US government can announce 4-letter bailout programs. I want some clarity on what the rules will be. I want to see single family home prices stop falling on their own, and not propped up ever more directly by federal programs. Preparation notwithstanding, I want to make sure that the worsening economy does not hit home to such a degree that I would be forced to liquidate my stock funds. Until then, I might trade off of short-covering fueled and hope-filled bear market rallies, but I will not put in money for long term investment. If my strategy is wrong, and I’m late to the party, I won’t make as much money as the prescient (or lucky) bottom fishers. However, if I’m right, have some net worth left to deploy for the next secular bull market.

Copyright © 2009 Chuck DiFalco
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Living in League City, Texas, Chuck DiFalco is a software engineer by day, and an unconventional thinker and writer by night. He can be reached at cdifalco@comcast.net.

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