Tuesday, May 18, 2010

5 reasons why we wont see a 1987 crash

Everyone seems so pessimistic these days. It's almost as if the market is unsure of its own worth, and feels sinful for returning so much in 2009. The DOW is at the same place as it was a decade ago -- but that hardly tells the story.

Anyhow, the prime concern of the day seems to be that we will witness a crash-a-la-1987 very soon (in the next 2 weeks). It's sounds rather stupid to be honest. I know that I should not be offering opinions on the market, anything, literally can happen. However, let me state why I don't think it will happen. Recognize, these are the same reasons why I am bullish on America right now.

1. The 1987 came at the end of a 7 year bull market. If someone thinks that we are in a bull market, they should think again. Dividend yield on the S&P is hovering around 3.5%, much higher than the 1.5% we have seen over the last decade. Of course, in 1986, dividend yield was also 3.5%. However, dividend yields have fallen significantly over the last three decades -- partly because of a different interest rate regime, partly because of the increased use of stock buybacks- - and the last time the dividend yield was above 3% was in 1991!

2. There is so much cheap money around. Interest rates all over the world are at levels possibly never seen before. Sure we are headed for a currency crisis. But, given that people can borrow money rather cheaply, it makes equities supremely attractive.

3. Greek crisis is over stated. I simply can not connect the dots between a Greek default and a crash of the stock market. If European governments default, why on earth should stock prices suffer. IF anything, people should be selling their debt instruments. I recognize that there is an argument for contagion and that if European banks stop lending, things could turn out to be pretty bad. But, the risks are overstated. The memories of 2008 have still not faded, Governments will do anything and everything to keep the ball rolling. And people who think that this will cause the Euro to break -- well, really, the costs of breaking the currency is just too high. I don't think Governments in Europe have the political capital/will to do so. And it would be a terrible waste of resources.

4. If the case of human affairs, if you predict an outcome it changes the outcome. In other words, if everyone has prepared for something, it just won't happen. Of course, the caveat is that everyone may be thinking the same things as I am. Hence, no one is really prepared. We shall have to see. However, I think its safe to bet against the media in affairs such as this -- and the media, or rather people who get highlighted in the media, seem very gloomy about things in general. I really wonder what George Soros is thinking... Apparently he sold of some of his Gold holdings, so I guess that reduces the risk of a currency crisis, but he has also stated that "Humpty Dumpty can not be put together again". But if everyone is attending to Humpty Dumpty, he's unlikely to break under the spotlight.

5. What we are underestimating here is the strength of the Asian savings. Over the last decade Asia has saved like there's no tomorrow. Just look at the reserves. Those things will sooner or later lay claim to "real" assets of the West, rather than just paper bonds. Might be a sad day for the US dollar, but if you want to protect your wealth, equity is the best place to be in.

Oh, one final note. America is NOT Japan. The reason why Japanese equities have lagged is because return on capital vanished from the country. The marginal utility of capital in Japan is pretty much 0. The same can not be said about America. Just compare the Japanese consumer to the American consumer and you'll know why. And, in general, I think its easier for American businesses to establish footing in other countries than it is for Japanese companies (thanks to the British Empire).

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