As befitting a nearly 300 year old institution, the American stock market is laden with cliches, axioms, and mythology. Some of it can be useful ("We're all going to die but it's a lousy trade"); some financially destructive ("You don't take a loss until you sell").
In an effort to help viewers distinguish between market myths and present reality, Breakout invited frequent guest, native Minnesotan and FOB Jim Paulsen to share his wisdom. Jim gave us a unique take on four popular assumptions surrounding today's market.
Of deep recessions are steep recoveries made
It's both intuitive and conventional wisdom that deep recessions would lead to steep recoveries and vice versa. Sort of a "coiled-spring" theory of economics in which years of pent-up demand would overwhelm diminished production supply. Nope. Paulsen's studied recession recoveries since 1941 and found no correlation whatsoever between the depth of the slowdown and pace of the ensuing recovery.
In other words you can be depressed about the slow-pitch softball pace of the economic improvements since the Great Recession but it's wrong to use your disappointment as a short-thesis.
Mega-cap multinationals are the way to play stocks safely
Looking to hideout in the Microsofts (MSFT) of the world because they've "got to improve sometime" and provide relative safety? Wrong both times. Bad stocks are bad stocks. If the "trend is your friend" then you're hanging out with the wrong crowd in the large caps. Just as is the case above, the case for megacaps seems logical but, alas, there is no historical support.
The housing crisis is getting worse
Looking at S&P/ Case-Shiller, Single Unit Housing Starts, and Single-Family Home Sales over the last 5 years Paulsen notes all three have been more or less flat since 2009. A ringing endorsement for going back into the house-flipping biz? Oh my God, no. Once popped, bubbles tend come back sometime between "never" and "about a million years from now". From where I'm sitting (most often in the house I rent), home prices figure to remain somewhere in the "neighborhood" of where they are now forever or until my lease runs out, whichever comes last.
This is the riskiest stock market ever!
Not even close, say's the Bunyon-esque Minnesotan. Paulsen cites the Sharpe Ratio here. I actually studied under Bill Sharpe himself and I'm only vaguely familiar the mechanics of his ratio. Simply put, it measures "excess return for unit of risk". In English, it's the bang for the buck you can expect for stepping up in your portfolio here. In this case some intuition pays off handsomely. To quote the Oracle of Omaha, "Be greedy when others are fearful." When investor sentiment is most cautious, ensuing returns tend to be better.
Trading is all about risk/ reward. Favorable Sharpe ratios coupled with low sentiment is the stuff of which bull markets are made. Eventually.
There you have it; four reasons to step-up and buy stocks as markets continue to pullback from the explosive rally of early July. Want to call shenanigans on the whole thesis? Of course you do and we welcome opposing and supportive thoughts either in the comment section below or via email: BreakoutCrew@Yahoo.com