Saturday, August 27, 2011

What Do Markets Assume?

There are very scary stories out there: 1) a European debt crisis; 2) Incredibly slow economic growth in Western countries; 3) A potential for Asian economic growth to top out. Does this mean stocks cannot do well?

Surely "the market" knows what we know. How much worse news is yet to come?

Greece will default. Has the market fully factored that in? While the initial shock of a Greek default would likely cause stocks markets to skid, the reality is that a Greek default could be the harbinger of good news to come. The sooner that defaults and workouts become the order of the day in Europe, the sooner Europe can begin to heal its economic woes.

Why are defaults and workouts therapeutic for Europe? The reason is that politicians will never be able to reverse the spending and entitlement train. They just won't be able to do it. Instead, a default will let the market itself force the necessary reforms on Europe. It won't be possible for Europe to access debt markets in the future unless Europe begins to tackle its unaffordable spending and entitlement programs. Market discipline will solve a problem that politicians have no hope of solving. This is good. So, defaults are good news not bad news and defaults are coming soon.

What about the US? It is unlikely that the US is headed for a recession. Try as it might to strangle the economy, Obama and his allies will not be completely successful in their efforts to destroy the American economic engine. Besides, unless Obama shifts ground and does it quickly, he will be a one-termer and his successor is likely to to do a complete about face on the Obama agenda. This is good news as well, whichever way it shakes out. The hide tide of government intrusion and regulation in the economy may be just over the horizon. In any event, a downturn in GDP isn't likely. Slow growth, not negative growth, is probably our future for the next year or two until the cavalry arrives.

All of this suggests that stocks are probably a good buy for the long term investor. For the short term investor, who knows? But, for the long term investor, this is probably a historic opportunity to own equities.

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