Bulls, Bears, Recessions, Oh My!

Well I think Wednesday’s big rally gave us a very clear message:

The market is far more focused on Bernanke bombs than Middle Eastern ones. As well they should be. At the end of the day, so long as the Middle East conflict stays localized, then it’s a human story … not a business story.

The summer can be a challenging time. Sometimes it can bring great markets, but a lot of the time the lower trading volume leads to very whippy moves like we are seeing now.

We are currently witnessing an epic battle between the bulls and the bears. On one side the bulls are saying “Hey, earnings are good, rates will stop going higher soon, the housing market is cooling not collapsing, valuations are modest, and we look to have a soft landing.”

On the other side the bears are raging that “valuations are only modest looking if current earnings do not prove to be ‘peak earnings,’ inflation’s rearing its ugly head, the Fed’s not done raising rates, $70 oil is killing the world economy, we’ve got a war in the Middle East, a recession is imminent, and the US dollar is headed for oblivion.”

Who’s right? Who’s wrong?

Who cares!

That’s right, I said it. So much of this junk is manufactured by the media to sell newspapers and to get you to watch TV. At any point in the cycle, either the bulls or the bears will have it, but the thing to remember is that the pendulum swings both ways, and the super long-term macro trend is always UP.

But there’s no law that says you can’t profit from either side of the market. In every market there are short term, intermediate term, and long term trends at work.

At any point in time, the short term and the intermediate term trends can be down, and the long term trend up. Just as easily, the long term trend can be down and the short term and intermediate term trends up. That’s why it makes sense to have balanced positions.

It’s important to think of market weakness as an opportunity to buy your favorite long term stocks on the cheap, and to view market strength as an opportunity to weed the dogs out of the portfolio and put on a few judicious shorts.

Remember, both the S&P and the DOW are still in a long term up trend. That’s not a vain hope talking, it’s a statistical fact. The short term picture is more muddled and is much more news driven. So any day of the week we can be faced with a different market.

In times like this it’s important to maintain your own emotional equilibrium. Use your common sense. Do you really believe that the American economy is going to fall into the ocean and that we are just going to fade away? That’s just not a realistic scenario, but so many people are buying into that vision of our country’s future. That doesn’t mean we can’t have a punishing recession, of course we can. But it also doesn’t mean that the whole country will slip into a coma and we will be relegated to third class global status either.

Recessions and slowdowns are part of the business cycle. They set the stage for the next phase of wealth creation. And the truth is we have seen much, much scarier times.

1998 was a nightmare compared to what we are seeing today. 1987 was another horror show, as was most of the 1970’s. The recession of 1991 had people thinking that New York City was going to be a ghost town; they were virtually giving commercial real estate away in Manhattan in ‘91.

But those times do not last long. We’ve come a long way from the myopic policy decisions that led to the stagflation of the 1970’s, and I don’t think the new millennium is the 1970’s redux.

As a nation of confirmed optimists, it’s just tough for us to stay bummed for too long. We are the most optimistic people in the world, as well we should be: We live in the greatest country in the world, with the most economic opportunity.

It’s important to remember that recessions are opportunities to amass staggering wealth. Asset prices get hammered during recessions and can get bought on the cheap. The wealth of today’s real estate barons was built on the back of the 1991 recession.

Funnily enough, though, the moment that we get a confirmed recession (i.e. the general agreement becomes that we are in recession) happens to be the absolute perfect time to buy stocks. Remember that the market is a discounting mechanism, a leading indicator that looks to discount events 12-18 months in the future.

So when the news is at its absolute worst is when you should be doing your most aggressive buying. Remember that when everyone around you is prophesizing the end of American global trade dominance, you must go the other way … it’s the only play that makes sense.

What I’m saying is, the global financial community has gotten successively smarter with each financial meltdown that it’s gone through. Financial institutions are better managed, better capitalized, and better regulated than ever before. Much of the systemic risk that used to plague the system has either been purged or moderated. Systemic risk will always be present to a degree … you can never eliminate it, and we will have meltdowns, but so far we’ve seen some pretty destabilizing events over the last year and the financial markets have handled it surprisingly well.