With Asset Boom Essentially Over, Is It Time to Buy?
August 2, 2007
The great asset boom is over.
Market historians may want to mark last Wednesday, July 25, on their calendars to note the end of an era. That's the day the Cerberus-led high-yield debt offering for Chrysler collapsed. Or perhaps it's July 19, the day the Dow Jones Industrial Average closed over 14000. Or maybe it's June 22, when private asset manager went public. After last week's stock-market carnage and debt-market paralysis, they already seem like distant memories.
Let's step back a moment from the subprime crisis, which morphed into a mortgage-backed-securities crisis into a collateralized-debt-obligation crisis into a junk-bond collapse and now a credit freeze. What should be clear by now is that global liquidity is part of one continuous stream, and when one of the springs that feeds it -- in this instance mortgage money -- dries up, the stream shrinks to a trickle.
This is not, as most had expected, because long-term interest rates have risen. After briefly surging above 5% (hardly catastrophic) they are again well below that level. Investors were so fixated on interest rates that they lost sight of the other side of the equation: asset values. High leverage makes sense as long as asset values kept climbing. But the moment appreciation falls below the cost of capital, or worse, actually declines, the leverage effect goes into reverse, leading to massive losses.
Asset values couldn't keep climbing forever. Investors in everything from real estate to precious metals and other commodities to art and collectibles had been enjoying annualized rates of return over 20%. Real estate was the first to go into reverse, and that's where the first tremors started. But now the effects are coursing throughout the financial system, as investors are re-evaluating risk in everything from private-equity buyouts to emerging-market debt.
Despite all the attention given to last week's stock-market meltdown, stocks were one of the last asset classes to experience the lift from all that cheap liquidity, and thus, in my view, are among the least overvalued. Indeed, in a world where almost everything was highly overvalued, large-cap-growth stocks, such as and (both of which I own and have recommended), were reasonably priced.
Even with last week's turmoil, most market averages remain solidly in positive territory for the year. Small-cap stocks, which have led the decline, were flat. Some technicians have pointed out that bull markets typically end in selling climaxes -- big gains on high volume accompanied by soaring investor optimism -- not sudden declines. But in the long term, occasional corrections like the one now under way are healthy, inevitable, and set the stage for future gains.
As investors, we can't predict the future, but we can be prepared. If you've followed my advice in this column, you've already taken some profits and have cash at your disposal. You don't need to sell into a falling market and are positioned to take advantage of it. But many readers have asked if it's too late to sell. It's not, but barely. It's very late in the game. If you haven't raised any cash in this aging bull market, and feel you need to, you should move swiftly.
The more timely question is whether it's time to buy. The answer: not yet. The Common Sense approach is to buy lower, sell higher, and stocks are now indisputably lower than they were just a week ago. I buy at intervals of 10% declines in the Nasdaq Composite, which peaked at 2720 on July 19. A 10% decline would take it to 2450, which is my new buying target. Even though we're not there yet, you should begin to map out a buying strategy. At this rate it may not be long before it's time to implement it.
With other asset classes correcting even more drastically, it may soon be time to consider buying strategies that go beyond stocks. But it's still early. Given how overvalued many assets had become, and how long the rally continued, I expect them to fall much further before real bargains begin to appear. It could easily take another year or two, for example, before junk bonds bottom out, and real estate is anybody's guess.
Let's look on the bright side. For now you can say goodbye to the $5,000-a-square-foot Manhattan condos, the $10 million midlevel Wall Street bonuses, the $8 billion private-equity moguls, the Wall Street bashes with live appearances by aging rock stars, and the $70 million Andy Warhol car-crash paintings. Won't that be a relief?
James B. Stewart, a columnist for SmartMoney magazine and SmartMoney.com, writes weekly about his personal investing strategy. Unlike Dow Jones reporters, he may have positions in the stocks he writes about. For his past columns, see: http://www.smartmoney.com/.