Sunday, October 12, 2008

Fair Value Isn't Always Fair When You Need It To Be

There's a guy over at SeekingAlpha who thinks the market is near a bottom. The author cites a lot of technical data to support his contention that the market is oversold and investors should feel comfortable buying again.

The problem with this kind of analysis is that it's derived from the past performance fallacy: it assumes that future recoveries will be like past recoveries. The difference this time is that the U.S. economy is laboring under a huge debt overhang that needs to be paid down before corporate earnings can start contributing to equity growth again. Treasury's TARP (ugh!) and the Fed's commercial paper facility (double ugh!) haven't even started buying up debt yet. Markets won't be able to judge whether any of these actions are effective until they've been in operation for several months. Even the G7 coordinated rate cuts will have a six-month lag before the economy feels their effects.

Nouriel Roubini also thinks the market is oversold, but then goes on to state that only drastic macroeconomic policies can stave off further declines. He clearly knows that our previous understanding of when equities are "oversold" is about to be seriously tested. Is the S&P 500 fairly valued at 1000? I'm not going to take that bet.

This kind of stuff makes me glad to remain bearish on everything except gold (a true store of value) and China (which holds the largest store of currency reserves).

Nota bene: Anthony J. Alfidi holds short calls on SPY and IWM but does not own the underlying shares; he is long FXI (with covered calls), IAU, and GDX.