Friday, October 17, 2008

Uncle Warren Says Buy, But I Say No Thanks

Warren Buffett penned a rare op-ed in the NYT today enjoining investors to start buying stocks again:

To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.

Mr. Buffett qualifies his advice by saying that "sound companies" rather than "all companies" are a good buy, so he's apparently got a few beaten-down value stocks on his mind. So do I, but I'd like to see my candidates go a bit lower in the short term. Widely followed indexes like the S&P 500 and the Russell 2000 have a bit farther to fall themselves, IMHO.

But will other investors follow his advice? Probably not this time, for a reason I'll discuss below:

In better times, such a clarion call from Buffett -- amplified Friday by repeated commentary on CNBC -- might spark a big stock market rally. Yet stocks ended another volatile session lower on Friday, after fresh economic data elevated worries about a potentially deep recession.

A constant stream of deteriorating macroeconomic news is not the only reason to keep fresh cash away from the markets for now. Hedge funds that are unable to unwind their illiquid positions - derivatives and MBSs- have to meet investor demand for redemptions by selling their equity holdings:

"Forced selling to cover redemptions and delevering by hedge funds has put downward pressure on selected stocks," David Kostin and his colleagues at Goldman wrote in a note to clients earlier this month.
"We expect hedge fund selling/deleveraging to continue," they added, while telling investors to bet against stocks heavily held by hedge funds and to buy stocks with the fewest hedge funds as shareholders.

Thanks for the advice, Uncle Warren, but I think you're still a few months premature. Sound companies are indeed being beaten down by The Great Hedge Fund Unwind of 2008, but why not wait until most of the hedge fund industry has collapsed before going shopping for equities? Mr. Market hasn't quite finished wringing his anxieties out of U.S. stocks, so I'll stay on the sidelines until he's done.