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Long-time readers will know that we generally subscribe to the view of noted investor Sir John Templeton that these are the six most dangerous words for investors in the English language. For example, this was the rationale that many investors gave for the wild overvaluation of stocks during the internet bubble in the late 1990’s. However, right now we think they are quite appropriate to assuage the fears of investors that we are headed for another debacle like we saw in the fall of 2008.
We are not saying that there won’t be continued volatility in the market. Investors are clearly nervous, and nervous investors make for volatile markets. What we are saying is that many of the factors that nearly brought the global financial system to its knees in late 2008 and early 2009 are not present in mid-2011.
The biggest difference is leverage (i.e. too much debt)--at several different levels. In 2008, financial institutions were too leveraged, companies were too leveraged, investors were too leveraged and households were too leveraged.
Today, partly because of new regulations and partly because they are still shell-shocked from 2008, most financial institutions are significantly less leveraged than they were three years ago. In 2008, most institutions were being far too aggressive. Now, if anything, the opposite is true. Many of the problems with the U.S. economy stem from the fact that banks and other institutions are being too conservative and not lending enough.
Most corporations today are in great financial shape. They have cut costs over the last few years and hoarded cash. If stock prices stay low, we are likely to see a new wave of acquisitions and mergers, as these companies begin to put their cash to work. Of course, there are still a number of overleveraged companies out there, but that’s not all bad either. It will give us turnaround investors something to work with.
Some investors are still leveraged today, but many fewer than in 2008. And those that still use leverage are using much less. Hedge funds that might have borrowed 400% of their equity in 2008 are only borrowing 100% or perhaps 200% now. Of course, these hedge funds still have hair triggers, which we believe is one of the major causes for the current volatility.
Finally, individuals are less leveraged. While the housing market is not fully fixed yet, there is no longer a large industry devoted to encouraging people to take on mortgages that they cannot afford. Moreover, many families that were still buying on credit card debt in 2008, are now spending less and saving more.
Less debt means more flexibility at every level. When you are highly leveraged, you are often forced to sell things you don’t want to sell, and sell them at the worst possible time, to meet the demands of your lenders. When you are less leveraged, you can wait to sell at a more favorable time, or perhaps not sell at all.
That’s all good news, and we believe it will prevent a meltdown of the magnitude we saw three years ago. Now, not only are people not being forced to sell, but many of them have plenty of “dry powder” to put to work buying stocks when they get cheap enough.
The bad news, of course, is that while banks, corporations, investors and households have cut back their leverage, many nations are more leveraged than ever. Several European nations are teetering on the edge of default, and even the U.S. is no longer the paragon of economic virtue that it once was.
While this may not be great for the longer term, we do not see this as a threat to bring down the system in the short run. Governments--even over-leveraged ones--have a lot of tools at their disposal to bail themselves, or their trading partners, out.
Speaking of bailing, we certainly do not recommend bailing out of the stock market. Instead, we recommend shopping for bargains. Almost everything is a lot cheaper than it was a few weeks ago.