Uncertainties breed weak stock markets; certainties bring bull markets. These often run to extremes, as in the dot.com days of 2000 when excessive certainty in ever growing earnings sent many technological stocks to prices over 100 times their earnings. One example, Art Technology Group, after trading for over $100 in 2000, later slumped to one dollar, recently agreed to be acquired by Oracle for $6.00. As this illustrates, the “Buy and Hold” strategy requires forethought on the buying as well as patience in the holding.
Similarly, in 2007, when the financial panic created the Mother of all Uncertainties, the Dow Jones average plunged to 6,547. Despite persisting skepticism, it has climbed 71% in three years. This rewarding rise took place against an anxious background of high unemployment, erratic corporate earnings and political quarreling.
This contrary behavior by the stock market is a good indicator of future stock market direction. It’s too bad that someone hasn’t created an “Anxiety Index” that would signal buying by strong willed investors whenever worries were peaking and selling when complacency overcame fear.
This suggests betting on the inherent irrationality of investors and markets. That usually will work but one should bear in mind the wise caution of John Maynard Keynes, “Markets can remain irrational longer than you can remain solvent.”
Lord Keynes also said, “Successful investing is anticipating the anticipations of others.” Applying a theoretical Anxiety Index in late 2010, we find that the uncertainties of a mid-term election are behind us and the Federal Reserve has committed to an ambitious program of buying government securities. Recent tax cuts expire soon but the lame duck Congress will do something, probably some form of extension, removing another uncertainty.
This suggests a softening of the Anxiety Index over the next few months, encouraging the recent stock market rally to keep running. Forthcoming actions by the Federal Reserve will increase the money supply, weakening the relative exchange rate of the dollar. This will benefit well positioned companies with strong overseas sales like DuPont (DD-$48), 3M (MMM-$86), Int’l Flavors & Fragrances (IFF-$53), General Electric (GE-$17), Intel (INTC-$21), IBM (IBM-$146) and, of course, Apple (AAPL-$318), whose iPad tablets will probably soon rack up the biggest holiday gift sales in retail history.
Both gold prices and Chinese stocks fascinate investors. The new Federal Reserve policy will promote higher gold prices. I much prefer high quality gold mining stocks to the actual metal and recommend Barrick Gold (ABX-$52) and Goldcorp (GG-$47). Both pay dividends and are reporting rising earnings.
China is troubling, as its fast growing economy will continue to strain its autocratic government in addressing all segments of its society. This, after all, is the country where millions were “encouraged” to attend its recent Expo, sometimes taking eight-hour bus rides for a day at the fair.
China Yuchai (CYD-$27) is a manufacturer of diesel engines with $2.4 billion of sales, growing at 18%. Forecast earnings are not available but earnings per share over the past four quarters through June were over $4.00 a share, a reasonable valuation. There is also a modest dividend and moderate debt. Baidu, a current investor favorite, is growing more rapidly than almost anybody but still has less than half the sales of Yuchai and is valued much more richly. Its rising stock price probably reflects some complacency.
The Anxiety Index has moderated while growth continues in the global economy. This is promising for the stock market, which is showing increasing signs of beating 12,000 by year-end. Investors will then have reason to remember another Keynes comment, “I should have drunk more champagne.”