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Investors, listen up. It's time to take a deep breath, regain your balance and buy stocks.
Go right into the eye of the storm and buy cyclical stocks, the ones that are the most closely linked to the health of the economy. These are the stocks in sectors like retail, technology, basic materials and manufacturing. (I have a complete shopping list below.)
Cyclical stocks will rebound nicely because they are among those that have gotten hammered the hardest due to unfounded fears that the subprime mortgage meltdown is going to bring economic Armageddon.
Global economic growth is not coming to an end. A bunch of mortgage borrowers who may have fibbed about their incomes to get loans -- predominantly in California and Florida -- are not going to bring down the powerful growth engine in places like China, India and Latin America, or even Europe.
Likewise, here at home economic momentum is too great -- and too many conditions are in place to keep it that way -- for the mortgage mess to bring down the economy.
This crisis is more about fear than any real economic problems, and fear is an easier problem to solve -- especially when you have the Federal Reserve on your side, as we do now. Thanks to help from the Fed, cyclical stocks won't only rebound nicely from here -- albeit with some bumps along the way -- they will continue to do well as the economy hums for at least another year.
"It is time to take advantage of people's fear and buy what they are selling," says James Paulsen, the chief investment strategist at Wells Capital Management. Paulsen acknowledges there's likely to be more wicked volatility before things settle down, as more bad news surfaces about mortgages. But if you step back and think about it, his reasoning about why you should be bullish now makes sense.
The only thing to fear . . .
Lenders are edgy now about having exposure to any kind of debt instrument that may have risky subprime mortgages embedded inside -- or any hedge funds that may own that kind of debt. This has created a state of panic in parts of the credit world that has the bears telling us that there is a liquidity crisis. By this they mean that there is a shortage of money to borrow, so the engines of capitalism will grind to a halt.But the bears have it wrong. "Everyone keeps saying this is a liquidity crisis. But I don't buy that," says Paulsen. "There has been superliquidity, and I still see lots of evidence of that." The global money supply -- a measure of the amount of cash, savings deposits, balances in money market mutual funds and other cash instruments -- has been growing rapidly for the past two years, and it is as high as it has been in 10 years. It grew again by 10% in May. The U.S. money supply grew by 6% in July.
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Personal balance sheets are strong in the U.S., where consumers have almost the highest levels of net worth in history. Employment is high and income growth is strong. Companies -- which the bears say will bring the economy to a halt because they can't borrow -- are actually flush with cash. Abby Joseph Cohen of Goldman Sachs (GS, news, msgs) estimates that S&P 500 ($INX) companies outside the financial sector have cash balances of about $800 billion, or roughly 10% of their market capitalization and double the historical average. This is as much as they need to hire, invest, buy out other companies, boost dividends or buy back stock, she says.
If not, most companies can still also borrow at higher -- but not onerous -- levels. The difference between corporate bond yields and 10-year government bonds has widened, but not to the extreme levels associated with economic meltdowns. "I really don't think it is a matter of liquidity, but a matter of fear," says Paulsen.
The disaster scenario is that the fear is allowed to fester, creating a serious economic impact. However, when the Federal Reserve cut the discount rate last week -- the rate at which member banks may borrow short-term funds from a Federal Reserve bank -- the central bank signaled it stands ready to calm financial markets' fears and prevent those fears from bringing down the economy. The Fed said it is "prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets."
Continued: Confidence in Bernanke