Let the Panic Begin

The media have been falsely savaging the economy for so long, that everyone now believes we’re doomed. Today’s mega market dump is the result of self-fulfilling prophecies of economical doomsayers – an outcropping of the hatred of the Republican administration.

Donald Luskin is chief investment officer of Trend Macrolytics, an economics consulting firm serving institutional investors. Don analyzes this effect in Smart Money:

Panic Is Driving Today’s Stock Market

ARE YOU SATISFIED, all you permabears who have been preaching financial Armageddon — for years? Your patience in the face of reality has finally paid off. You’ve talked the American public into outright panic, and so now we’ve got the first real stock market break since the present bull market began in early 2003.

With the S&P 500 making new 52-week lows, having fallen 15% from all-time highs in October, as the Bard of Avon might ask, “There, art thou happy?”

Before I rant any further, let me get one item out of the way. I admit that I’ve been very wrong. I’ve been saying to buy stocks all the way down since the October highs. I was wrong. I repeat: I was wrong. If nothing else I get the satisfaction of being unique. How many stock market pundits do you know who will admit when they’ve been wrong?

So what do you do now if you’ve been wrong right along with me?

The first thing to do is to stop and think. You do not — repeat DO NOT — want to do anything hasty just because you’ve lost money, and you’re scared or angry or both. You’re not going to help by making another mistake by acting precipitously, just for the sake of “doing something.”

The last thing to do is to thoughtlessly reverse course. It’s false logic to tell yourself that just because you’ve been wrong to be bullish the last couple months, therefore it must be the right thing to do to be bearish now. Sure, it would have been better to be bearish two months ago. But that was then, and this is now. The issue is: What’s the right thing to do now?

Making that decision requires analyzing why stocks have fallen. Just because they’ve fallen, doesn’t mean they’ll keep falling — unless whatever made them fall is still operating, or there is something new that will also make them fall.

If you determine that there was no good reason for them to fall in the first place — or, even if there was, that there’s no good reason for them to continue to fall — then you have no reason to sell now. You may even want to buy.

Oh, yes, I can imagine some readers are rolling their eyes at that last sentence. “Permabull Luskin,” they’re no doubt saying to themselves. “No matter how bad things get, he always comes up with some rationale for being bullish.”

First, that’s not true. Look at the archives of my early SmartMoney.com columns from 2001 and 2002, and you’ll see I can be plenty bearish. But since early 2003, I’ve been generally bullish, and that’s been exactly the right way to be. Now, just as over all those years, I’m only interested in looking at the facts as I understand them, and making the best call I can.

Second, even it were true that I’m a blind permabull, you’d be crazy not to at least consider being bullish here. If you think there’s an open-and-shut case for bearishness just because stocks are down 15%, then you don’t know how to play this game. You don’t make money in the stock market by assuming whatever just happened will happen again. You make money by figuring out what’s going on and why, every day, and acting accordingly — and, if possible, being right.

With all that said, here’s my best shot at what’s going on here, and what we ought to be doing to profit from it.

I think we’ve got a panic on our hands. A good old-fashioned fire sale. And it’s about time, because ever since this bull market started, investors have had it too easy. Until now there hasn’t been even a serious correction in stocks. Nobody’s had to get really, really scared. That’s actually the norm in markets. And we’re now being reminded of that — reminded hard.

Panic dynamics are very simple. You get scared. You sell. That makes stocks go down. That scares the next guy. He sells. That makes stocks go down more. The next guy gets even more scared.

It doesn’t end until all the people who trade with their emotions instead of their minds have sold everything at the very bottom.

Believe me, my emotions are saying “sell, sell, sell.” But my mind can’t find a good reason to, other than that I suspect that the dynamics of panic may have a little longer to run before they burn themselves out. Those dynamics can’t be predicted or understood in any rigorous way. They just have to play themselves out. But setting aside the difficulty of perfectly timing it, that’s what I think is happening here. Pure fear. Fear for fear’s sake.

I don’t see any realities — other than the dynamics of panic — that justify stocks coming off 15%, especially when they weren’t especially overvalued to begin with. And I don’t see any realities — again, other than panic — that would justify them falling further, especially since now they’re extraordinarily undervalued.

The economy isn’t falling into recession. Retail sales are just fine — the supposedly horrible numbers for December look pretty much like the kind of numbers you get every couple months in the normal ebb and flow of a growing economy. We still haven’t had any negative jobs growth. The unemployment rate is now 10% lower than the historical average for economic expansions. Jobless claims are at the low end of the range of the last several years. S&P 500 forward earnings, outside the financial sector, are at all-time highs. Some credit markets are in disarray, but bank lending is operating at very near all-time highs. Damaged credit markets, such as the market for asset-backed commercial paper, have been steadily recovering from the summer crisis.

Fine — the housing market is in the gutter. But it has been for two years now, and so far it hasn’t substantially affected the rest of the economy at all. In fact, since the housing slump started, the rest of the economy has had its best period since this economic expansion began in 2001.

To put it another way, I think the permabears and the politicians who’ve been saying literally for years that America is heading for a recession, or already in one, have basically just gotten lucky here. Their broken clock is finally right. Stocks haven’t fallen because of all the crazy stuff they’ve been fear-mongering about all this time. If anything, these people have contributed to the atmosphere of fear that’s feeding the panic we’re in. That’s not being right — that’s being an arsonist.

Let me repeat one more time — just to hang onto a little moral high ground — that I fully admit I’ve been wrong about stocks the last couple months. I’m not evading that responsibility. I’m being honest about it, and getting myself centered to make the best call I can looking forward, not backward.

I can’t say when this panic we’re in will burn itself out, but I think it could be a matter of days. If this thing goes the way they usually do, it will end with one spectacular down day where you become absolutely convinced that stocks are going to zero, and that it’s time to pack up and give America back to the buffaloes and the bald eagles.

You’ll be amazed how good everything suddenly looks the day after that bottom.