Coming in from Right Field

I'd take a different approach, buy on bad news, or reporting of bad conditions, lighten up on good news.

From the American Enterprise Institute:

"Want to get rich in the American stock market? Here's some advice: Don't watch the news.

I'm not being facetious here. One of the iron laws of U.S. news reporting is that the economy gets positive reviews under Democratic presidents and negative reviews under Republican presidents.

In 2004, the Virginia-based Media Research Center (MRC) produced a stark summary of the disparity.

In 1996, Bill Clinton ran for reelection as president. The U.S. economy was doing well at the time: unemployment down to 5.2%, inflation under control at 3%, and overall growth at 2.2%. And the press reported all this good news: According to the 2004 MRC study, 85% of all major economic stories on the economy in the summer of 1996 were positive.

Eight years later, George W. Bush was running for re-election as president. The U.S. economy in 2004 did much better than in 1996: The economy grew at a 3.9% pace, while unemployment and inflation roughly matched their 1996 levels (5.4% and 2.7% respectively). Yet this time, 77% of all major media economic coverage was negative. (For the full report, see www.mediaresearch.org/realitycheck/2004/fax2004
1020.asp.) And since the 2004 election, the barrage of bad news has continued: reports of housing bubbles, warnings of an imminent collapse in the U.S. dollar, and so on.

The economist John Makin has done some interesting calculations on the consequences of the euphoria of the '90s and the persistent gloom of the '00s. As the economist who most accurately predicted the Japanese stock market crash of the late 1980s, Makin deserves attention when he assesses valuations.

Makin points out that the usual determinants of stock prices are a function of expected corporate profits and interest rates. The more we expect companies to earn, the lower we expect interest rates to be, the more we will pay for a share in a company. Based on this formula, economists calculate a "fair market value" for stocks--a base line around which they expect stocks to trade.

Between 1998 and 2000, the S&P 500 traded at a premium of some 60- 80% above fair market value: Investors, it seems, were making the mistake of believing Bill Clinton's PR--and of course it ended in tears. In the single year 2000, the S&P dropped from almost 1,600 in March to 1,300 by year end. The S&P finally hit bottom at under 800 in the fall of 2002.

Then the recovery began. Investors who disregarded the gloomy Bush-era reports from CBS and The New York Times noticed the rise in corporate profits and the reductions in interest rates. They began to buy and buy and buy--pushing the S&P past 1,400 at year end 2006.

Makin, however, points out that even at 1,400, the S&P remains some 20% below its "fair market value": "If the stocks in the S&P 500 were currently valued as they have been on average over the past 20 years, the index would be at 1,775 instead of 1,420."