Rational Advisor

Just another normal week in the equity markets – now that the new normal features wild and sudden price swings and more than the usual dollop of odd trading behaviour. That’s what happens when hope mingles with panic and bargain chasers run headlong into fleeing mutual fund investors and hedge funds are hit by a wave of margin calls and withdrawals ($31-billion U.S. alone in the third quarter).

Here’s the drama check: There was historic intervention as governments injected billions into banks around the globe. There were violent flip-flops, The VIX volatility index wailed to a recent record above 81.

Crude has plummeted 51% from the all-time high it set in July.

The months-long oil collapse has largely been triggered by the demise of investment banks, said Fadel Gheit, a senior oil analyst with Oppenheimer & Co. Banks have drastically curtailed their highly-leveraged businesses, such as commodities trading, due to “the tightening credit, the diminishing appetite for risk and tougher government regulation,” he said.

Reduced speculative activity could keep oil prices closer in line with supply and demand for months to come. When the global economy stabilizes, “there’ll be a base for oil prices, but definitely lower than the current level,” Mr. Gheit said.

To be sure, these global government work outs take time and none of the emergency funding that was talked about will find its way into the financial system for a few weeks yet.

The question, of course, is whether a market that has already surrendered all its bull-market gains has sufficiently discounted the coming gloom. Here, it helps that investor sentiment is shot. The expectations bar is set pretty low when your benchmark is the Great Depression. In fact, a Merrill Lynch survey of 172 global money managers conducted just before Oct. 9 showed that 69% believed the world is in recession, up from 24% in August. A record 87% see company margins slipping and 43% now say stocks are undervalued — the highest in more than a decade.

It also helps that banks last week were charging marginally less to lend to each other, and a world suddenly on “Libor watch” makes credit shocks less likely.

In recoveries from past market plunges, trading has remained volatile even after the major indexes reached their lows, so it is widely expected that Wall Street will ratchet higher and lower for some time.

Despite the dizzying swings, the market has started building a base, which is the first step on the road to a genuine recovery. And if history is any guide, this will occur months before the economy gets up off its sickbed.

Similar sentiments were evident in a column in last Friday’s New York Times by renowned investor Warren Buffett, who recommended buying U.S. stocks. The billionaire said that his entire personal fortune may soon be invested in the domestic market in anticipation of an economic recovery.

“If you wait for the robins, spring will be over,” wrote Mr. Buffett. “Bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.”

In his article, Buffett tells the world why he is buying U.S. stocks now. A simple rule dictates his buying: Be fearful when others are greedy and be greedy when others are fearful. When Buffett speaks, we should all probably listen.

Warren Buffett has been moving his personal investments from safe U.S. treasury bonds into U.S. stocks, he wrote in an opinion piece in Friday’s New York Times.

“If prices keep looking attractive, my non-Berkshire net worth will soon be 100 per cent in United States equities,” he wrote.

“To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions,” he wrote. “But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records five, 10 and 20 years from now.”

“Let me be clear on one point: I can’t predict the short-term movements of the stock market,” he wrote. “I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.”

Warren Buffett and other savvy investors are, as of right now, positioning themselves to take advantage of the current fire sale in the stock market. They’re certainly analyzing financial data, looking for sound businesses whose stocks are battered by the current bear market but whose businesses are sound, strong and profitable, making them excellent candidates for strong long-term growth.

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