Should you be bullish on stocks?

September 13th, 2009

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Marc Faber is a well-known contrarian bear. He has such a pessimistic streak in his blood that he is given a nickname of “Dr. Doom.” But many people were surprised that this bear is actually quite ‘bullish’ on stocks. For example, even though he believes that stocks are going to face a major correction soon, he believes that the rally can still have more room to run.

How do you reconcile his bearish temperament and ‘bullishness?’

The trick is to understand that his reason for ‘optimism’ is different from the reason espoused by the “green-shoots-of-recovery” crowd. The basis of his ‘bullishness’ is based on a very pessimistic view of the economy. This Lateline interview sums up his view very well:

As we wrote before in Can we have a booming stock market with economic calamity?,

But as we stressed many times in this journal, it is possible to have economic calamity with booming asset prices, especially stock prices

Based on conventional economic theory, there is no explanation for such a stellar performance for the Zimbabwean stock market when the GDP was collapsing (see Zimbabwe: Best Performing Stock Market in 2007?). A stock analyst using conventional valuation analysis will hard pressed to justify the lofty heights of stock prices.

But followers of the Austrian School of economic thought have an explanation for this illogical phenomena. In a perfect world, every single cent of the printed money will go straight into repayment of debt and thus, wiping out debt obligations, introduce financial stability and not cause price inflation in one swoop. Unfortunately in the real world, the plans of the governments and central banks do not always work out perfectly. In a dysfunctional economy, the massive printing of money can lead to some of them being used for speculations of assets and commodities instead of de-leveraging. As what happened in 2008 (see Who is to blame for surging food and oil prices?), the speculation of the latter can lead to strong price inflation.

In the same way, the current bout of monetary inflation is the cause of the rally in the stock market. In fact, Marc Faber believes that this rally has more room to go beyond the current impending correction. It is possible that the coming correction may not come in the form of tumbling stock prices- stocks may stagnate sideways until the technical overbought condition deflate to a more balanced one.

Today, it is the stock market that gets artificially inflated. Tomorrow, it can be the commodity markets. Now, the question is, should you buy stocks to protect yourself against price inflation? We will look into it in the next article.

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