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Time to Buy Stocks -- Not Sell

Despite the frightening events on Wall Street, this bear market may be over soon.

By Steven Goldberg, Contributing Columnist, Kiplinger.com

September 18, 2008

"The time to buy is when blood is running in the streets." Baron Nathan Rothschild issued that famous dictum in the early 19th century, but it holds equally true today.

The crisis on Wall Street has caused so much panic that I think it's time to increase -- not decrease -- your allocation to stocks. All the usual caveats apply: Don't do this with money you're going to need in the next few years, and don't overdo it. But if you're a long-term stock investor, go ahead. A year or two from now, I have little doubt you'll be glad you bought during this tumultuous time.

Why? When the fear is this thick, almost everyone who is going to sell stock has already sold. Further bad news -- and I have little doubt that there will be more financial failures -- will likely push stocks down only so much further. Conversely, even a thimbleful of good news will turn sellers into buyers.

Steve Leuthold of the Leuthold Group, a Minneapolis investment-research firm, is one of canniest analysts of the stock market, which he has been studying for nearly a half century. After the Dow Jones industrial average plunged 449 points September 17, he issued the following advice to clients:

"This is no time to be joining the overwhelmingly frightened investor crowd. At minimum, the market looks to be on the verge of a major rally even if it's only a snapback bear-market rally. Even though you believe the market is ultimately headed much lower (we don't), this is absolutely the wrong time to sell stocks."

Leuthold isn't basing his recommendation on gut instinct. He and his colleagues study hundreds of market and economic indicators. Their record of calling market turns is terrific. Among those he nailed almost to the day where the start of this bear market almost a year ago, and the start of the previous bull market five years earlier.

Leuthold's signals have been flashing positive (obviously wrongly) off and on for much of the summer. But as the market has fallen sharply this week, his models have turned much more positive -- particularly those indicators that measure investors' emotions.

"It's been almost 21 years since the current level of fear has prevailed in U.S. financial markets," Leuthold writes. That was right after the 1987 crash when stocks plummeted 23% in one day. What's more, in the 45-year history of his model measuring investor sentiment, the current readings are "the most bullish ever."

His model measures emotions related to short selling, options activity, mutual-fund selling and a host of other data points. They are screamingly bullish because investors are so frightened.

Is there reason to be frightened? Of course. Major financial institutions are failing right and left. The Federal Reserve and the Treasury remind me of the legend of the little boy who prevented Holland from flooding by sticking his fingers in the dikes. You fear the government will run out of fingers -- or, in this instance, the trust of the world's investors.

Housing prices, meanwhile, continue to tumble -- meaning the underlying value of all that toxic mortgage debt continues to erode. It's hard to see the economy bottoming before the housing market does.

But, remember, the stock market is a discounting mechanism. I think that most of the current and future economic woes are already reflected in stock prices. Indeed, the stock market generally turns up about six months before the economy does.

Despite the current crisis, I don't believe we're headed for anything like the Great Depression. For one thing, the Fed and the Treasury are squarely facing up to our problems. Unlike the case in Japan in the 1980s, no "zombie banks" are being allowed to stay afloat for years and years, bankrupt in everything but name. Instead, we are quickly taking down the weak institutions that are overwhelmed with subprime collateralized-debt obligations and other bad paper.

From its high October 9 of last year, Standard & Poor's 500-stock index has fallen 26% through Sept. 17. I know that's bad -- I'm an investor, too. My holdings are hardly soaring. But in the average bear market since 1945, the S&P 500 has fallen 32%. We're not far from that level now. Might the market fall 35%? Sure. But I believe we're closer to the bottom than most people think.

Sam Stovall, chief investment strategist at Standard & Poor's agrees. "We believe that from a technical perspective the bottom will likely occur on or above the 1060 level, which would equal the average bear market decline of 32%," he wrote in a note issued after the market closed September 17, with the S&P 500 at 1156. What's more, he says the market will finish the year 8% higher than the September 17 close.

That's not all. Once a bear market ends, the stock market tends to rise sharply. On average, stocks surge 38% in the 12 months after a bear market trough.

Says Leuthold: "Traders should be buying stocks, futures and ETFs now. Long term investors should use this current opportunity for selective buying, including some financials When your emotions say sell, sell, sell ... don't."

Steven T. Goldberg (bio) is an investment adviser and freelance writer.

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