The Middle Ground

Every time the market rallies for a few weeks we start hearing about a self sustaining recovery and every time we sell off we start hearing about another 2008. Both these opinions have been completely wrong as we have seen a muddle through economy for the past 3 years with fits and starts. The market is now declining so the 2008 chorus is growing loud.

A major difference between 2008 and now is the starting point. The S&P 500 trades at 13 times projected earnings. Going into 2008 valuations were significantly higher. Valuations are already pricing in a bad economy so in order to move the needle the economy and earnings will need to be significantly worse than expected. In 2008 the economy and company earnings were being inflated by a real estate and a debt bubble. The decline in earnings were a result of this bubble disappearing. There are far fewer excesses in today's economy.

A muddle through economy like we have been seeing would likely be a victory for the bulls even if it is on the slow side. There are numerous imbalances in the economy so the bear case is possible. The way I deal with these risks is to own companies that will be able to survive and remain profitable in any economy as well as holding some hedges. But I have no interest in being net short. It just seems like a poor risk/reward given that an economic collapse is needed for the bears to win. What if we muddle through for another year?


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