Reflections on the Recent Market Rally

After living through the fierce market rebound since March 9th, I thought it prudent to distill some key takeaways from Q4 of last year to now:
1. The market is very smart – when the rebound started occurring in early March it was important to question one’s bearish orientation and continuously strive for positive data points in a sea of negative news – both of which I think I did sufficiently well)
2. Government stimulus works – whether you are politically or morally opposed to it is irrelevant when considering its short-term implications on the market and psychology. On a longer-term basis, perhaps we will be debating the merits of TARP, TALF, PPIP, and other government programs (frankly, I am still unsure what to think). However, stimulus generally works and in this instance I think the government played its exceptionally difficult hand right (at least in terms of infusing capital in the banks)
3. The market and economy are all about confidence – the world was ending in Q4 and early March only because the media would have you believe that was the case. Now that the media has moved on to the next story, the American public can go about the business of living (admittedly, a bit more frugally)
4. It is always darkest before the dawn. I remember listening to a few earnings calls with CEOs commenting that orders were down 40-50% in their businesses and the outlook appearing just as grim. I don’t care how bad things are – the world was not decelerating at such a pace. After two quarters of 5-6% GDP declines, it should be apparent to everyone that we would need to rebuild inventories.
5. Investing is all about valuation (and this is where I fault myself for not truly appreciating the potential magnitude of this rally). I’ve said it many times, but it bears repeating. When industry leading businesses with solid franchises begin trading at single digit PEs off of trough earnings, you have to buy. You just never know when the bottom will hit and people will always miss the “easy” move off the lows if they obsess about trying to catch this elusive trough. One has to buy prudently, but once the market recedes into “the world is ending territory” the name of the game is to consistently average down (and try and contain your glee as great businesses get handed to you at generational lows!).
6. I think in many instances I saw a lot of the credit excesses coming. However, in 2005 & 2006, I certainly didn’t appreciate the magnitude of the housing decline (almost to the point of being clueless). I remember reading how subprime accounted for more than 20% of mortgage originations in 2006, but somehow never put the pieces together that it would cause 35% peak to trough declines in housing (and still counting). I was extremely skeptical of the private equity bubble (even mystified), but never considered how that should be wrapped up in a truly macro bearish scenario. In short, I would grade myself a C over the last 4 years as an investor (and believe me I take no pride in that self-evaluation). However, I would argue that a lot of other supposedly smart investors didn’t see the tsunami as well. In fact, many that didn’t see the storm in 2005/2006 have convinced themselves in 2008/2009 that the world was ending. Why the media hangs onto these bearish views at market bottoms from people who failed to forecast the current situation is beyond me. However, the media loves a good scare story and there were plenty of investors willing to provide the fodder. Our economy has tremendous self-correcting mechanisms built into it and the world was no sooner going to end in Q4 2008 as it was going to continuously operate at the peak levels of 2006.

As always, I could very well be wrong and perhaps the worst is yet to come (certainly if history is any guide, the former will prove correct).