Opinion: Still time to buy?

Eighteen days ago — on March 9 — GlobalPost ran an opinion piece in which I used historical precedents to make the case that the stock market had an uncanny ability to predict economic upturns.

I cited three examples in which the U.S. stock market anticipated better days ahead, typically by six to nine months. The Dow Jones Industrial Average closed at 6,547 that day, and hasn’t looked back since. It is now some 20% higher, traditionally viewed as bull market territory.

So now what? It’s still time to buy.

I believe the early part of March marked the bottom not only for the U.S. stock market, but for Japan, Singapore, Australia and the UK as well. A number of other markets appear to have hit bottom last fall, such as China, Malaysia, South Korea, Thailand and Brazil.

My optimism rests squarely on the shoulders of Fed chairman Ben Bernanke. By an extraordinary stroke of good fortune, Bernanke stands at the helm of U.S. monetary policy. Better yet, his policies are being copied by other central banks, including the Bank of Japan and the Bank of England.

Bernanke became obsessed with the Great Depression in the early 1980s, not long after he received his Ph.D. in economics from MIT in 1979. His fascination with deflation — falling prices — prompted him to delve into attempts to reverse these forces that ravaged the U.S. economy in the 1930s.

Not surprisingly, Bernanke was fascinated by Japan’s battle against deflation in the 1990s. He analyzed every twist and turn of BOJ policy as the country descended into its "lost decade."

One of Bernanke’s most revealing essays — and a strong clue to his playbook today — was written in 1999 while he was head of the economics department at Princeton. Called Japanese Monetary Policy: A Case of Self-Induced Paralysis? (If you want to really geek out on Bernanke’s penchant for "non-standard measures," see page 23 of this pdf).

Bernanke’s essay ends with a short section called: “Needed: Rooseveltian Resolve." The money quote:

“Roosevelt’s specific policy actions were, I think, less important than his willingness to be aggressive and to experiment — in short, to do whatever was necessary to get the country moving again. Many of his policies did not work as intended, but in the end FDR deserves great credit for having the courage to abandon failed paradigms and to do what needed to be done."

I often wonder what Bernanke’s first, semi-conscious thoughts are as he wakes each morning. Here is a man who spent his life thinking about which policies succeeded and failed during the Great Depression and in Japan of the 1990s, the two episodes of economic history that he understands perhaps better than anyone in the world.

Is he living out his dream, confident in his ability to draw from his vast reservoir of knowledge and lead the world out of the deepest downturn since the 1930s? Or, given the gravity of events, is he haunted by the prospect of failure?

The verdict is in.

Despite an ill-timed presidential transition, the confusing and ever-changing policies of former treasury secretary Hank Paulsen, the lambasting of U.S. Treasury Secretary Timothy Geithner and the mind-boggling partisanship of Congress, Bernanke has engineered a succession of policies that are succeeding in normalizing credit markets.

This is a harbinger of economic recovery. Future historians will marvel at how swiftly he acted at a time when the world economy seemed to be hopelessly, and relentlessly, unraveling.

One of the most pivotal events came last week when Bernanke announced the Fed would buy some $300 billion of U.S. bonds. He hinted at such a move last December, but then backed away from it, preferring instead to use the Fed’s balance sheet to underwrite other programs, such as the TALF and various mortgage-related programs.

The outright purchase of treasuries reveals the full force and determination of the Fed chairman. This is “Rooseveltian resolve” in action. It is one thing to buy mortgage-backed securities from Freddie Mac and Fannie Mae. It’s quite another to wade into the world’s largest bond market.

Bernanke’s goal is to make risk-free assets so unattractive that capital unavoidably spills into risky ones. He has said repeatedly that one of the great lessons of the Depression was that policy became restrictive too early. Better to keep the foot on the gas pedal until one is certain of a return to economic prosperity.

So what does all this mean to global markets?

The economic data is becoming less uniformly bad, just as monetary policy is ramping up to the highest, most potent level of stimulus. Retail sales are beginning to improve; home sales are finally stabilizing in parts of the country; even durable goods, though a volatile data point, finally turned positive last month.

Meanwhile, JP Morgan, Bank of America, Wells Fargo and even Citigroup are reporting better profitability during the first couple months of this year. In fact, several leading financial companies are saying they do not need any more government money, while others are eager to return it.

The doomsayers don’t know what to think about these surprisingly favorable economic developments.

But the answer might just be simple: the corrective mechanism of the market is alive and well. Drive down prices far enough on clothes and houses and buyers come in. Write down bank assets far enough and year-on-year comparisons become more flattering.

Add cheap money and a big fiscal injection to the self-correcting nature of markets and things could really start to improve. We’re talking about lower interest rates on mortgages, student loans, car loans, business loans, and yes, even government bonds, against which all sorts of loan rates are pegged. And as yield spreads narrow, rates are driven still lower.

The first phase of a bull market is often greeted with discomfort.

Is this the real thing, one asks? Am I guilty of sitting on the sidelines? Will these bargains be around for awhile? Numb from losses and paralyzed with fear, investors want that feel-good factor to re-emerge. Yet the bargain valuations we’re seeing happen just two or three times a century. Larry Summers recently said that the Dow Jones Industrial Average, when adjusted for inflation, is at the same level it was in 1966. That’s a strong statement.

As of early March, the major U.S. indices were down around 55 percent, the second largest decline in history. Sure, markets have rallied some 20-30 percent off the bottom. And nothing goes up in a straight line.

But as evidence mounts that Bernanke’s medicine is bringing the patient back to life, the risk becomes one of being under-invested.

Andrew Parlin is co-founder of Parlin Investments, an investment partnership in Boston. 

For more on the global economic crisis: