Nervous about being nervous

Right now as an investor I am nervous about being nervous.  What makes me nervous is that huge drop in Consumer Confidence in February.  I am also nervous that the “positive” economic data that keeps coming is barely positive.  In other words, it looks and feels to me like the economy is treading water without definitive, strong movement in either direction.  But being this nervous makes me nervous because the financial markets are staging mini-rallies.  I have this nagging suspicion that I am wrong and shouldn’t be nervous about the economy.  But then there is that consumer-confidence number that just keeps serving as The Filter through which I am seeing all of the economic data right now.

I do know this, the financial markets remain fairly to slightly over valued on a Price to Earnings basis.  However, if the first quarter has been better for U.S. corporations than expected that means that the earnings will rise, thus lowering the P/E ratios and making the stock markets look fairly to slightly under valued.  It’s like this: if a stock is trading at $20 per share and earnings are $1 then the P/E ratio is $20 divided by $1 or 20x.  If the price stays the same, but earnings are better than expected, such that the ‘E’ portion goes up to, say, a $1.50 then the P/E ratio is $20 divided by $1.50 or 13.33 x.  That kind of surge in earnings is possible because of earnings leverage.  Right now companies are running very bare bones operations, having fired all unnecessary workers, squeezing suppliers, and closing down marginally performing businesses.  That means that almost every incremental dollar of revenue falls to the bottom line.  That means that earnings can surge fairly quickly when exiting a recession.  That means that today’s valuations may look inexpensive in a month.

Mitigating against my nervousness is a preference for liquidity (i.e. cash) when I am uncertain.  In my world, “maybes” are the same as “nos.”  That is, the only reason to exit the safety and certainty of cash is when there is certainty of return in the illiquidity of some other asset, like stocks.  This means that I am not a speculator, but an investor.  Right now my bias is to be in cash and to be comfortable with surrendering a little bit of potential upside performance in the stock markets for some certainty that the overwhelming bias in the economy is one of improvement.  But I don’t want to look like a jack ass to my loyal readers either.  So I am nervous about being nervous.

In conclusion, I am waiting for definitive evidence of no spectres hanging over the economy, like the radical drop in February consumer confidence, before I start pounding the table and demand that you buy into assets as risky as stocks.  The cost of this caution maybe 5% of upside in the financial markets.  That is a price that I am willing to pay and I ask a little patience from you if my nervousness turns out to be unwarranted.

Jason