Tuesday, March 13, 2007

Investor Fear and Liquidity

“The key to making money in stocks is not to get scared out of them.”
~Peter Lynch

The market volatility the last few weeks has led to media speculation about possible causes: China's late February market plunge, the precarious financial straights of subprime mortgage lenders, and the biggest baddest reason of all .... Recession. In a different market climate, such events would have had little impact. But the market price action is now driven by emotional investors. By understanding how investors' fear generally plays out during such times, one can act proactively (rather than reacting) to such emotional markets.

Markets worldwide have been booming. In fact, on February 21st during a trip to India last month, I met the head of Asian investments for one of the largest New York-based hedge funds. He confided to me that "nothing in the world is cheap right now." And that was true for every broad asset class. In fact, the conclusion of our conversation was, "Only volatility is cheap." And that's a frightening position to be in. Within 2 days of our conversation the Bombay Sensex index began its latest correction, to be followed shortly by the Chinese and worldwide sell-off.

Many pundits have identified the "global liquidity glut" as the force behind stock market and commodity booms worldwide. But what is liquidity, really? Liquidity represents confidence -- the sense that one can borrow and make a greater return on their investments than the risk-free rate of return. And what is confidence but the lack of fear?

Today's sell-off is an opportunity. Many people who recently acquired risky assets are heading for the exits. But like last May, soon there will be a great time to load up on emerging market bargains.

Hundreds of billions of dollars have been committed to private equity, venture capital, and stock market investments in emerging markets. These outlays will be made over several years and will support emerging markets generally.

However, as with every opportunity, it's usually when it feels the hardest to buy, that the best price is available.