Worst Slide Story

If laughter is the best medicine, try a dose of this take-off on West Side Story.

Walt Handelsman, a Pulitzer Prize-winning political cartoonist and animator, has some fun with the songs of the classic musical, which is in revival on Broadway. I think you’ll find his version of West Side Story much more current, and funny to boot.

You are encouraged to sing along, if the spirit moves you.

To get to the web site, click here.

Dow Jones Music Video

Is it possible to be as proud of a friend’s child as you would be of one of your own?

Adam Baff, whom I have known for 30 years, is the son of close friends. Adam has many talents, and recently he wrote the music and lyrics for the Dow Jones Music Video.

I think it is very well done and effectively uses humor, irony, and great visuals to express the many moods we’ve all experienced. No doubt, for many of us, the last few months have been “trying” (to say the least), but Adam’s tongue-in-cheek view of life in these United States gives us something to smile about. Adam’s band Downsize performed the music, and the video features Nicole O’Connell an aspiring model/actress.

The link to the YouTube video is here.

The song is available for purchase at Amazon.com and also through iTunes.

So, I ask again, is it possible to be as proud of a friend’s child as you would be of one of your own? Absolutely! Way to go, Adam.

The Scream of the Lizard

Bob Veres writes a well-respected newsletter for financial planners. Recently Russ Thornton posted one of Mr. Veres’ articles, The Scream of the Lizard.

I loved this article, because I believe that Veres captures, so perfectly, the fear that is motivating, not just many inexperienced investors, but himself, as well. What’s interesting is that, while he has a very well developed and rational understanding of what investing in the stock market sometimes entails, he is still gripped by the fear of the “roller coaster ride” and the scary (but unrealistic) feeling that we are about to fall into the abyss.

Even though he knows better, he still can’t help the way he feels, because of what he refers to as “the lizard-like part of the back of (the) brain” which screams “against all logic and against many things I (know) to be true.”

If you are extremely fearful and cannot possibly imagine that there is a bottom to the stock market, give yourself a little understanding and possibly a little more TLC. You are not alone; in fact, you are in good company.

I recommend that you read the whole article, but here is the conclusion.

I’m one of those financial media types, and also a pundit on occasion, and I can tell you that I can hear the lizard’s scream echoing across the financial landscape, so loudly that it’s hard to remember that stocks are on a fire sale now and they are certainly a hell of a lot less risky than they were last August, and that these rides are seldom fatal to those who stay in their seats, and they are usually at least harmful to those who panic, unhook their seatbelts and jump over the side toward the distant anthill below.

I can hardly wait to look back on those charts and wonder what the hell we were thinking getting so panicky about a blip, and I know at that time that the lizard will be giving me a different message: that if only I’d had the sense to buy when everybody else was selling…

This too shall pass, and 99% of your brain knows it. The market belongs to the lizard now, and I am ashamed to admit that I, the pundit, the media guru, still feel that sense of panic on the way down, irrational as I know it is. I feel it so much that sometimes I can barely hear the rational part of my mind over the screaming that echoes that are calling up from a deeper part of my consciousness. I would curse the designer of this roller coaster, as I did the fiend who put that damn thing up at Sea World, but I’m afraid this time it is us, collectively, who designed our own fear machine.

Nobody is Buying Stocks?

“One of the funny things about the stock market is that every time one person buys, another sells, and both think they are astute.” – William Feather.

As stock prices have declined this week, I have noticed some sloppy journalism. According to newspapers and TV programs, there is so much pessimism about the economy that no one is buying stocks. Clearly if everyone else is selling, you would be foolish to be a buyer.

To get a sense of this interpretation, take a look at today’s New York Times article Slump Humbling Blue-Chip Stocks, Once Dow’s Pride by Jack Healy.

Here are some relevant quotes with my comments:

“With so much uncertainty, investors are parachuting out of companies like banks, retailers and utilities, and abandoning stock markets everywhere from Asia to Europe to Wall Street.” (Parachuting? Nice metaphor.)

“No one is taking a back-seat approach. Everyone is just selling.” – Peter I. Cardillo, chief market economist at Avalon Partners.  (Everyone?)

“Nobody wants to be invested, that’s the problem. I don’t believe we’re at the bottom yet.” – Eric Ross, director of research at the brokerage firm Canaccord Adams. (Nobody?)

A similar story was portrayed in an article in the Wall Street Journal, Stocks Hit ’97 Level, Signaling Long Slump, on March 3, 2009 by Tom Lauricella and Annelena Lobb.

Here are a few quotes with my comments.

“It’s like an unending nightmare” – Kent Engelke, managing director at Capital Securities Management . (This is an exaggeration and seems to suggest prices will continue to drop.)

“The relentless decline is pushing investors to the sidelines.” (Not really. See explanation below.)

“I want to wait for a firm turnaround, and be as safe as possible,” Bijon Mishras, a financial-services consultant in New York. (Whoa, Nelly. Remember this quote and see how it turns out.)

“Nobody wants to buy a market today that they think is going to be down 2 or 3% tomorrow,” says Michael O’Rourke, chief market strategist at brokerage firm BTIG LLC. (Nobody?)

A Reality Check

Yes, the economic news coming out of everywhere is very bad, and yes, stock prices have had steep declines. But guess what? Every single time that someone sells a stock position, someone is on the other side of that transaction. Every single time. What do we call such a person? Insane? No. How about “buyer.” Sellers and buyers must be equal!

For every person who sells because he or she doesn’t like the prospects for the future (a.k.a a “pessimist”), there is someone who is buying (a.k.a. an “optimist”). That person thinks the investment is at a great price. Those two groups of investors or participants in the market have to be in equilibrium at all times.

When you look at it from that perspective, you don’t get the overwhelming sense of doom that the media creates — that there’s only one way for prices to go, and that is down. If that really is the case, then there are a lot of crazy people who are buying now.  I don’t think so.

The fact that prices have been going down does not mean that they will continue to go down. Just as in 1999, the fact that prices had been going up did not mean that it was a good time to buy stocks.

Risk/Reward

No one knows what tomorrow will bring, but unless capitalism ceases to function, stockholders will be rewarded in the long term for owning stocks and for taking risks. Yes, there is risk in owning stocks, as we have recently experienced. Since we’ve already seen the risk, how about staying around for the reward?

An old Wall Street proverb is that “Nobody rings a bell at the top or the bottom of a market.”

Are you waiting for that bell to ring? Don’t.

Searching for a Better Investment Guru

U.S. stocks declined yesterday to the lowest prices in more than 12 years. The Standard and Poor’s 500 closed at 700. You would think that now would be a very good time to have a reliable investment guru offer sage advice and words of wisdom. Times are tough, the economy is tanking and there is panic in the streets (Wall Street and Main Street, both). What is an investor to do? Should she buy, sell, hold? “Surely,” you think, “the ‘experts’ must know.” Unfortunately, you’d be thinking wrong; the correct answer is that he or she really doesn’t.

Last month, in an article titled Why the Experts Missed the Crash, Money Magazine published an interview with UC Berkeley Haas Business School professor Philip Tetlock. The professor has spent his career evaluating experts and authorities in a variety of fields, and he is not at all surprised that the vast majority of financial “gurus” failed to predict the recent steep market decline.

Here is a summary of the article:

Despite everything, we can’t shake the belief that elite forecasters know better than the rest of us what the future holds.

The record, unfortunately, proves no such thing. And no one knows that record better than Philip Tetlock, 54, a professor of organizational behavior at the Haas Business School at the University of California-Berkeley. Tetlock is the world’s top expert on, well, top experts. Some 25 years ago, he began an experiment to quantify the forecasting skill of political experts.

Tetlock has analyzed “not just what the experts said but how they thought: how quickly they embraced contrary evidence, for example, or reacted when they were wrong. And wrong they usually were, barely beating out a random forecast generator.”

Why did so many experts miss the economic crash?

The people intimately involved in packaging [financial derivatives like] CDOs must have had some sense that they were unstable. But their superiors seem to have been lulled into complacency, partly because they were making a lot of money very fast and had no motivation to look closer. So greed played a role.

But hubris may have played a bigger one. … In this case the biggest source of hubris was the mathematical models that claimed you could turn iffy loans into investment-grade securities. The models rested on a misplaced faith in the law of large numbers and on wildly miscalculated estimates of the likelihood of a national collapse in real estate. But mathematics has a certain mystique. People get intimidated by it, and no one challenged the models.

Money has written about human mental quirks that lead ordinary folks to make investing mistakes. Do the same lapses affect experts’ judgment?

Of course. Like all of us, experts go wrong when they try to fit simple models to complex situations. (“It’s the Great Depression all over again!”) They go wrong when they leap to judgment or are too slow to change their minds in the face of contrary evidence.

An Alternative to Finding a Better Forecaster

A good part of the article explores the question “What makes some forecasters better than others?” Professor Tetlock has a detailed answer, which makes interesting reading. He recommends looking for “self-critical, eclectic thinkers who were willing to update their beliefs when faced with contrary evidence, were doubtful of grand schemes and were rather modest about their predictive ability.”

But my answer to the same question is radically different. I believe that it is futile to rely on gurus who have been right more often than others. Various “experts” will be right or wrong at different times, and you cannot, regrettably, know in advance when that will be. So if in essence, the future is unknowable, and experts are so unreliable, you need to have a strategy that does not depend on “accurate” forecasts.

No one, yes no one, knows how markets will behave in the short term. Accordingly, my recommended approach has been and continues to be a disciplined long-term strategy. To understand why, it is absolutely necessary to have perspective on financial history:

• There have been many financial crises in the past; none have proven fatal.
• We have experienced a dozen other Bear Markets since World War II.
• Stock prices have rebounded from all previous declines, even steep ones.
• The stock market goes up in roughly 3 out of every 4 years.
• Stock market losses are temporary; stock market gains are permanent.

Furthermore, waiting for the “right time” to invest doesn’t work for most people, most of the time. The likelihood is that you will miss out on the really strong rebounds that happen when you least expect them. In other words, don’t wait until it looks safe to invest in stocks.

Accordingly, I leave forecasting to the “experts” who according to Professor Tetloc “barely beat random guesses – the statistical equivalent of a dart-throwing chimp – and proved no better than predictions of reasonably well-read nonexperts.”

I do believe in controlling what I can:

• Costs (through low cost mutual funds)
• Risk (through global diversification and sensible asset allocation).

I believe in staying the course so as to participate in the eventual and inevitable recovery.

In short, I do not have a forecast; I have a philosophy and an approach. It’s not perfect, nothing in this world is, but experience shows that it works better than any other approach.

Investment Guru Predicted Crash

“There will always be someone predicting disaster and someone predicting great fortune. At one time or another, each will be closer to correct than the other. But it won’t matter to you if you understand this and have invested responsibly. You have a long-term plan; stick with it.” Peter Lynch.

In my previous post, one of the individuals quoted was Jeremy Grantham, a very successful money manager, who has been getting a great deal of media attention lately. He was among the “Fortune Tellers” featured in New York Magazine’s December 7th article, Oracles of Doom.

In addition, late last month, Grantham was the sole guest on PBS’s popular investment program, Consuelo Mack: WealthTrack. She described him as a modern-day “Cassandra,” noting that he predicted today’s depressed stock prices a decade ago.

I might be in the minority here but, in my opinion, being pessimistic 10 years in advance isn’t all that useful.

Now, don’t get me wrong, I think Grantham is very intelligent and quite eloquent. He’s also very convincing. The problem I have with him is that he has been bearish for so long, that eventually, he had to be right.

You can read more about his prophesies in Here Comes the Crash, an article published in the November 15, 2004 Fortune magazine.

Talk to Jeremy Grantham about the stock market, and you get the impression the sky is about to fall. For years the chairman and chief strategist of money-management firm Grantham Mayo Van Otterloo has been gleefully rattling listeners’ nerves with his claim that the excesses of the dot-com bubble still haven’t been unwound and that the market is headed for another precipitous drop. About a year ago his prediction became alarmingly specific. Shortly after this year’s election, he says, the market will sink into a “black hole,” losing about a third of its value over the next two to three years. He sounded this warning most publicly at the annual Morningstar investment conference in July. In late October, speaking from his elegant Boston townhouse, he told FORTUNE, “We’re still in the unraveling of the greatest bull market in American history.”

To be fair, from what was printed in the Fortune article, he has been right:

Using GMO’s computer models, he has made several well-timed calls. In 1982, with stocks selling at fire-sale prices and the economy recovering, he predicted the market was ripe for a “major rally.” That year the U.S. market kicked off its longest bull run ever. He also called the top of the Japanese bubble in 1989, the resurgence of U.S. large caps in 1991, and the rallies in U.S. small-cap and value stocks in 2000.

But, he has also been wrong:

He turned bearish on U.S. equities in the mid-1990s, prompting clients to shift money to other firms.

His prediction in 2004 was that “The low will come two or three years from now, at a level below 700 on the S&P.” That’s not what happened at all. In fact, the S& P 500 went up in 2003, 2004, 2005, 2006 and 2007. Finally, in 2008, his pessimism paid off.

A web site from CXO Advisory Group rates investment “gurus.” According to them:

Jeremy Grantham has been persistently very negative about the prospects for U.S. equities (apparently since 1994), but not for international equities.

Based on subsequent stock market performance and our judgments about his forecasts for overall stock market direction, Jeremy Grantham’s forecast accuracy rate is 48%, which is about average. His forecast sample size is very small, as is our confidence in this score.

Note that carefully: 48%. One could argue that an accuracy rate of 48% is not dissimilar from simply using a coin tossed in the air to determine your prediction.

Finally, if the stock market had gone up this year, I doubt that Jeremy Grantham would be getting this much favorable press.

Are We Nearer To A Market Bottom?

Milo Benningfield, a fee-only Certified Financial Planner in San Francisco, asks a very good question – Are we closer to the stock market bottom, now that some well-known pundits have turned bearish?

Huh? Market “experts” are worried, so we should get ready to BUY stocks?

To the novice, this may seem perverse, but some stock market observers believe that when “everyone” has become bearish, there is no one left to sell “at any price.” Therefore when “everyone” is fearful, the stock market is likely to go up. So “negative sentiment” is bullish, and vice versa, at least at the extremes (at turning points).

I am obviously delving into the dangerous area of technical analysis by even considering whether stock market sentiment can be an indicator of the future direction of prices. As far as I know, there is no independent academic research showing that this approach results in improved investors’ returns.

For most people, at most times, a buy-and-hold strategy works just fine. And when you think, “this time is different” you are just as likely to be wrong.

On the other hand, I can’t resist.  I simply find this line of thinking fascinating, so here is Benningfield’s post, Pundits Capitulating — Are We Nearer To A Market Bottom?

After months of good-faith efforts to bolster investors’ spirits, several prominent financial journalists threw in the towel this week and turned gloomy. The pundits, at least, are capitulating. Could this mean we’re closer to a market bottom?

Example 1 — Ben Stein
Back in the summer of 2007, after the first wave of the credit crisis hit, New York Times columnist Ben Stein told us the market sell-offs were “nutty,” since “This economy is extremely strong. Profits are superb. The world economy is exploding with growth.”

Over ensuing months, while acknowledging the steady stream of poor economic news, Mr. Stein continued to maintain an upbeat attitude, encouraging investors not to panic and telling them “this big, strong economy will sail on through.” That changed this week. Mr. Stein asks, “What if a slowdown is a never-ending story?” His column raises the specter of a depression, telling us, “This time it’s different . . . The problem now, as in 1929 to 1940, is that the economy is not functioning normally.”

Example 2 — Jason Zweig
Wall Street Journal columnist Jason Zweig has done a valiant job these past several months urging investors to avoid panic and to see the silver lining that has emerged with cheaper stock prices and higher expected returns.

But this week, he, too, turned to the Great Depression in his Wall Street Journal column, “1931 and 2008: Will Market History Repeat Itself?” In the gloomiest terms I’ve ever read from him, Mr. Zweig warned us:

“It is vital to realize that markets are never under some obligation to stop falling merely because they have already fallen by an ungodly amount. It also is vital to explore how bad the worst-case scenario can get and to think about how you would respond if it comes to pass.”

Example 3 — Floyd Norris
The chief financial correspondent for the New York Times, Mr. Norris has done a great job reporting on the credit crisis and, unlike many shyer souls, has been willing to stand up and be counted with his predictions for where a market bottom will likely be found. Not this week. As Mr. Norris put it in his blog, “P.S. I am following the suggestion of several commentators on this blog. I am giving up on trying to identify a market bottom.”

Market bottoms typically require a “capitulation” where the vast majority of investors finally sell most of their assets and walk away in disgust. By many measures, we’re not there yet (and may not be for months). But pundits capitulating is at least a good start.

Nice job, Milo.  I have added your blog Margin of Safety to my list of recommended blogs.

How Bad Is This Bear Market?

“Technically, a bear market is when stocks fall 20% or more from their highs. But there’s a saying that a bear’s true signature is making a fool out of everyone. Based on that, we’re all laughingstocks, because there has been virtually no way to avoid this bear market’s claws.” – Matt Krantz.

An article in today’s edition of USA Today, Bear Market Swipes at More Than Just Stocks by Matt Krantz, spells out just how bad the markets have been this year. Here is a summary:

Following a 445-point slide to 7552 Thursday, the Dow Jones industrial average is down more than 6,600 points from its high. The broad stock market is at it lowest level in 11½ years, with the Standard & Poor’s 500 index off 52% from its high in October 2007 and on pace for its worst year ever, S&P says. Only 13 of its 500 stocks are not down for the year, and more than 100 trade for less than $10 a share.

The pain extends far beyond stocks. Oil has crashed 66% from its record close in early July. Even the so-called safe harbor of gold is down 25.5% from its high in March.

This bear has trashed nearly every investment strategy and asset class. It has humbled some of the most powerful names in the stock market and blown holes through long-held tenets in investing. Market historians strain to think of previous bear markets that have disproved so many investing philosophies at the same time.

“There is nowhere to run and hide,” says Ken Winans of investment management firm Winans International. “You have gotten bludgeoned in every direction.”

The extent of the earth that’s been scorched is breathtaking. Brand-name investors such as Warren Buffett, Carl Icahn and T. Boone Pickens have suffered massive losses. Do-no-wrong mutual fund managers, such as Legg Mason’s Bill Miller, are down big. Hedge funds run by managers once thought to be infallible are having their worst years ever.

Even investors who saw the bear coming have been mauled. Those that rushed into commodities or foreign currencies to sit out problems with the U.S. economy have suffered massive losses.

The pros are struggling

Even investors who’ve sought professional help have been stung. Money poured into mutual funds, hedge funds and private-equity firms run by experts known for out-foxing markets in good times and bad. The bear has proved to be smarter than the fox.

Legg Mason’s Value fund (LMVTX), famous for the longest streak beating the S&P 500 under the leadership of portfolio manager Miller, is struggling. It is down more than 65% this year, the third year in a row that it has lagged behind the market. It now has just a one-star rating, out of a possible five, from Morningstar.

Eddie Lampert, the hedge fund manager for celebrities such as David Geffen and Michael Dell who was routinely compared with Warren Buffett just a few years ago, has seen his investments sour. His personal worth has fallen to $2 billion from $4.5 billion just two years ago, Forbes says. His hedge funds’ biggest investment, Sears Holdings (SHLD), has collapsed 70.5% this year.

Speaking of Buffett, the bear snagged the Oracle of Omaha, too. … Buffett’s personal worth is getting mauled, too. Forbes estimated his net worth at $62 billion in February, but that is based mostly on his large holdings of Berkshire Hathaway stock, which is now down $74,150, or 49%, from its high of $151,650 a share.

Commodities aren’t shelter

Investors who thought they saw the stock crash coming figured they had the answer: commodities. Fears of inflation and economic problems pushed many investors into gold. An ounce of gold soared 53.6% in the year leading up to its peak on March 18 as investors poured in. But investors who piled into gold in March have been dealt a 25.5% loss.

A similar story with oil. The price of crude was soaring earlier this year, and gas prices were a national fixation. At the closing peak of $145.29 a barrel on July 3, crude was up 51% for the year. With predictions of it hitting $200 or more, it seemed like a can’t-lose proposition. Speculators lost and lost big as the price crashed nearly $100 a barrel to about $49 now.

The Reuters/Jefferies CRB index of 19 raw materials dropped more than 4% Thursday, hitting its lowest level since April 29, 2003, according to Bloomberg News.

Global diversification is making things worse

We’ve heard it before. Own both U.S. and foreign stocks, and your portfolio’s ups and downs will be moderated. When domestic stocks zig, foreign stocks are supposed to zag.
But that hasn’t worked either. The iShares MSCI EAFE index fund (EFA), which tracks stocks in developed nations in Europe, Asia and the Far East is down 54.5% this year. That’s worse than U.S. stocks’ decline.

What about emerging markets stocks? Up-and-coming nations such as China, Brazil and India were supposed to be growing fast independent of the U.S. Well, the iShares MSCI Emerging Markets (EEM) index has fared worse, tanking 64%. Every major nation’s stock market is down this year, says S&P’s Capital IQ.

Buy-and-hold investors are getting hurt

Buy-and-hold investors know short-term swings are normal. They hold through tough times, knowing returns come to those who wait. But investors who invested in the S&P 500 10 years ago have seen the value of their stocks decline 35%. Even investors who used dollar-cost averaging and invested $500 a month starting Dec. 31, 1996, and reinvested dividends lost $13,225, or 17%, as of Oct. 31, says Winans.

Bonds are eating away at portfolios

Rather than buffering losses on stocks, corporate bonds are falling apart. The iShares iBoxx Investment Grade Corporate Bond fund (LQD), which invests in bonds with high credit ratings, has a negative return of 14.4% this year. That may not sound that bad, except investors buy bonds because they want very little volatility.

Sam Stovall of S&P says that it’s usually not wise to give up on investing in the depths of a bear market. While it takes five years on average for investors to get their money back after a 40%-plus decline, those who keep investing when stocks are cheaper are made whole faster.

Conclusion

A small point: The article overstates the damage to bond investments. Not all have suffered. In fact, Treasury securities have done quite well this year, as investors have fled to these very safe investments. (As the yield of a bond goes down, the price of the bond goes up.)

But the article is generally correct. Unless the stock market recovers from these low levels, which certainly could still happen, 2008 will go down in history as the worst year ever, as measured by the Standard and Poor’s 500 Index. I believe, though, that this is not the time to get discouraged and abandon your well thought out portfolio. In this instance, doing nothing is preferable to selling everything.

There are some opportunities out there. If you can do it, this is a good time to convert your traditional IRA to a Roth IRA. It might also be a good time to rebalance your portfolio. For more information on these two issues, you should consult your financial advisor.

Going forward, we all must re-examine our actual risk tolerance. When times are good, it’s easy to tell yourself that you can weather the (hopefully) temporary storms of declining stock markets. This year certainly proves that living through a substantial bear market, in real time, is another matter entirely.

Finally, if you are so worried about the stock market that you are having trouble sleeping, consider scaling back your equity allocation. That way you will still maintain some exposure to stocks, rather than making an emotional decision to “sell everything.”

photo credit: lexdennphotography

Investor Capitulation, Part 3

“Bear markets sometimes end with a bang, sometimes with a whimper. You’re more likely to see a unicorn in your backyard or a chimera in your kitchen than you are to spot an indisputable sign of market capitulation.” – Jason Zweig.

Of late, I have been writing about the possibility that the current stock market decline could end with a great big bang, followed shortly thereafter by investor disgust and despondency. It’s more of an intellectual exercise, because I am basically an agnostic on the subject. Frankly, no one really knows whether or not we will have such a “selling climax.”

Jason Zweig’s Intelligent Investor post on October 25 is called Capitulation: When the Market Throws in the Towel. Surprisingly, Bear Markets Don’t Always End With a Bang — Sometimes It’s Just a Whimper. His point of view is worth reading and emphasizes that we just never know what will happen.

There’s a belief that the market can hit bottom only when vast numbers of investors finally capitulate, throwing in the towel and selling off the last of their stock portfolios. In theory, if you could spot this moment, you could make a killing buying at the bottom.

There are two problems here. First, capitulation is almost impossible to define. Second, even if you could get a positive ID on capitulation, that might not do you any good. Market lows aren’t necessarily marked by tidal waves of frantic selling; just as frequently, stocks bottom out in a dull and lonely atmosphere as trading dries up and most investors no longer even care. Bear markets often end not in capitulation but stupefaction.

Oddly, even market pundits who believe in capitulation admit they can’t define it. “Capitulation is a state of mind, without any specific definition,” says Al Goldman, chief market strategist for Wachovia Securities. “You can’t measure it; it’s best identified in hindsight.” Hugh A. Johnson, chief investment officer at Johnson Illington Advisors, says almost wistfully: “I wish I could quantify it for you so I could say, ‘Here, this is capitulation.’ But a lot of this is anecdotal. Talk to enough investors and you get an idea of whether we have capitulation.”

“The most interesting thing about [the 1974 market bottom] was its dullness,” veteran fund manager Ralph Wanger recalled to me. “It wasn’t a crash, it was a mudslide. You came in, watched the market go down a few points and went home. The next day you went through the same thing all over again.” And then, without a moment’s warning, the bull woke up and took off. By Jan. 6, 1975, the market had shot up 10%, and a year after that the Dow had risen 54% from its 1974 low.

In short, bear markets sometimes end with a bang, sometimes with a whimper. You’re more likely to see a unicorn in your backyard or a chimera in your kitchen than you are to spot an indisputable sign of market capitulation.

Conclusion

The obsessive attention so many investors are paying to the huge swings in the Dow suggests that we may not have hit bottom yet; stupefaction seems not to have set in yet. What we can be quite certain of, however, is that stock markets around the world are already on sale. If you have cash to spare, put some to work. If you don’t, save up until you do. But don’t kid yourself into thinking that you will ever get a clear signal out of such an unclear indicator.

I sincerely hope that my posts have not added to the “obsessive attention” to the stock market swings. I believe that when an investor owns, even a single share of stock, he actually owns a share in a business. A share of stock is not like a lottery ticket, and it’s more than just a piece of paper based on numbers that crawl across the bottom of a TV screen.

As providers of capital, investors are entitled to a return. In the short term, returns can vary tremendously. Historically, over the long term, stocks have returned more than safer investments.

As for the short term, i.e. what we are living through now, there are dramatic factors that have been causing stock prices to decline – specifically, margin calls and hedge fund redemptions.

An example of a margin call is a company’s CEO who had earlier borrowed money to exercise company stock options. Because the company’s stock price has since declined in value, the CEO must either put up more capital or sell the stock in the account to meet the broker’s margin requirement.

Hedge funds have been selling stocks, currencies, commodities – basically whatever they could sell – to prepare for imminent redemptions. This is, in effect, “forced selling,” similar to margin calls. And there is just no way to know when this will all end.

Since everyone knows this, it is possible that stock prices already reflect the negative situation. If that’s the case, this could be a great “buying opportunity” for stocks. Unfortunately, we will only know if we were right in retrospect.

photo credit: erin MC hammer

The Cloudy Crystal Ball, Part 6

 

 

“These types of forecasts are wildly off-base. What they’re always about is extrapolation. People are always extrapolating recent trends. And you don’t know how far the trend is going to really run.” – William A. Fleckenstein.

This post is a continuation of articles on how no one can predict the stock market or any other market, for that matter.

Going for the Gold in Gloom and Doom by Michael M. Grynbaum has an analysis of the phenomenon of people who make predcitions that are extreme.  They not only confidently assert their forecasts, but they are frequently wrong.  And they are not held accountable for their mistakes.

“Financial forecasters are in a race to call the bottom to the bear market. And just as on the way up, when analysts competed for attention with their forecasts of bigger and bigger gains, the financial pundit class now seems compelled to out-gloom the next guy.

“To make a crazy forecast today is not crazy,” said Owen Lamont, a former professor at Yale who has studied economic forecasting. “It’s not crazy to predict the Dow is going to 2,000. That’s in the realm of possibility.”

“Even in normal times, forecasters have a strong incentive to make extreme predictions, which is why those “Dow 1,000!” reports persist. “It’s eye-popping. It’s relevant. It seems exciting,” Mr. Lamont said. Such predictions attract publicity, name recognition and a bigger client base in a business where investors pay thousands, if not millions, for stock advice and investment guidance.

And even if a forecast is off-base, there are few repercussions because they are almost always quickly forgotten. “The reason that people do these games is because no one’s really tracking accuracy,” said Mr. Lamont, who now works at DKR Capital, a hedge fund in Greenwich, Conn. “No one is carefully, prudently giving more business to the guy who is 2 percent more accurate than the next guy.”

Some say this is a system that propagates ignorance and poor advice.

“Anyone that invests 10 cents on the basis of someone’s forecast of the Dow is desirous of losing a good portion of their 10 cents,” said William A. Fleckenstein, president of Fleckenstein Capital, a money management firm in Issaquah, Wash. “It is almost the height of arrogance to say this is where the Dow is going to trade.”

“These types of forecasts are wildly off-base,” Mr. Fleckenstein said. “What they’re always about is extrapolation. People are always extrapolating recent trends. And you don’t know how far the trend is going to really run.”

Some financial pundits, however, are all too happy to broadcast their predictions to the public, no matter how apocalyptic.

Peter Schiff, the president of Euro Pacific Capital in Darien, Conn., and a prominent financial Cassandra, has seen some of his most dire forecasts confirmed amid this year’s turmoil. On Friday, he predicted plenty more pain to come.

Forecasters who get too far ahead of themselves would do well to remember an instance of notoriously poor prognostication. One of the few times that a financial strategist has been widely taken to task came in 1999, when Kevin A. Hassett and James K. Glassman published “Dow 36,000: The New Strategy for Profiting From the Coming Rise in the Stock Market.”

The book, which arrived just months before the technology bubble burst and stocks plummeted to earth, was actually an argument that bonds and stocks should be considered as equally risky investments. But the title — cartoonish in hindsight and, in its authors’ defense, proposed by the publisher — has since become a popular punch line for jokes about irrational exuberance in turn-of-the-century Wall Street. (The Dow closed on Friday at 8,378.95).

Still, while the reputation of its authors may have taken a hit, “Dow 36,000” has not seemed to hurt their careers.

If you had taken their book seriously, you would be much poorer.  But while their predictions were way off the mark, both authors have done just fine.  One has a prestigious position with the American Enterprise Institute and one with the Bush Administration. 

Conclusion

Wildly optimistic forecasts and wildly pessimistic predictions are often wrong. Frequently the prognosticators are merely extrapolating the recent past. The main thing they accomplish is to gain attention for themselves. If you listen to such predictions and act on them, you do so at your own risk.

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