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July 21, 2008

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Brian

Interesting post (as always). One of the things I struggle with when I hear historically-based arguments such as this one (i.e. comparing this cycle to '90-'91,'73-'74, or some other cycle; or the average bear market is down x% and lasts z years), is that it assumes the past is representative of the future. Maybe it is, and maybe it isn't, and maybe there's just not much better to go on.

The 21st century was a unique time in human history in which economic growth was far greater than in almost any other time preceding time period. However, we only have good stock market data for the 21st century.

Therefore, I tend to be concerned that the sample may not be representative of the population. That is not to say that economic growth will forever stagnate from here - in fact, it could accelerate for all I know.

Anyway, just a random musing about a topic that has been bugging me.

The Financial Philosopher

Brian:

I could not agree with you more...

While I believe Twain's musing that "history does not repeat itself, but it does rhyme," I would not invest or plan my future according to history.

As I inferred in the immediately preceding "Non-Bottom Callers" post, it is foolish to believe "things are different this time" just as it is foolish to assume "things are the same this time." Perhaps Twain should have added that, "history sometimes doesn't rhyme, either!"

There is such a thing as "abnormal returns..."

My bottom line is that we do not know for sure what the future holds; therefore, we should not predict it.

As I stated in a latter paragraph in this post, "What we do not know is that our logical conclusions will become a reality, for this assumption would be illogical, especially when emotion and perception are factors."

It certainly will be interesting to see what the market does from here and I look forward to observing it... primarily as a passive observer...

Thanks for the comment and for reading The Financial Philosopher...

Kent

Leonardo

Indeed "history does not repeat itself, but it does rhyme". It is we that repeat history through our emotional responses to events.

For this reason, we have yet to see true fear in the market (and I'm not talking about capitulation that can be quite easily engineered) The true contrarian trade today is to believe that things will be far worst than what the market believes. Consequently, just because the US has had a depression it does not mean it won't have another. For all we know it could be even worst than that of the '30s.

The first tale tell signs are appearing from the recent rate cuts that are not producing the required stimulus unlike 2002. What most people fail to realise is that events unfold slowly but as a society we demand instant results.It has required nearly 12 months to show that the rate cuts have had no effect. That is why I believe that the truer picture will be evident around mid 2009 where people will finally realise how problematic things really are (and not just in the US. In my mind Europe is in far worst shape). Until then, we may even possibly have a strong rally from the summer-end onwards.
But with all this said and done, the beauty of it all is that the future comes one day at a time....

The Financial Philosopher

Leonardo:

I believe your assessment that we have not seen true fear is likely to be correct. The challenge of making investment decisions based upon our assessment of emotions is that fear manifests itself so quickly that investment opportunities are difficult capture.

For this reason, I have suggested and personally practiced the strategy of "selling into strength and buying into weakness" while maintaining a passive core holding, such as a large-cap index fund or ETF.

If I were to write this post again, I may have included Newton's second law of physics, which I believe captures the general behavior of market cycles in terms of motion. The law says, "The alteration of motion is ever proportional to the motive force impressed." The velocity of the preceding bull market was not on the level of the 1920's or the 1990's; therefore, applying Newton's 2nd law of physics, we would expect this bear market to be less severe than those of the 1930's and early 2000's.

To underscore all of my thoughts, I would not make large bets either way and remain mostly passive. Our logic is purely for observation and perspective.

This is not to say that an investor or trader could not make a contrarian bet that the lack of fear in this bear market suggests there is more downside to come.

Recall that our logic suggested that the overall market would still need to fall approximately 10% to reach "average."

This leaves much room for fear...

Thanks for adding to the discussion...

Kent

Vered

Interesting!

I consider myself a long-term investor and pride myself on dealing with stock market fluctuations on a purely logical basis. I pretty much assume that I need to keep some of my money in the market, and ignore it except for rebalacing once a year.

The Financial Philosopher

Vered:

Your strategy is certainly prudent for a long-term investor.

I believe that we tend to be our own worst enemy, especially in matters involving emotion.

On a separate note, I like your blog...

Cheers...

Next Gen Politics

From this article(and I know you don't intend readers to use it as such), I may deduce through logic that I should wait until the market drops another 10% and then restart my investing. Is that sound, considering historical and current events? Anyway, it was an interesting article and fun to read. Keep up the good work, and I hope you'll pop over to our site for a quick look too. Have a great week.

The Financial Philosopher

Next Gen:

To answer your question, it is more prudent to invest your money according to your risk tolerance and objectives first, with little or no consideration for current market events.

If you could choose one of three times to invest, Yesterday, Today or Tomorrow, the best of the three, for a long-term investor is yesterday.

What I am saying is that you should invest according to your risk tolerance and objectives as soon as capital (money) is available to put to work (invest).

As for our logical exercise, I would only assume, based upon the averages, that the market is closer to a bottom than a top.

Thanks for the comment. I will certainly take a closer look at your site...

Kent

Rob

"As for our logical exercise, I would only assume, based upon the averages, that the market is closer to a bottom than a top."

Do you mean the market is closer to a bottom in time or closer in price? I think it is an important distinction. I'm a technical trader, and we are still in a downtrend. Until I see indications to the contrary, I remain predominately short.

Rob

The Financial Philosopher

Rob,

Based upon the logical assumption that this bear market is not a generational occurrence, then the decline in price is approximately 2/3 to the bottom (22% decline, 33.5% average) and the decline in duration is a bit past half-way (appr 9 months in, 16 month avg).

Thanks for the comment. I always enjoy hearing from technical traders.

Cheers...

Kent

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