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October 06, 2008

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Riz

I agree that now is a good time to be buying stocks for the long time, or at the very least not jettisoning your positions, but I would view the idea that 'Real risk has an inverse relationship with perceived risk' with a note of caution: while actual outcomes seem to have proven this statement to be the case, it may only be so because the extremely low probability of a total crash (eg: Japan, Great Depression, etc) haven't yet materialised. And so it is that with hindsight we build up a picture that the market keeps getting it wrong on these occassions.

The Financial Philosopher

Excellent point, Riz! I especially agree with your cautionary approach...

As I inferred in the post, the size and shape of this bear market will not be known until it is history.

Additionally, we will not know when the "real risk" is lowest until we know when "perceived risk" is highest, which may not have yet materialized.

Also, as many a philosopher have spent careers arguing, there are no real "absolutes."

"There is no truth. There is only perception." Gustave Flaubert

Thanks for adding to the conversation...

Kent

Peg

Kent - I am just a small investor in the Midwest. Many years ago, I was dating a wealthy man much older than myself. I wanted him to TELL ME what to do, as I viewed him as an "expert."

What he told me was this. "Learn as much as you possibly can yourself. No matter what expert you to go for 'financial advice' - the more you are aware and knowledgeable, the less the odds that you will take someone's advice and do something harmful or stupid."

I certainly have made many a poor decision over the years. Nevertheless, I'm not broke (yet!) - and I am in better shape than many of my acquaintances.

Nevertheless - I will tell you that I have been more fearful this past week than ever in my financial life. All that I've studied and thought I knew seems to be flying out the window right now. Very scary to see 25 years of investing almost melt before my eyes.

Still - I thank you much for your words. I hope that you are correct, and that, however awful and long this period is - eventually it will end. I hope that my faith in free markets and our nation's economy eventually will bear fruit, once again.

Leonardo

As much as I find myself in agreement with Kent (as usual), if useful, I would like to make the following considerations:

Unless one is trading actively daily, anytime is a good time to buy or sell according to the view that has been personally formed.

The question therefore one should be asking right now is, " how do you view the economies in 1 to 2 years from now" If you're negative, sell. If positive, buy. This may sound like a platitude but it really encapsulates all that one needs to know about investing. You may forgoe some profits initally but over the medium/long term you will come out better-off irrespectively of the way you lean. People need to start extending their horizons over years rather than days or moths. Especially in these markets

The main reason being that if one awaits the 'technical bounce' you can bet that all media and financial pundits will be touting that the worst is over and emotionally, you will not have the strength to sell into the rally only to then see it at lower levels in 6/9 months time.

In the apparent immortal words of Bernard Baruch when ask the secret to his investing, he replied "I always sold too early".

With regards to the advice given by the expert to Peg, ""Learn as much as you possibly can yourself. No matter what expert you to go for 'financial advice' - the more you are aware and knowledgeable, the less the odds that you will take someone's advice and do something harmful or stupid." is probably the single best advice anyone can ever receive.

A quick thought on the current markets. If we consider that the 2003/2007 bull market (and wealth) was created from thin air (or debt should I say) there is a very strong likelyhood that the whole move will be retraced at some stage. If such a scenario occurs, you can be sure that we will also overshoot those levels.

History will then tell us why....

The Financial Philosopher

Excellent thoughts, Peg & Leonardo!

Peg:
Your anecdotal lesson defines wisdom, which in my humble opinion is defined by an individual's awareness of their own ignorance. Education never ends; we learn from our mistakes; we acquire knowledge but do not substitute that knowledge for judgment; and we define words and objectives for ourselves and from within ourselves -- not from others...

It's quite difficult to qualify our decisions without knowledge of the subject matter... Thanks, Peg...

Leonardo:
Yes, your thoughts are quite "useful." I especially like your inference that media noise is focused on the short-term nature of Wall Street: Stocks are priced today (discounted) based upon expectations of profit performance six to nine months -- not years -- into the future.

Stocks are now essentially being "re-priced" for a recession that is stronger than previously "expected."

The individual, therefore, must tune out "media noise" and focus their attention on those things that are within their control (their own objectives and asset allocation).

A long-term investor making decisions that are based upon short-term conditions is no different than selling a car in a traffic jam during long-distance travel that has thousands of miles remaining...

It is no mistake that one of the most taught and most useful virtues for thousands of years is patience...

"Patience is the companion of wisdom." ~ St. Augustine

"The two most powerful warriors are patience and time." ~ Tolstoy

Thanks again for sharing your thoughts...

Kent

semyhr

Oh well, it is worse now than it was a year ago so I am not sure that it will be better after a year, however, 3 to 5 years from now and everything should be OK ;) Very interesting times to witness such markets and I think that the next couple of years is a good time to slowly accumulate more stocks.

The Financial Philosopher

semyhr:

You bring up a great point when you say, "it is worse now than it was a year ago so I am not sure that it will be better after a year..."

When things are going well, it is normal to expect those positive conditions to continue. Conversely, when things are going poorly, it is normal to expect those negative conditions to continue.

I would argue, however, that "normal" ways of thinking are exactly what causes problems for investors...

A year ago, the Dow Jones closed at its all-time high above 14,000 and bullish (positive) sentiment was quite high. Prudent risk management would have an investor, at that time, anticipating lower stock prices over the following year to 18 months (as I consistently stated on this blog).

Now that the environment is completely opposite (extreme pessimism and arguably oversold conditions), prudent risk management would have a long-term investor anticipating higher returns over the next 12 to 18 months.

I'll post on this in one year and we'll see where the market is then. It should be interesting!

Thanks for sharing your thoughts...

Kent

anon

There are a few problems with your point:

1. You have not looked at the totally of the US stock market from 1900 to current, if you did you'll find that the random walk they are selling doesn't work

http://stockcharts.com/charts/historical/djia1900.html

This theory has not seemed true since 1933 but it is looking better by the day:

http://en.wikipedia.org/wiki/Kondratiev_waves

2. You might not have read current news but the problems facing the world are dire, and with the S&P at 2003 levels you'll see that the economy is in worse shape than 2003. So this bottom could very well look like a top.

http://www.fdic.gov/bank/individual/failed/banklist.html

Between 2002 and 2033 the last recession 17 banks failed. 13 banks have failed this year and one bank WaMU is bigger than all the 2002-3 banks combined.

3. If you like statistics investors having be paying increasing higher premiums, P/E, in the past 10 years than historical averages. So in some senses the market is not cheap. Check current P/E for S&P 500.

http://online.wsj.com/mdc/public/page/2_3021-peyield.html?mod=topnav_2_3028

4. If you read accounts of the great depression it took 20 years to get a 0% return if you bought in 1930 after the crash of 1929.

On the upside, if we do enter a depression, and you are investing stocks not mutual funds, at least you own something of value.


The Financial Philosopher

anon:

Great points! As you may guess, I do not fully "buy into" statistical measures, fundamental analysis or technical analysis.

Logical analysis is the foundation of my risk management.

Logic, as you know, does not pretend to be "the truth" -- it is simply deductive reasoning based upon knowledge.

Uncertainty still weighs heavily in this (and all) bear markets.

Let's come back in one year and see where we are...

I still believe the S&P will be higher than today in October 2009...

Cheers...

anon

Financial Philosopher,

I like your attitude.

I too question fundamental analysis for the average investor. I don't believe that the average person can access the same information available to the professionals. For instance, Bloomberg terminals provide a wealth of information which is inaccessible to most, such as current CDS information on companies.

On your side the buy and hold strategy works if you understand history like Buffett. Buffett's wealth was created by reading Keynes, and buying companies which flourished during the tough years after the crash: Disney, Coke, and Gillette.

And as far as the stock market, being higher (S&P 500) than 963, I couldn't hazard a guess.

I'm just hoping it is still there after Monday when all of the CDS on Lehman come due.

http://www.reuters.com/article/rbssFinancialServicesAndRealEstateNews/idUSN0841811720081008

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