The Financial Philosopher

Weekend Wisdom: The Certainty of Doubt

"If a man will begin with certainties, he shall end in doubts; but if he will be content to begin with doubts, he shall end in certainties." ~ Francis Bacon, Advancement of Learning

Last week we pondered the media pundit ponderings over the definition of recession and if the U.S. economy is (or is not) in the midst of one now.  I noticed similar questions this week across the blogosphere that essentially wondered if we are in a Bear market rally (temporary but significant rise in stock prices during a Bear market), or if a new Bear market has begun at all.

In the true spirit of a philosopher, I am inclined, as Francis Bacon suggests, to "begin with doubts" by addressing those kind of questions with more questions:  Even if we could, with absolute certainty, say that we are in a recession or not and that we are in a Bear market rally or another leg of a Bull market, what would we do with the information?  How can we be certain either way?  Shouldn't we adhere to the same investment strategies, regardless of current economic and market conditions?

"Those who have knowledge, don't predict.  Those who predict, don't have knowledge." ~ Lau-tzu

I understand that the answers to those questions will differ, depending on the nature of your investment style and strategy.  And, of course, I frame this in the context of a long-term view, but the prudent investor will frame investment decisions through the lens of risk management rather than market timing and prediction science.  Is it not prudent to act as if we are in a Bear market rally and that we are in the midst of recession rather than wager that the Bull market is alive and well?  Is the apparent  risk worth the prospective return?  Should an investor not be at least a bit more defensive now than they were one year ago? 

Let's consider a few points (hat tip to The Kirk Report) that should have us yielding  to the side of doubt and asking more questions for our own investment style and strategy:

• Oil is blowing past $125.
• Weak home sales data.
• Consumers turning to credit cards in surprising numbers.
• A significant decrease in boomer spending.

Of course, the real prudent investor will do as one of my favorite financial philosophers, Warren Buffett, advised to a long-term investor this week:

I would just have it all in a very low-cost index fund from a reputable firm, maybe Vanguard.  Unless I bought during a strong bull market, I would feel confident that I would outperform... and I could just go back and get on with my work.

Well said, Mr. Buffett.  Ultimately, our money should not be a means to an end but quite the opposite and our priorities should be shaped accordingly...

What do you think?  Are we in a bear market rally?  Does it matter if we know?  Won't the market just do what it does, anyway?

Personally, my only real certainty is that there is much to doubt...

Related Posts: 

Finding God in Personal Finance

Where to Invest 2008

TFPAuthor, Kent N. Thune, QPFC, is the President and founder of Atlantic Capital Investments, LLC (ACI), a 'fee-only' financial planner and Registered Investment Advisory firm located in Mount Pleasant, SC.

Greed Finds a Way

"The ignorant mind, with its infinite afflictions passions, and evils, is rooted in three poisons:  Greed, anger, and delusion." ~ Bodhidarma

After reading news of the US Treasury department's proposal for "the most far-ranging overhaul of the financial regulatory system since the stock market crash of 1929 and the ensuing Great Depression," it really left me scratching my head...

The plan, as communicated by Treasury Secretary Henry Paulson, would change how the government regulates thousands of businesses "from the nation's biggest banks and investment houses down to the local insurance agent and mortgage broker."

What's more, the U.S. Senate Banking Committee said the proposed plans are "not even close" to resolving the financial crisis...

Who is the greater fool?

I do not expect logical thought and government actions to be included in the same sentence but I can not help myself from asking a few logical questions to remind myself of my own sanity in the face of poor judgment chasing poor judgment:

• Greed always seems to "find a way."  Can it be contained with government regulation? Has it ever been contained?  Does greed not always manifest itself into different forms?
• Do politicians really believe that they can make lasting "change" or are they just reacting just to prove they are "doing their job?"
• Have we forgotten that the current crisis was largely a result of greed finding money through derivative sources?  Those corporations and institutions wishing to find capital found their way around traditional sources, such as banks, and found venture capitalists, hedge funds, various secondary markets, and complex debt structures more than willing to fill their hungry appetites.  Won't greed just find another way, as it always does, to find what it wants after any forthcoming "rules" are established?
• Does government intervention, as with the Bear Stearns case, encourage more risky behavior or discourage it?  Does Fed intervention keep financial markets "orderly" or does it prolong an agonizing end?
• Is the capitalist structure not sufficient enough at correcting its own behavior without "help" from the government?
• Are there really that many "unwilling participants" or "innocent bystanders" out there that may be deserving of a "rescue" in the wake of financial turmoil?

Here's another thought worth noting:  As I was perusing The Wall Street Journal this morning and shaking my head at the foolish games being played between the federal government and financial institutions, I found a quite interesting article that reminded me that greed never really dies and will do whatever it can to survive: 

Enron's Skilling Attempts to Reverse His Guilty Verdict

At a minimum, I should not be surprised at the fallibility of human emotion but I will always remain fascinated by it, especially by the power and clever tenacity of greed...

Perhaps some of you readers can help me rationalize this or perhaps I would be wise not to look for reason where there is little or no reason to find.  What are your thoughts?

TFPAuthor, Kent N. Thune, QPFC, is the President and founder of Atlantic Capital Investments, LLC (ACI), a 'fee-only' financial planner and Registered Investment Advisory firm located in Mount Pleasant, SC.

 

Is Recession 'Priced In' To Stocks?

"It's easy to see, hard to foresee." ~ Benjamin Franklin

The stock market is often referred to as a "discount mechanism."  Discounting, in reference to stocks, is essentially a means of pricing the value of stocks today based upon their expected value in the future, typically six to nine months in time -- a "crystal ball," if you will, reflecting forward expectations of economic health.

In other words, much like a barometer that measures the general business and consumer confidence of our economy, stock prices today reflect our nation's general economic health six months from now.  For this reason, the stock market, as measured by the S&P 500, is a component of the economic Index of Leading Indicators.  Common sense would follow that all of the informed analysts and investors' scrutinization of quarterly corporate financial reports and macro-economic data would place their collective finger on the pulse of the economy... and yet a reliably consistent "forecast" still falls short...

Could the stock market and its participants see a recession in its crystal ball now?  Using a bit of logic and history, it is beginning to look that way... whether its forecast is correct or not... 

From the high mark on October 11, 2007, to the recent low mark put in on January 23, 2008, the price movement of the S&P 500 is a 19.4% decline.  Of course, we will not attempt to "call a bottom" or make any predictions here, but let's make a few observations with data taken from Fidelity's Market Analysis, Research & Education (MARE) titled, Has the U.S. Stock Market Discounted a Recession?:

Economic recessions generally coincide with stock market downturns; the last four recessions coincided with market conditions of between 17% and 49%.

Because economic data lags & stock markets look forward, sometimes much of stock market declines have occurred before a recession is officially diagnosed.

The circumstances surrounding [the 1990] recession might be the most similar to today: a real-estate-induced economic downturn; a banking system spillover; the Federal Reserve already easing; and average stock valuations.

OK, let's absorb this information and make some sense of it:  If economic recessions are typically "diagnosed" six months after they begin and stock prices lead recession by six months, then we may have already entered a recession that may not be officially diagnosed for several months.  Let's consider a "key takeaway" and a bit of paraphrased data highlighted in the MARE article:

The important thing is not whether the U.S. economy has or may enter recession, but to what extent the stock market may have already discounted economic weakness.

For the recession starting August 1990, the total stock market decline (peak to trough) was -20%. 

Fed Action prior to recession was "easing..."  Stock valuation prior to recession start was "average..." Stock market performance 12 months after recession trough/announcement was 27%...

A few more thoughts: 

• If economic recession has begun, it may not be "officially diagnosed" until the third quarter, at which time stock prices may discount or "forecast" a recovery in 2009. 
• Since economists look back and investors look forward, an announcement of recession, if and when it comes, is a signal to prudent investors that a recovery for stocks is just around the corrner.
• At the same time, sound investment strategies and, of course, timeless wisdom, tell us that we would be foolish to assume the "worst is over" now.  In fact, the prudent investor prepared for this market downturn months ago and long-term investment decisions are not led by short-term market conditions...
• Time in the market is more likely to prevail over timing the market, and prudent investing really is about diversification, asset allocation, simplicity, moderation, and, of course, self-awareness...

While there is no way of knowing how far stock prices will fall before resuming a sustained march forward, the oft-repeated wisdom of Mark Twain, "history does not repeat itself, but it does rhyme," should be the mantra of prudent investing: Logic would follow that a 20% decline, which has already been marked as of January 22, 2008, suggests, at a minimum, that the beginning of the end of the decline may be upon us -- once again, based on the "rhyme of history."

Stay tuned...

Related Post: Understanding Cycles Part 2: Stocks & The Economy

TFPAuthor, Kent N. Thune, QPFC, is the President and founder of Atlantic Capital Investments, LLC (ACI), a 'fee-only' Registered Investment Advisory firm located in Mount Pleasant, SC.