Friday, July 27, 2012

Don't be a Financial Hypochondriac

Excess of Pessimism, Don’t be a Financial Hypochondriac

"In the United States today, we have more than our share of nattering nabobs of negativism. They have formed their own 4-H club -- the hopeless, hysterical hypochondriacs of history."  The above is a famous quote from 1970, an excerpt from a speech written by then Nixon speechwriter William Safire, spoken by Vice President, Spiro Agnew about the media.

“If its individual citizens, to a man, are to be believed, [America] always is depressed, and always is stagnated, and always is at an alarming crisis, and never was otherwise.”
Charles Dickens in 1844.

Is there really a valid reason to be pessimistic, or is it just a normal state of human nature?   Is our current situation really that bad?  Is the world really facing impending doom? Or have we become a nation/world of financial Hypochondriacs.

In his book, “Upside: Surprising Good News About The State Of The World.", Bradley Wright tells us that while we are generally optimistic about our individual futures, we are bombarded with “news” from “prophets of doom” about the world in general. “Forecasting doom is a viable career strategy, complete with strong book sales, frequent media appearances, and the occasional Nobel Prize.”, he says.  Such “prophets of doom” have been at it for hundreds of years. For example, in 1766, Malthus predicted that the human population would continue to grow until it exceeded the availability of natural resources needed to keep humans alive—in other words, we would run out of food.  Instead, the world is getting more obese every year—despite there being more than 6 billion of us, we have too much food! Remember that it was predicted that all the computers would stop at the Y2K date—it did not happen. We were told the world would end if S&P downgraded the US’s credit rating—interest rates did not rise—they went down to record levels as people all over the world want to lend money to the “downgraded” US Treasury!

With the explosion of media sources, it has only gotten worse as one way to gain attention is to exaggerate the negative.  We have little “news” today from the media and way too much opinion.  Pundits don’t report that markets fell, instead they tell us they plunged.   Instead of opinions of what is most likely—we get a steady stream of what extreme negative outcomes might be possible. We don’t talk about a debate and conflict about tax policy—we are told there is a fiscal “cliff” that we might fall off of.  Every organization or government that has excess debt is a potential “Lehman Moment” likely to escalate into worldwide financial ruin. (An interesting fact is that if you simply ignored the real “Lehman Moment”; Lehman Brothers bankruptcy on 9/15/2008, and owned the S&P500, your investment would today be 9.4% HIGHER. If you had bought the S&P500 the day before the TARP bailout was approved in October 2008, your investment would today be 25% higher.)

The media pundits throw out outrageous headlines so we pay attention to the advertising that follows and don’t change the channel. The average person just does not have the time to sift through this hyperbole to get the real facts. (I now have to spend a lot more time sifting through “information” sources to make any sense from it. There is a lot more “noise”. )  With so many terrible outcomes “possible” many people conclude maybe “where there’s smoke there’s probably fire—so I’ll just do nothing and sit this one out”. Indeed, that seems to be the most common reaction as people and corporations hoard cash and “conservative” investments like T-Bills paying less than 1%. (“I’m not making anything but it’s not going down” is a common thought.) Earlier, I mentioned Bradley Wright’s conclusion that people are generally optimistic about their individual futures—but it turns out there is a paradoxical “optimism gap”. Most people are generally pessimistic about other people’s future and the world in general.

Admittedly, there is a clear economic slowdown occurring in parts of Europe.  This will and does effect the US and Chinese economies by reducing exports to Europe.  The falling Euro currency exchange rate does in fact make US based global businesses less profitable.  Admittedly, there is political turmoil in the US regarding taxes and government spending.  While there is a potential for real drama, the worst case scenario is so improbable, worrying about it is like worrying about a global pandemic or a massive life-extinction asteroid strike.   Yet, an unhealthy obsession on low probability events is what markets have succumbed to over the last three years.  Good news is being dismissed as irrelevant and bad news gets most of the attention.  If we let such negativity affect other parts of our lives, we would become agoraphobic, never venturing out into the “risky” world.  

Let’s focus on just a few bits of good news:  This quarter, ATT reported best profits from wireless phones—ever. Boeing increased its guidance for future earnings from airplane sales. Caterpillar raised its guidance with revenues up 21% year over year. Amazon intends to open 12-18 new fulfillment centers over the next year—almost doubling their present number. These companies are financial bell-weathers.   Mortgage rates are lower than ever and home sales are rising so fast that sales are constrained by low inventory! We are on pace to produce and sell 81 million cars and trucks worldwide—a new record.  (More in China than in the US.)  I agree with Caterpillar’s CEO who said, “It does not feel like 2008”.

Excess pessimism causes stock markets to be undervalued and creates big opportunities for investors.  Over the past year international stocks (EAFE) are down 18.74%.  The broad range of US equities, including Mid and Small Cap US stocks (Russell 2000) is down 6.73%.  The Global Developed World Index is down 11.62% Only large cap US stock indexes are up for the last 12 months—but not by much with the S&P500 up 0.45% and the DOW 30 up 1.4%.  Yet during this same period, Caterpillar experienced a 21% increase in revenue and Boeing got lots of orders for new planes.

I do see great risks regarding short term market levels. But, I also see a more likely scenario of time proving that stock markets are presently undervalued significantly.  Energy, Health Care, and Necessities are the themes for future growth.   Do not underestimate the fact that the number of “middle income” consumers worldwide is growing rapidly.

I think the most likely scenario in Europe is that they will do the very least that is necessary—but still they will do what is necessary to avoid the worst case. The ECB has the ability to solve the crisis—only political haggling over political philosophy delays the final solution. (It is highly likely that Greece will exit the Euro Zone with a great deal of teeth gnashing and hand wringing, but what is necessary to stabilize Spain and Italy will be done with a high degree of certainty.)  Europe will continue to prosper and will become significantly more competitive with a weaker currency and lower cost labor from their southern tier countries—Italy, Spain and even Greece. (It may turn out that the lower cost labor results from a mass migration of unemployed labor from the south taking jobs in the north—it is already happening for white collared professionals.)

I think that transportation costs will likely rise and there will be sufficient automation improvements to cause a great deal of manufacturing to return to the US—causing a substantial expansion. I think the US housing situation has bottomed and will begin to expand faster (no longer slower) than the rate of new household creation. I think taxes and interest rates will rise.  I don’t think that these trends will be affected by who controls the White House or Congress.  Who controls the White House and Congress will not determine a positive or negative outcome—simply the magnitude of the positive outcome—and which part of the population gets the most benefit from growth.

I think US politicians of both parties will do the very least that is necessary to compromise—but will still do what is necessary to avoid the worst case. Sooner or later taxes will go up and deficits will go down as the cost of servicing debt with rising interest rates will become more significant.  As interest rates rise, more US debt will be held by US citizens, many of who are retired who will plow the income back into the economy.

Political haggling in Europe and the US has been going on for hundreds of years—you can’t sit on the sidelines just because politicians are fighting and haggling. Capitalism has and will continue to prosper, despite politics.

I think that the growth of the middle income population in the emerging markets of Brazil, China and India will be phenomenal. Along with improvements in communication technology, this theme is probably more significant and will affect us more than the industrial revolution and railroads affected the world in the 1800’s.

Keep in mind that investing requires patience and a focus on long term value.  And, without income over the long term from investing, it takes a lot more money to support a comfortable retirement. Also keep in mind that your investment portfolio is always subject to short term risks and fluctuations.

Always remember that on any given day, half the participants engaged in short term stock market transactions are wrong as the market moves the next day in the opposite direction they expected. It is those that predict the long term direction of stock markets that have a much higher probability of being right.

My advice—be cautiously optimistic and take advantage of price levels of great, well capitalized companies that seem quite attractive. My long term indicators are 80% green. (They have not been this high since 2010.) The higher your tolerance for short term risk and fluctuation, the more patience you have, the higher your exposure to global stock markets should be. (Heed all the warnings in the disclosure below.)

I wrote this in 2010—it is on our website, It is still valid.

“Ever since Adam and Eve were cast out of Eden, Life has been uncertain, difficult and dangerous. Uncertainty, difficulty and danger will continue to exist. Some will be able to recognize opportunities despite such danger and difficulty and will prosper mightily. Others will simply adopt proven strategies to survive and prosper reasonably in a changing world where the future will always be uncertain. In the longer run, the future is seldom as bad as the pessimist believes, nor as good as the optimist predicts.”

------ Wayne Strout, 2010

This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.