"Believe in nothing, no matter where you read it, or who said it, no matter if I have said it, unless it agrees with your own reason and your own common sense." Buddha
I'm no Economist and I'm certainly no PhD. I do know, however, that reason alone is not often useful in explaining psychological phenomena. With all due respect to higher education, I've found that common sense works well, especially where reason does not... With that said, I've had significant difficulty in finding much about current market conditions that makes sense to me...
Here's what I'm having trouble with:
Bullish investors have driven stock prices back into record territory. While that alone doesn't bother me, it's the apparent logic used in getting where we are today. The new "conundrum" , for both the Fed and for investors, is that latter are betting, at nearly 100 percent odds, that the former will continue cutting rates...
Why does the Fed cut rates? The recent 50bp rate may have been more psychological than fundamental, but the underlying reasoning was to ward off recession. Ben and the Fed also clearly wanted to restore order to the markets and provide liquidity in the face of a mounting financial crisis. At least to some degree, the recent run up in stocks indicates order is restored and liquidity has improved. Unless recession is still a significant threat, why would the Fed cut rates again this month?
There is certainly little argument in the financial world that the U.S. economy is slowing. Does that not mean that corporate profits will slow as well? The "bad news is good news" investor mentality does not make sense to me. I'm no historian either but I don't know of a time in history where stocks can continue rising as the economy continues slowing...
I did, however, run across something today that makes sense to me. It was in The Wall Street Journal article, "Margin for Error: How Stocks Could Be Hit by Falling Profits." Here are a few choice excerpts:
Corporate profits have been growing far faster than the economy. That can't go on forever...
...notes New York economic consultant Peter Bernstein... "It's impossible for that to be sustained because, if it was, all income would be profits."
...corporate profit growth will likely slow from the recent dizzying pace, and thus stocks could face lower returns in the years ahead.
It's hard to know how all this will play out, and your portfolio should reflect uncertainty. Allocate 25% or 30% of your stock-market money to foreign shares. Consider stashing a little more than usual in bonds and cash investments.
Maybe most important, rein in your expectations. Don't bank on earning the stock market's 10%-a-year long-term historical average -- and, to compensate, boost your savings rate to 12% or even 15% of your pretax income.
Sound familiar? If you're a regular TFP reader, all of the above should reinforce what I've been saying since around January of 2007: It makes sense to "overweight" foreign stock, large-cap domestic stock, bonds, and cash along with "defensive" stock, such as health care; and to "underweight" investments that under-perform in a recessionary environment, such as small-cap stocks. Do not pay attention to uncontrollable variables but DO pay attention to those that ARE controllable, such as asset allocation and savings rate. To keep perspective, we must remember that short-term market conditions make for interesting blog posts but are not the basis for prudent long-term investment decisions.
Once again, I'm no Economist or PhD but, to borrow from an economic and investing concept, "everything returns to the mean." I would translate that in simpler terms: Everything returns to common sense...
TFPAuthor, Kent N. Thune, is the President and founder of Atlantic Capital Investments, LLC (ACI), a 'fee-only' Registered Investment Advisory firm located in Mount Pleasant, SC.
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