"It's important to choose not who you think is the prettiest girl, but who the judges think is the prettiest girl." ~ John Maynard Keynes
Are we in a recession? The answer to that question depends on who you ask...
Some believe we are already in a recession while others believe we are not, never were, and probably won't be any time soon.
Does it really matter if we know, by definition, that we are in a recession? Do we need the National Bureau of Economic Research (NBER) to officially say, "Yep, the U.S. Economy, as measured by growth in Gross Domestic Product (GDP), has been negative for two consecutive quarters; therefore, we are now in a recession. You may now worry about your money and jobs accordingly," before we alter our behavior or attitudes in our personal lives?
I am certainly no economist so perhaps someone can help me here...
It would seem that close analysis of macro-economic trends to gain some form of truth or insight into the direction of financial markets is rooted a bit too deeply in reality where reality does not factor into the big picture equation.
"The market can remain irrational longer than you can remain solvent." ~ John Maynard Keynes
Here's where I need some help or, perhaps, your feedback and even anecdotal observations of recession in your life:
- Perception is reality and it can not be quantitatively measured. Financial market movements are defined by the behavior of its participants. This herd behavior will move on its collective perception of reality, and does not take its behavioral cues from quantitative reports.
- Financial markets are not, to say the least, always rational. People spend more when they feel wealthy and spend less when they do not; Investors pile into stocks when prices are higher and jump out when prices are lower; and our human perception of risk is lowest when real risk is highest and vice-versa. This behavior is not rational (insert your example of historic booms and busts in financial markets here).
- The average Joe and Jane on the street do not behave according to
Government reports. I believe those who have lost jobs and are having difficulty finding a new one believe we are in a recession; I believe people who are stealing gas believe we are in a recession; and, despite what the out-of-touch politicians think, average Americans suffer in times like this, recession or not.
- What do we do with the information, anyway? Whether or not we are in a recession, what are we to do with knowledge of the truth? Do we change our investment portfolio? Do we change our personal spending habits? Why or why not?
The economy is complex and there are many factors involved, such as food, energy and commodities prices, currency valuations, job creation, inflation, and the list goes on. But who really looks at the macro-economic data and reports and bases any significant financial or personal decisions on that information? Why or why not?
I would love to know your thoughts: Can you help me by answering any of my previous questions? What signs of recession (or lack thereof) do you see where you are? Do you feel the economists and politicians are so disconnected from daily life, such as buying groceries and pumping gas, that their own perception of reality is flawed? Does reality really matter if people's perception defines their reality anyway?
Through a prudent investor frame and in the spirit of Keynes' Beauty Contest, is it not wise to think how the judges will think rather than what YOU think? As with beauty, is recession in the eye of the beholder?
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.
Interesting post Kent.
I think the heart of the issue you are raising is: Is perception reality in finance and economics?
And the answer is No.
Just because many now believe that the stock market has turned a corner does not mean that it has. People base their decisions, including decisions to buy or sell stocks, on their perceptions. So the current perception that stocks have bottom can, for a while, create that reality.
But perception is not completely myopic. Perception can be altered by the emerging reality. Should it start to become apparent that the facts don't fit with the emerging consensus, there is no reason perception can't change and send stocks heading down again.
Wall Street, like any other group, is subject to herd behavior. But there are also a lot of smart thought leaders on the street that can sway the herd if they voice contrary opinions.
Philosophically, the issue is what Ayn Rand termed the primacy of existence. It goes back to the origins of modern philosophy in Descartes "Meditations": I think, therefore I am. What is the relationship between mind and reality? It is not cut and dry but for the most part the mind is able to perceive an independent reality and not create it. Not completely, but for the most part. Reality is primary.
The investor who best understood this, and profited massively from it, was the great Michael Steinhardt whose theory of Variant Perception is an application of this to investing.
Posted by: Greg Feirman | May 02, 2008 at 03:19 PM
Greg:
I will not argue your thoughts but will clarify mine:
1. If we are not in a recession by definition but the American consumer perceives it as so, then they will act according to their perception, not according to the observations of economists.
2. If the investor herd becomes complacent, evolving into greedy, then real risk increases as perceived risk decreases, creating "over-bought" conditions. Similarly, the investor herd will push stock prices lower as fear increases, regardless of valuation, creating "over-sold" conditions, as perceived risk increases and real risk decreases.
3. Economic reports and market data may say one thing but the herd may act in a completely different way, which leaves economists and financial pundits either scratching their heads in disbelief or saying, "I told you so," depending on their most recent rants.
As for your comment, I absolutely agree that an investor can take advantage of dislocations caused by extreme herd perceptions or emotions and make contrarian moves accordingly.
Above all, I simply enjoy observing human behavior. The stock market is the ultimate "people watching" experience!
Thanks for the thoughts...
Posted by: The Financial Philosopher | May 02, 2008 at 05:26 PM
It is interesting to study what causes these periodic moments of panic in markets and the economy. It typically starts out as a story of greed and misjudgement concerning risks and rewards.
Here are a couple of articles on the 1907 panic, which few people know about:
http://americanhistory.suite101.com/article.cfm/march_13th_stock_market_crash
http://www.boston.com/business/globe/articles/2007/08/12/lessons_from_1907_about_market_crashes/
The events of the past year again focus on banks and large investment companies. Many banks and Bear Stearns were seduced by the high returns of the sub-prime market, but failed to properly analyze the risks involved. Greed overcame reason.
When problems started to surface last summer concerning these sub-prime investments, banks started to become suspicious of other banks, and refused to lend money to anyone. The initial attempts by the Federal Reserve did not help because banks are reluctant to borrow from the Federal Reserve short term window, since it may make their bank look desperate and perhaps signal underlying problems in their bank.
The net result was cash flow from banks into the economy was approaching zero.
With this uncertainty, healthy investment firms decided to remove money from the equity markets and put it into commodities and foreign currency. It has not been until this week that indications seem to point to these investment firms rolling money back into the equity markets and away from foreign currency and commodities. These rollovers involve a lot of money, and take a long time to complete. However, the rolling-over process does seem to be taking place.
Charles
Posted by: Charles | May 03, 2008 at 07:31 AM
Kent,
I agree with all your comments.
I think Soros's theory of reflexivity comes in here: perception effects reality and reality effects perception. Causation goes both ways.
But I do think it is important to keep clear in one's mind the distinction between prevailing perception and reality.
The fatal flaw of pure technical analysis, in my opinion, is that it looks only at market action and therefore only at perception. If you just look at the charts and various sentiment and technical indicators, this move can look very much like a V-bottom and that the worst is in. And, of course, it looks that way because many who are buying and pushing the indexes up do in fact believe that.
But they could be wrong. There is always the question: Is it true? Pure technicians have nothing but contempt for the question of "fundamentals" which is essentially the question of truth (Of course, this is a very thorny subject in modern philosophy, but I think you are more classical in your beliefs about truth, like me).
Fundamentalists make the mistake of looking only at facts, and sometimes an incomplete set of facts that ignores macroeconomics, and therefore have no resources for understanding the role perception plays in driving market action.
That's why we have to heed the wisdom of JS Mill, the greatest philosopher of reason of all time, and take what is good from all the different schools and put it together into a coherent whole:
http://www.topgunfp.com/the-kirk-report-links-to-top-guns-post-the-wrong-question-and-the-right-question-about-todays-market/
(You have to scroll down a bit for the JS Mill quote).
Posted by: Greg Feirman | May 03, 2008 at 01:59 PM
Greg & Charles:
Thanks to you both for the added insight and links! I've learned a great deal from you...
Kent
Posted by: The Financial Philosopher | May 04, 2008 at 06:10 PM
All that we see or seem is but a dream within a dream.
- Edgar Allen Poe
Posted by: jimcos42 | May 06, 2008 at 12:23 PM