“Errors of Undue Pessimism”

In at least parts of the investor class there is certainly a brewing crisis of confidence with Obama’s economic policies.  I believe it’s too soon to pass judgment, but the cries of alarm are on the right (“socialism!”) and left (“nationalize the banks now!”).

Getting back to my favorite topic of behavioral economics / investing, here’s a relevant post via Economist’s View.  An excerpt:

However, Keynes can be our savior only to a very partial extent, and there is a need to look beyond him in understanding the present crisis. One economist whose current relevance has been far less recognized is Keynes’s rival Arthur Cecil Pigou… Pigou was much more concerned than Keynes with economic psychology and the ways it could influence business cycles and sharpen and harden an economic recession that could take us toward a depression (as indeed we are seeing now). Pigou attributed economic fluctuations partly to “psychological causes”…

It is hard to ignore the fact that today, in addition to the Keynesian effects of mutually reinforced decline, we are strongly in the presence of “errors of…undue pessimism.” Pigou focused particularly on the need to unfreeze the credit market when the economy is in the grip of excessive pessimism… One of the problems that the Obama administration has to deal with is that the real crisis … has become many times magnified by a psychological collapse. …

Emerging Debate in Financial Planning

As I have stated elsewhere, I believe that we are in a long-term bear market.  Most of us started investing in the greatest bull market of all time, the period from 1982 to 2000.  Most investors adhere to principles that were developed during that time.

Concepts like asset allocation, diversification, indexing, mean regression, etc., existed prior to the great bull but they became commonly accepted, even canonized during that period.  What we are seeing now, however, is that these concepts largely fail during bear markets.

During bears most asset classes become highly correlated, eliminating the benefits of diversification.  It is now clear that there are very real limits to traditional asset allocation during periods of high correlation.

This article is representative of new commentary that is beginning to emerge.  The bottom line from these authors is that “advisors should focus more on hedging than diversifying”.  This certainly assaults the current orthodoxy of my profession.

Something Interesting Did Not Happened Today

As the markets took another bath today on no news of note, something very interesting did not happen.  I did not get a single call from a client.  Not one.  This is the first time in a long time on such a big down day.  A sign of capitulation in the retail investor market?

And here’s my favorite quote of the day: “the markets are the most oversold they’ve ever been until tomorrow”.

More Off Topic Commentary

The changes of note that I saw today are more political than financial.  I mentioned the recent exchange with my conservative friend in Chicago.  It seems this was part of a much large narrative.  Here’s The Big Picture’s take on those who are trying to pin our current mess on Obama.  Here’s Reich’s spin.  And here is John Stuart’s spin on the idiots at CNBC.

Note: I have equal disdain for both major political parties as well as all the idiots on the financial news networks.  The financial pundits are as criminal with their unintelligent and misleading commentary as the heads of the Wall Street have been in their stewardship of our common financial system.

Partisan Bickering

I would characterize myself as a political moderate.  My conservative friends ridicule me a liberal and my liberal friends think I’m a conservative.  Frankly, I have equal contempt for both parties.

I’ve been having a long email conversation with one of my conservative friends.  He was a Mitt Romney supporter and has hated Obama from the beginning (this friend lives in Chicago).  I have defended Obama, primarily because he’s the president and I want to give him a chance.  We’re all in this together and I’d rather hope that his administration will work until proven otherwise.

This friend sent a link to a WSJ editorial that I thought was completely unfair to Obama.  Here is a copy of my email response.

Positive Sign in the Gloom?

Obama has described his plan for economic recovery as a stool with 3 legs.  One of those legs is the banking system.  And as we all know, the banking system will not be healthy until the “toxic assets” are purged from the system.  Geithner’s plan for doing this was intentionally vague at first, but details are emerging.

More clarity came today, although the plan is far from complete.  The crux of the plan is an embryonic “private-public partnership” that will buy the questionable mortgages (the “toxic assets”) from the bank.

Many commentators have been taking potshots at the plan, for good reason.  Until the details are known and some reasonable consensus for success forms, Geithner is just whistling in the dark.

But, this story in the NY Times is hopeful.  A group of investors have formed specifically to buy toxic assets.

(This group has) been buying up delinquent home mortgages that the government took over from other failed banks, sometimes for pennies on the dollar. They get a piece of what they can collect.

“It has been very successful – very strong…In fact, it’s off-the-charts good,” … even as the financial markets in New York were plunging.

So, the good news is that private entities are forming to do exactly what Geithner said they would, even without government assistance.

But, part of this story makes me somewhat ill.  It turns out that this group has been formed by execs from Countrywide Financial.  So, the same “entrepreneurs” who made themselves rich by getting us all into this mess are now figuring out how to make another fortune off our collective misfortune.

Who says crime does not pay?

“Stocks Finally Start Looking Affordable”

That’s the title of this NY Times Economix entry today.  As I have discussed repeatedly of late, a key metric to watch is the overall P/E ratio.  The article agrees.  Using Schiller’s method of calculating the S&P P/E, it is down to 12.3 at today’s close, which makes the market undervalued by about 30%.

And, “when the p-e has been between 12 and 13 over the last 125 years or so, stocks have doubled over the next decade, on average. (Adjusting for inflation, they have risen almost 50 percent.)”.

But, in the 1930s and 1980s the P/E dropped all the way to 7.  So, we could be in for some more cliff diving.  “But long-term investors – and that describes most of us – should start to feel perfectly fine about buying stocks.”

I think it’s entirely premature to buy stocks.  But it may finally be too late to sell.  Although based on the number of panic calls I got today from clients, a new wave of panic selling may be forming.

Uh-Oh

If you are a member of plastic pocket protector set, or just a wannabe, this entry at Econbrowser is all for you.  It provides a mathematical model showing fair market values based on historical dividend payout.

The conclusion is that if dividends are not dramatically cut, current fair market value of the S&P is 830.  If dividends are cut to Great Depression era levels, fair value of the S&P is 608.

I found this just after reading the FT article below…

“Worst year for dividend cuts since 1938”

The Financial Times says so.  1938…

“marked a decline in S&P 500 dividends of 36.3 per cent, according to Standard & Poor’s. Dividend pay-outs for 2009 are forecast to slide at least 22.6 per cent, the worst year since 1938, said Howard Silverblatt, senior index analyst at Standard & Poor’s.”

What makes this especially painful is that the standard advice from many firms, including mine, has been to take refuge in safe, high-quality, dividend paying stocks.  Now we find out that such a thing does not exist.

How Low Will We Go?

I’m not sure what to make of the market today.  On the one hand, the S&P dropped 2.36% to set a new cycle low, closing at 735.09, with an intraday low of 734.52.  Clearly, closing at the lowest level in 12 years is not good news.

But, the economic news today was horrible.  Q4 GDP numbers were massively revised down, GE slashed its dividend by 68%, Citi had another massive infusion of taxpayer dollars, GM is truly on the precipice of bankruptcy, etc.  The S&P could easily have dropped more.  And 735 is just 2% below my approximate “fair value” number of 750.  Signs of resilience?

On the other hand I’m reminded of this quote that I posted earlier:

The singular feature of the great crash of 1929 was that the worst continued to worsen. What looked one day like the end proved on the next day to have been only the beginning. Nothing could have been more ingeniously designed to maximize the suffering, and also to ensure that as few as possible escaped the common misfortune.

- John Kenneth Galbraith, “The Great Crash”

And, it’s time to look at the Four Bad Bears chart again.  It looks a lot like 1929.