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Irrational Pessimism?





It was impossible to get a conversation going; everybody was talking too much.” – Yogi Berra

In 1996, Fed Chairman Alan Greenspan coined the term “irrational exuberance” to describe what he felt was unjustified speculation in the stock market as the S&P 500 rose past 744. Now, 12 years later, the S&P500 has moved past 744 again, this time on the way down in what may be another case of irrational markets. Do we now have “irrational pessimism”?

We have talked to literally thousands of people in the last few months and found it amazing how unanimous everyone’s outlook is now. “It will get worse in 2009”, “It will take 3-5 or even 10 years or more to recover”, and “it is the worst since the Great Depression”. Doomsday scenarios are also common. Pessimism is everywhere!

The argument that this pessimism is justified is everywhere in the news. Here are the reasons why it may be “irrational pessimism”.

When you look at the economy, however, all the pessimism is hard to understand. An advisor to John F. Kennedy created the “Misery Index” to gauge the pain of an economic crisis. It simply adds unemployment rate and inflation. By this measure, we are now only at 7.6% which is nowhere close to the recessions of the 70s and 80s when it was 22% and 19.9%.

In fact, despite all the bad news, the US economy is holding up better than these other recessions by all the main economic stats:

2008-2009 1981-1982 1973-1975
Real GDP -1.1% -2.7% -3.1%
Industrial Production -6.1% -9.9% -13%
Unemployment 7.6% 10.8% 9.0%
Inflation -0.1% 14.6% 12.2%
30 Year Mortgage 5.2% 18.5% 10.0%
Misery Index 7.6% 22.0% 19.9%
S&P500 -45% to -50% -13% -43%
TSX -40% to -45% -39% -35%

* New York Post

This recession is, of course, not over yet and may deepen, but none of these statistics are expected to get as bad as the prior recessions. An average of 55 forecasters in the January 15 Wall Street Journal survey expect real GDP to eventually reach only -2.1%. Industrial production appears to have bottomed in September 2008. The news is full of stories of massive lay-offs, but unemployment is only expected to rise to 8.9%.

The main driver of the economy is still consumer spending, which rose 3.6% in 2008. It fell sharply in the last quarter, but rebounding early in 2009. Other than the last quarter of 2008, consumers held up fine with high oil prices (though it did hurt car sales), falling house prices, and tightened credit markets.

In short, the economy is in an ordinary recession. The economy needs to pause to clear off over-building. Far too many houses had been built, so new construction has slowed to clear these off. The current level of auto production would take 27 years to replace all cars, so demand will come back. The economy is not the problem.

So, how do you explain the stock market having its worst year in history (other than during the 1930s)? The crash is more surprising, since there are no good alternatives. In 1982, not only was the economy worse than now, you could buy a GIC at 19 7/8%, and yet the stock market still fell less than today and recovered in one year.

There are real reasons why the stock market crash has been larger:

  1. It was exaggerated by the popping of 4 bubbles at once – real estate, oil/commodities, China (BRIC countries) and a debt/financial bubble. Four more cases of irrational exuberance! Not surprisingly, the market problems have been mainly in the same 4 sectors.
  2. The banking crisis created fear among consumers, made it harder to get credit, and took the entire financial index down 80%.
  3. The recession is global (like 1973-74).

Do these reasons justify the current pessimism?

  • The 4 bubble sectors have probably deflated fully – and probably more – except for real estate, which has a bit more to fall, especially in the U.S.
  • The US financial index is down 80%, so there is not much more room to fall. This despite the worst banks, Citibank and Bank of America, both making profits again in 2009.

Is the fear and constant bad news now out of control?  Everyone is wondering how bad the economy could get and when it will recover, but the economy is not the problem.  Everyone is wondering how low the stock market will get, while trillions of dollars sit in cash on the sidelines waiting for the right time to jump back in.  The media is also full of ridiculous comparisons to the Great Depression.

Has “irrational pessimism” become the latest bubble?  If so, then just like the last 4 bubbles, you can never predict how far irrational bubbles will go, but they all eventually pop. This time, it would need a “melt up”, not a “melt down”.

MDJ readers are well-read. What do you think? Do we now have “irrational pessimism”?

Ed Rempel is a Certified Financial Planner (CFP) and Certified Management Accountant (CMA) who built his practice by providing his clients solid, comprehensive financial plans and personal coaching.  If you would like to contact Ed, you can leave a comment in this post, or visit his website EdRempel.com.  You can read his other articles here.





54 Comments, Comment or Ping

  1. 1. Peter

    I don’t disagree. Positive markets action begets positive outlooks, and vice versa. I predict as markets really start to recover and jobs start getting created we’ll hear a lot of news reports about how “the recession really wasn’t all that bad, it was just because of so and so and such and such”.

  2. 2. archanfel

    The problem is that the market was probably far more irrational in this bubble than before. In the end, the market does not care about the economy, all it cares is the future earning of the companies. Right now, the S&P has a negative earning, therefore the P/E ratio is worse than infinity. Also, Canadian GDP is dropping by more than 8.5% this quarter, US GDP dropped by more than 6%. Unemployment will get far worse. Compare the number now is like comparing a growing child to an adult and say he will always be shorter.

    The hope is that the companies dumped all their bad write downs in the Q4 reports, so Q1 might get significantly better. From all the indicators, I highly doubt that.

  3. 3. Ray

    irrational? markets are based heavily on emotions and emotions are almost always irrational on the upside and downside. When oil reached $140 was it irrational? yet some people were saying it will reach $200. when it feel those same people were saying it will go to $25. I remember Jeff Rubben CIBC chief economist on BNN in early 2008 being of of those. Is there irrational pessimism? yes. Markets will always be irrational, unless computer models are designed to do the trades and human emotions are taken out of it.

  4. 4. Matt

    Ed,

    I respect your opinion, however, I think you are incorrect in your assumptions. Your last article “How to take advantage after a crash” was full of inaccuracies as well. My comments and the quotes of others were also dismissed. What happened after this? Markets tumbled to 12 year lows.

    When the GDP is dropping, unemployment is rising, governments worldwide are running billion/trillion dollar deficits, markets are RISING, and politicians are saying things are getting better – I am at my most pessimisitic.

    Be fearful when other are greedy and greedy when others are fearful. Here is to Mr. Buffet and being fearful.

  5. 5. archanfel

    Ray, I think the emotion is being overestimated. The market is trying to predicts what will happen 6 months to a year down the road, maybe even longer. Take weather forecast for example, super computers were invented to make long term weather forecast and it was a total failure despite the lack of emotions. The reason is that weather is such a complex system, it exhibit chaotic behaviours (aka butterfly effects). The economy is probably no less complex and it evolves far faster. It’s only natural that the predictions swing widely as conditions change.

    Another factor is that human emotion is part of the economy. Even if a computer model can be developed, it needs to take human emotion into account. I doubt it would lower volatility that much.

  6. 6. Al

    Ed and his kind will cause lots of bear market rallies. Play the volatility if you are brave (stupid?), or stear clear if you are not.

    The debt bubble took a long time to form, it will not dissappear in a few quarters. Keep an eye on dividend cuts, and companies failing because they can’t roll over their debt.

  7. 7. Scott

    It’s terribly difficult to NOT be pessimistic this time ’round. Sure, the ‘Misery Index’ may not be any where near the ’70/’80′s watermark — although it might if the REAL unemployment and REAL inflation rates are calculated (unlike gov’t, try putting food and energy prices back in the mix!) — but other things are raging well past anything that happened back then.

    Irrational can easily be applied to our outlook as that is what has been fed to us for the last quarter century. Things such as the unbridled level of fraud and deceit and blatant theft which has, seemingly, infected a wide swath of society — especially those who hold the power and the money. The bad guys lied and stole from us, the good guys are lying and stealing from us (oft times to save their bad guy buddies); it’s a Wild West shoot-out but it’s all the by-standers that are getting nailed!

    A huge part of the pessimism is NOT knowing what is coming next, or in what shape, form, or intensity (what new fraud or level of deceit will be uncovered/introduced next?!).

    It’s also a very bizarre time. And, hate to say it, but the mass of investors have a stupidly short memory. For example, Citi shows a “profit” within two months, yet three months ago they required billions of dollars just to keep their doors open! That’s some good operatin’! From $60 billion in the hole to ‘profitable’ in two months!

    But really, it’s only North America. We the people won’t do anything except talk about it. So does it really matter how pessimistic we are (or aren’t)? The power and money will just keep on powerin’ and moneyin’ just as they have always done.

  8. 8. Paul

    The bottom of any market downturn is – by definition – the point where the most participants are selling and the least participants are buying. Therefore if one wants to buy at the bottom of the market one needs to listen carefully for the crescendo of market pessimism and swim against the tide a little.
    That’s all Warren does (with a lot of poking around in the company books too obviously). It’s not complicated. People over-react. Large groups of people over-react a lot. Sounds like FT is… listening. Which is smart.
    Of course it’s pretty hard to catch the turn exactly so I dollar cost average on the way down. (e.g. I buy a little more each time the price goes below my previous cheapest purchase.) I started swimming against the tide like this a few months ago when it became apparent we were in a doozey of an overreaction. I have a rather long time-frame to work with though. I’m relatively young and investing for retirement so I view this as a once in a lifetime opportunity whereas those with a shorter time-frame have more difficult decisions to make I’m sure.

  9. 9. Archanfel

    Well, you need to watch your fingers when trying to catch a falling knife. There’s no such thing as “once in a lifetime opportunity” in retail investment. 1929 certainly looked like a “once in a lifetime opportunity”, so was 1930, so was 1931. To this day, I heard tons of people telling me the “ridiculous comparisons to the Great Depression.”, yet I haven’t heard a single person convincingly stated why it was ridiculous.

    I like your approach though. If the economy recovers (let’s hope it would), dollar cost averaging is never a bad thing to do.

  10. 10. Paul

    I don’t really subscribe to the whole ‘beware of falling knives’ thing. It’s based on the idea that one can time the bottom of the market exactly. Which is a flawed assumption to say the least. My investment strategy makes this falling market a buying opportunity which puts me rather at odds with the majority of investors out there but I’d rather watch my investments take a hit in the short term while I load up the RSP than join the throngs of investors who will be chewing their fingernails when the market does recover wondering if now is the time to ‘get back into the market’. By the time most investors agree it is safe to get back in the majority of the gains will already have been made and I should be very much in the black.
    Actually this latest market jump has already brought me to within a hair of break-even but oddly enough I wouldn’t mind another big fall as I still have some funds kicking around I’d like invest.

  11. 11. Sarlock

    One thing to note is that the stock market was likely also overvalued, expecting lofty earnings to continue well into the future and this was reflected in P/E ratios.

    Now that the house of cards has come tumbling down and has exposed some distressing truths about what is at the core of the economy (a debt-burdened consumer) we may see the stock market having a hard time getting anywhere near where it was before it started to drop. Perhaps the Dow at 9,000 or so was actually a more “rational” valuation and if it was, we’re not that far off the peak anymore.

    There is more unemployment yet to come and the numbers will continue to get worse. That same comparative box, at the end of 2009, may look a lot closer to the two beside it, except for the inflation and interest rate figures… those are coming in later years in this cycle.

  12. 12. Archanfel

    Paul, the problem with catching a falling knife is when the investor is enticed by a perceived buying opportunity, he tends to change his investment behaviour accordingly. Since the majority of the falls are not opportunities, he ends up being trapped. This is especially serious when the investment concentrate on a small number of stocks (or even a single stock). A good example would be Bear sterns. I would certainly call a 90% drop of its share price a “once in a lifetime” opportunity, but if I had jumped in, I would have been burned very badly.

    Dollar cost averaging is usually safe to do for a long term investor though, especially if you are purchasing well diversified fund (index fund for example) rather than a particular stock. I always think the key to retail investment is to be disciplined and have the time to grind it out.

    This time might be different though. My worry is that the US will become a second Japan. The Nikkei index hasn’t recovered 20 years after the crash. Even for the Dow, after the great depression. it took the Dow more than 30 years to recover. I hope that not the case this time around, but Obama has not given me any confidence so far. We will see I guess.

  13. 13. Alexandra

    These’s really only one basic rule to investing: buy low, sell high. I have no problem with other people’s pessimism if it keeps stock prices low. Every month I buy, and secretly hope the prices remain low for awhile so I can get more bang for my buck. In thirty years, when I am ready to retire, I am pretty sure that the values will have grown significantly…maybe even enough to offset the inflated prices I was paying over the last 10 years. I laugh at my friends who are “waiting for the bottom” to invest. By the time they figure out where the bottom is, the prices will already be rising.

  14. 14. Victor

    In my opinion, what is ‘irrational’ is the certainty most people have that the US will DEFINITELY come back from this, and that it’s just a matter of time. The fall of every civilization in history says otherwise.

    I believe that the world economy will eventually recover because humans have an innate desire for progress and bettering their lives. The economy is just an amazingly complex structure that developed from basic barter. Thus, I have no doubt buying and selling will resume. However, I believe we will see a realignment of world powers as an outcome of this.

    The US consumer’s actions over the last decade have been unsustainable: Work less efficiently and more expensively than the rest of the world, own more stuff, and export debt. How could anyone think that this could go on forever? Who in their right mind could possibly think Americans are *entitled* to this (by some higher power? Manifest Destiny?) and thus things HAVE to come back to ‘normal’?

    Anyway, the sky is falling, blah blah blah. That’s my take; you’re welcome to yours. Regardless of what you think of what I wrote above, I suggest that if you want a good discussion on some of the banking that is driving this event, you read here:

    http://www.greenenergyinvestors.com/index.php?showtopic=4411

    Note that this thread started late last year and is now EXTREMELY long, so you may want to skip to the end.

  15. 15. John

    I agree that the economy is not as bad as it has been made out to be. But what is troubling is the hysterical reaction of the US government and other governments. The long-term fallout from these actions could be a legitimate reason for pessimism.

  16. 16. Al

    The economy might not be that bad yet, but where is it going? Is there going to be a flood of manufacturing jobs coming back to North America? Will builders be able to go back to building like crazy? Are we going to be able to go back an economy based on spending over 100% of earnings? The market is supposed to be forward looking, but it still seems to be backward looking (comparisons to former highs, or former earnings.)

    There seems to be the assumption that the market will start climbing at rates similar to what we saw in the last decade when we had all that debt induced buying. Has anyone considered that the TSX, for instance, may fall to 6000 over the next couple of years and linger around that level for several more while all that long term debt works its way out of the system? I’m talking about a bottom that lasts years, with less mad 400 pt swings in the markets. Dollar cost averaging at the 8000-9000 level may not seem so wise at that point, mor holding stocks purchased when the markets were at the 12000-14000 level.

    But maybe I’m just being overly pessimistic.

  17. I agree with Alexandra. While there is likely “irrational pessimism”… I will be quite happy if it continues for another year or two. Basically I get to buy stocks at half price and can hold them for 20-30 years.

  18. 18. Dana

    Good question to ask from time to time!

  19. Interesting comparison with the previous recessions, but I would be interested to see a one with the years of the Great Depression.
    I also see this pessimism from the bright side – for more time my automated stock purchase program will by stocks at low prices

  20. 20. Paul

    Archanfel,
    Good Point. It would be easy to loose a lot of money chasing individual stocks as they fall. A stock isn’t cheap just because it was more expensive yesterday.
    Myself, I have low MER indexed funds of SP500, TSX & International. It’s not a very exciting portfolio but then investing isn’t a game to me. It’s just part of my retirement plan. In my experience those that get excited about their investments are usually parted with their money in due course.
    I prefer Warren’s approach. Slow and steady wins the race. He of course has an edge on me because he has all those B.H. analysts busily counting those beans for him so I keep it simple and stick to indexes.
    I figure if the market hasn’t recovered in 35 years then the sky really will have fallen and we’ll all have bigger things to worry about.
    :-)

  21. 21. Mark

    Considering all the problems we are facing in regards to the economic situation and job losses I would agree that everyone has a “right” to be pessimistic.
    The problem with that though is that it won’t change anything.
    Many peoples have called me the “eternal optimist” & I believe I am. If I look at all the challenges I have faced in my life, most of these had nothing to do or related to money or even less a job or job loss. I believe though these situations gave me an opportunity to grow personally into a better a person.
    Yes, it does sound simplicit but why should it be anything else? Peoples need to look to themselves for many of the answers they are asking the Gov’t, Banks & what not to answer – don’t get me wrong, they do play a sizeable part in the whole scenario but it’s not the “whole” answer.
    What does it say about us when we have raised a generation that is pretty much called the “me” generation…

  22. 22. Scott

    To those of you who are “on the positive side of pessimism” because you get to “buy stocks for half-price”, I have a question: how do you know what that stock’s REAL price is?

    You are paying half-price of what the stock was 6 months, a year ago, but how do know if that was a REAL price? This is a big source of “irrational” pessimism — market/stock valuation.

    How are investors supposed to attain true and realistic prices when fraud and deception have been saturating Wall Street and government “regulators” and the markets for decades? Think your stock of choice is pure? Do you know the real value of it? Do you trust the information it’s “books” give you? Is it a case of ‘innocent until proven guilty’?

    One of the few things you can trust is good ol’ supply and demand. I guess that would lend itself more toward short term trading than investing (try selling a Cabbage Patch Kid for $500 today!).

    I would rather take a look at society and see what is going on, then look for companies that are being supported by such behaviour; that, rather than play a 300% jump in Citi based on idiotic fraudulent behavior that shows we are just as greedy (chasing the money) and stupid (buying stock in a bankrupt bank) as ever.

    That’s hardly change, and one I don’t believe in.

    As an end note, take a look at the 10-yr chart for McDonald’s (MCD) and overlay it with the DOW. They follow each other quite nicely until the great KABOOM of ’08 (you could even say the writing on the wall back on ’03!). Mickey D’s will keep going up for two reasons: 1) people are saving more of what little they have; why give it to greedy liars of Wall Street? and 2) there are a whole lot more poor people in the world now (aka the ‘Dollar Menu’ flourishes). Trade the trend.

  23. 23. Paul

    “how do you know what that stock’s REAL price is?”

    I imagine very few people do. And I’m not sure it has much to do with the market price anyway. It’s all about perception of value. If the majority of investors ‘think’ a stock is worthless, they sell, and therefore it is worthless. And visa-versa of course.
    Supply and demand curves assume a perfectly rational consumer with complete knowledge of the intrinsic value of any item. Let me know if you meet one of those. :-)

    Everything is worth what its purchaser will pay for it.

  24. 24. john

    During every US recession people are saying that this is it! The US is finished. During the 1970s this was particularly true. During that time it looked like the Soviet Union was going to win the cold war and become the dominant superpower. Today we of course see just how wrong those people were. People discount the power of the true american dream too much. The true american dream boils down to freedom. The idea that a people can chose their own destiny in life is quite powerful and will never fail. It took centuries to acheive the dream that is America and it will never die. America is an idea more than anything else and it will live on as long as people still live on this earth.

  25. 25. Victor

    >The idea that a people can chose their own destiny in life is quite powerful and will never fail. It took centuries to acheive the dream that is America and it will never die. America is an idea more than anything else and it will live on as long as people still live on this earth.

    In other news: The Roman Empire will never fall because “it puts its faith in God and its currency is the mainstay of global commerce.” The sun will never set on the British Empire. Full stories at 11.

  26. 26. Al

    Paul,

    Your comment #22 could be titled “Why bubbles happen”

  27. 27. Scott

    “The idea that a people can chose their own destiny in life is quite powerful and will never fail. It took centuries to acheive the dream that is America and it will never die. America is an idea more than anything else and it will live on as long as people still live on this earth.”

    In other words, give a slave a long enough chain and he thinks he is free — ergo America.

    When you OWE, you are NOT free.

    In hand with this, does anything the world leaders say about this state of economy relieve anyones “irrational pessimism”? I, for one, have absolutely no idea what my Canadian politicians are saying simply because I don’t pay attention to them. I just don’t think they are intelligent or bright enough to know what to do besides ape the tried-and-true Amerikan bailout/TARP/stimulous plans.

  28. 28. Cash Canuck

    Didn’t Robert Schiller coin the term “irrational exuberance”? He used in a speech to the fed, and then Greenspan ran with it.

  29. 29. jesse

    The economy is “not the problem”? Pardon me, but the last 10-20 years was exactly the problem. There is still way too much leverage backed against overvalued assets. Until that disappears and savings rates increase, there is a major problem.

  30. Scott,

    Well I do agree that it’s not easy to place a value on a stock, by “half price” I simply meant that some of the companies that I was interested in a a certain price and have been watching over the last 6 months are now half the price of what they were. While some stocks, like a Teck Cominco, had it’s price lowered for very obvious reasons… other stocks, like the Canadian banks, are half the price for no real reason other than “irrational pessimism”.

  31. 31. Victor

    @CanadianFinance – By that half-price logic, note that the TSX index is still quite expensive. Other than the bubble in 2000, it is still higher today than it was from 1999 (where my chart starts) through to October 2004. By that same logic, the TSX won’t be “half-price” until it’s in the 3500-4000pt range.

  32. 32. Gates VP

    @Ed: I’ve posted the reply on my own blog.
    http://gatesvp.blogspot.com/2009/03/irrational-pessimism.html

    There are simply too many arguments for me to post here without simply hi-jacking the thread. Feel free to reply here or there, but please at least use hyperlinks to highlight or support your arguments for “irrational pessimism”.

    It’s pretty clear that the average American is now carrying a very large amount of debt. That the debt represents a very large amount of goods and services as priced outside of the US and could represent a general US insolvency on an international scale.

    A 25-year trade deficit is a bubble just waiting to pop.

  33. 33. Scott

    “…other stocks, like the Canadian banks, are half the price for no real reason other than “irrational pessimism”.”

    How do you know that?! Show me the Proof! Look at all the Amerikan banks that are down 90% in the past 8 months, all due to “irrational pessimism”? Perhaps it’s their non-public internal business practices as to why they are now “half-price”. As Victor pointed out, they could all still be over-priced by half, and with good, albeit hidden, reasons.

    Gates is obviously right on the money. When debt fuels two decades of your economy’s “growth”…well, something nasty is just waiting to happen! That’s also why stock prices are being cut in half, if half your “growth” and “profit” are mere debt, and that debt is being called…we’re all witness to that catastrophe.

    All the “irrational pessimism” may also stem from the hoard of consumers (and business owners) finally realizing just what kind mess they are truly in, and they know it’s truly bad.

  34. I’m not arguing that the TSX, or any stocks in it, can’t go lower. In fact, I hope they do. I’m just saying that some are simply half the price that they were before when I was willing to buy them.

    For example, RBC (RY) was hovering around $50 for most of the year, before everything went off a cliff. I was willing to but RY in the high $40’s, why would I not want to buy when it’s $25-$35? I’m also not saying this won’t go lower, my biggest concern with the bank stocks is whether they might cut their dividends… not that I won’t buy them, I just rather do it after a dividend cut announcement than before.

  35. 35. Michael

    I love that the 08/09 inflation was set at -.1%, yet Helicopter Ben just announced the Fed will be printing over 1.2 TRILLION dollars. I think maybe, just maybe, that figure might be off a bit.

  36. 36. Scott

    Michael….as I’ve said, people are sick and tired of fraud and lies and deception from both corporations and government. Heli-Ben et al can jabber all they wants, are you going to believe them? Their irrational exuberance has become our rational pessimism.

  37. 37. Ed Rempel

    Hi All,

    By my count, there have been 9 posts agreeing that we in “irrantional pessimism” and 23 posts disagreeing.

    There definitely is a lot of pessimism!

    Ed

  38. 38. Ed Rempel

    Hi Matt,

    Are you trying to argue that markets are overly opimistic now because the markets are rising while bad news comes out?

    There is a common misperception that the stock market and the economy move together. The few studies that shed light on this show usually there is no correlation between them. Some even show a slight negative correlation, which means the market is slightly more likely to move opposite to the economy.

    The reasons for this are because the stock market is based on expectations created by all available information. This is why announcements of bad economic news, such as higher unemployment, often result in markets rising, because the expectation was a larger rise.

    The general expectations of how bad things will get before this recession is over are all built into the markets already, so if things keep getting worse and the economy gets as bad as expected, that should have no affect on the stock market.

    In the last 3 weeks, the 20+% rise in the markets appears to result mainly from being massively oversold and because the bad economic news since then was already expected.

    Ed

  39. 39. Scott

    Or a Dead Bull Bounce.

  40. 40. Ed Rempel

    Hi Scott & Paul,

    There is a real value for every company in addition to the supply demand and current market price. It take a lot of fundamental research to determine what it is.

    Private business owners generally have a good idea what their business is worth. But once it does public, nobody seems to care about the real value. Everyone is just focused on the trend, news, industry forecast, and how its chart looks.

    If you think like a business owner and do real research, you can figure out what a company is really worth.

    Most of the world’s top investors focus on fundamental research and figure out what a company would conservatively be worth if they were to buy it entirely. They call this “intrinsic value”. Then if they may invest in it if they can buy at a large discount to this price.

    Our fund managers are telling us they have never in their long careers seen so many companies selling for so much below their intrinsic value as now.

    Ed

  41. 41. Scott

    Ed,

    That’s great for you and your fund managers, but how is a regular off-the-street investor supposed to figure out the TRUE intrinsic value of a company when said company screws with their books and reporting to such a deep level (and for so long) that the TRUE value is almost impossible to find, perhaps even to insiders and CEO’s?

    THAT is why there is irrationality, pessimism, and irrational pessimism.

  42. 42. Scott

    As a contrarian thought, would this market also be subject to “irrational optimism”?

    I would vote yes on both counts (I.P. and I.O.).

    An I.O. example would be all the big American banks now posting “profits” — with the help of extremely “fuzzy accounting” — and the optimists buying into (and overlooking) the irrationality of it all.

    I guess, in the end, it doesn’t really matter what your mind set is because the market will never cease to be fueled by the two (always irrational) grand-daddies: Fear and Greed.

  43. 43. mojo30

    Irrational? the world is up to their eyeballs in debt, consumers, governments, businesses. This will take a very long time to control..it will never get fixed that is a fact, people these days dont know how to start small and work their way up..first time buyers spending $350k+ for housing instead of buying that $160k TH with no to very little dp BTW, 16 year olds buying BMW’s as their first car insteasd of that old junker so they can actually learn how to drive first.

    The stock market is emotion and manipulation, the big players with money control the market and it will tank again once they decided to take their ball and go home. The current rally is just speculation that the economy is getting better. Take citi, they were given $25b to keep them alive and now they are a profitable organization? I mean come on, are people really this stupid to actually believe this? I’m starting to believe , yes.

  44. 44. Ed Rempel

    Scott,

    That is what investing research is about. Choose a small number of companies that you understand and do a lot of research. You can’t just take the financial statements at face value. You need to understand what they really say, read the notes carefully, compare them to competition, go to the annual meeting and meet the the management, talk to people that work for competitors or that would be their customers to understand how they see the company, and then you can figure out what the company is actually worth.

    I understand your frustration over accounting practices, but most companies do not intentionally deceive with their financial statments. They just try to make it look favourable. Bank balance sheets are notoriously hard to understand, because they often have lots of off-balance sheet items, but many companies are much easier to understand.

    This may sound like hard work, but that is what the top investors do. Any owner of a private business knows what it is worth. However, once companies go public, it seems that most investors have little idea what the company is worth and buy based on trend, chart formations, or simple ratios such as P/E of dividend payout.

    Private business owners would never sell their company shares that way. There is a huge advantage for those investors that have done their own research and know what a company is really worth.

    If you don’t want to do this reasearch and all your information is from public sources, you will probably find investing very difficult. Then it may be better to invest with fund managers that are top professionals and do a great job of doing this research.

    Ed

  45. 45. Scott

    “If you don’t want to do this reasearch and all your information is from public sources, you will probably find investing very difficult. Then it may be better to invest with fund managers that are top professionals and do a great job of doing this research.”

    That is also part of the I.P. trend — fund managers. I can’t write any more about this without getting overly irate and thus incomprehensible. If you have a list of good (by all definitions) managers, I would love to get a copy of it.

    As well, for the vast majority of investors, it’s not a matter of “don’t want to”, but one of “can’t”. Heavy duty, in-depth research such as you recommended is a full-time job and most investors already have a full-time job (plus more!). It’s kind of damned if we do…situation.

    I await The List!

  46. 46. Ed Rempel

    Hi Mojo,

    The main problem with banks being shut down was not that they were not making money. It was that their reserves were too low.

    The biggest issue was that they were holding subprime mortgage notes as significant portions of their reserves. The “mark-to-market” rule that forced them to value these at or bear zero since there was no market for them, even though that is obviously not a reasonable value.

    The accounting standards organization has now softened the mark-to-market rule to allow a reasonable value when there is no market, which should mean that the remaining banks maintain enough reserves.

    Most have been making money all along, even most of those that were shut down. So, having Citibank make money is not at all a surprise. With all the stimulous money going around and being able to borrow at essentially zero, a higher profit is also not surprising.

    Ed

  47. 47. Ed Rempel

    Hi Scott,

    I provide a lot of free info on MDJ hoping it may be helpful for readers. I try to be as open as possible, but the one piece of info I prefer not to reveal is our specific fund managers.

    We do a lot of research to figure out who truly has talent. It is not as easy as looking at some stats and nobody is perfect. However, just like I believe I can figure out who the top NHL players are (They are not in Toronto.), we believe we can select the most talented fund managers.

    For most of our clients, we do not charge for comprehensive planning and making sure they are doing all the right strategies to achieve the life that they want, because we make our money from the investments.

    If you do not have time or desire to do all the investments research, then you should either find an advisor you trust to do this for you or stick with broad-based index funds or ETFs.

    Whether you choose to work with top fund managers or ETFs, we would also suggest to avoid sector or regional choices, and avoid trying to market time them. It is best to let them do their thing. Most investors will consisently choose the wrong sectors/regions and lose most of their return with bad market timing.

    Ed

  48. 48. Matt

    Ed,

    I precisely argue that exact point.

    Markets keep rising despite the bad news. However this is only part of the equation. Markets keep rising despite no end of bad news and markets keep rising when the bad news is not as bad as previously thought! This is the key. I am well aware of past history and the general consensus markets tend to recover 6-9 months before the economy. My point is: housing values in the US are nowhere near stable, inventory in the housing markets are at numerous year levels (forget new starts!), unemployment keeps rising (yes, it is a lagging indicator), accounting rules are changed to make things look less bad, we have not even seen the effects of the commercial mortgage fallout (stay tuned!), the response to fixing the problem of overleveraging and too much debt is to create more debt, etc. etc. etc.

    For anyone who is wondering what the future holds for the US stock market, please refer to Japan’s market crash from 1989 to present day. While checking that out also refer to Jim Rogers (go to youtube). Also, the inflation vs. deflation debate is alive and well (personally I think we will see the worst of both worlds as a result of mass unemployment coupled with eventual declines in supply of natural gas, oil, and food) either way look out.

    The question is not when we have another crash but how do we protect ourselves? Gold and commodities (hard assets), go short, and calculated profit taking (the days of buy and hold are looking bleak) are my bets to survive this uncertain financial environment.

    Do I think the stock markets are going to recover? Absolutely – just not permanently and just not linearly – again refer to Japan.

    I have been on vacation for a few weeks and am just reading many of these comments. Ed, I respect your opinion on things however I couldn’t disagree more. The problem with fund managers is they are not managing their own money. I found it startling when I read over 50% of fund managers do not even invest in their own fund! Now, I wish I could remember where I read this, but I think it was off Globefund.com MarketBlog. I believe most fund managers take their hefty salaries from MER’s and invest in sound index funds.

  49. 49. Ed Rempel

    Hi Matt,

    We think the recovery so far is just making up for over-shooting on the downside. The market had no business falling anywhere close to as far as it did. Who was selling at those ridiculously low prices? The market fall was far more than during other recessions that were far worse.

    That’s a very depressing viewpoint – but it does seem to be the general public view. I have heard your exact comments from lots of people – which is why we think these things are essentially priced into the market. Everyone knows about the housing market, too much debt, unemployment, etc., so none of these are relevant to future market direction, unless they turn out to be worse than expected.

    The accounting rules have actually made things look quite a bit worse. Sarbanes Oxley has resulted in profits showing quite a bit lower for many companies, even though their operations are the same. The “mark-to-market” rule changes will have no effect on profits except in extreme crisis situations.

    You can’t fear BOTH inflation and deflation. At least one of them won’t happen. In fact, both are extremely doubtful in the short term. The deflation fear appears to be history now, since the economy is showing signs of recovery. The inflation argument refers to running out of resources and Peak Oil. These may well happen, but probably not this year or next. This is a longer term issue.

    Japan is a unique situation, since they have an “old boys’ network” and continually prop up bankrupt banks and real estate companies. Here, we just bankrupt them and move on. That is why their market is way down for 20 years, but our market tends to recover quickly. Almost all bear markets have recovered fully in 1-4 years. Even during the Great Depression, the recovery only took 13 years. That is why we don’t think the Japan situation will ever happen here.

    Your comments about fund managers are true – but not your conclusions. Remember that most fund managers are just salaried employees of some big bank or insurance company. Their bosses restrict them in many ways, such as sector restrictions and wanting them to hold the stocks and sectors that the public is looking for (even though those are always the worst ones to own). So, why would they invest in their own fund?

    They are investors, so they will pick their own stocks. Most fund managers don’t buy funds or indexes, because they believe they can do better with their own picks (which of course the average fund manager cannot).

    However, the top fund managers and the average fund manager are totally different. Most of the top fund managers do invest in their own fund – often with the majority of their money. Why not, since their fund consists of exactly what they would inves in anyway?

    The top fund managers usually are not employees of someone else’s company. They own their own firm, have no bosses, and their firm follows the discipline and style that they believe in.

    One of our hedge fund managers requires that all employees of their company have 100% of their investments in their own funds. They say that really focuses everyone – and gives us a lot of confidence in them.

    Ed

  50. 50. Ed Rempel

    Hi Everyone,

    I’m surprised that there are no comments here yet taking notice that the markets are now up about 35% since this article was written. In retrospect, does the irrational pessimism not now seem obvious?

    We talked to quite a few people in December to March that believed that they should hold off investing until “things look better”. In November to February, there were several 15-20% bounces up and right back down. Nobody felt comfortable yet with a 20% bounce.

    That opinion seemed to be the general opinion of the public.

    So, we told onyone trying to time the market that they would not get in until the market was up 40% or more. Why would they wait and miss 40% or more?

    Now we are up nearly 40%. Is anyone feeling better yet?

    Ed

  51. 51. Victor

    I would feel a lot better about this rally if I could explain it.

    I still look around and see friends losing jobs. Unemployment in Canada is at 8%. Inflation is at 0.4%. Food prices are still rising. The prime lending rate is 2.25%, the lowest in Canadian history. Variable rate mortgages are at 3%. Two months ago the DOW fell faster than it did during the Great Depression, and in January investors panicked as British banks announced huge losses. The full effects of printed money have not been felt yet I believe. This must eventually result in inflation as dollars are devalued.

    So why the market rally? What real-world, concrete, positive news do we have to explain this?

  52. 52. Ed Rempel

    Hi Victor,

    The markets don’t work that way. All the bad news you mentioned is already widely know, so it is built into current prices and cannot be expected to move markets.

    Bad economic stats are irrelevant, unless they are worse than the general expectation. Very bad news that is only slightly less bad than expected makes markets rise. Therefore,, no good news is necessary to make markets rise – just the general expectations need to become slightly less bad.

    The full effects of printed money causing inflation obviously have not been felt yet, but the fear of inflation is rampant, even though it is a minimum of a year away. The fear of inflation built into current prices is likely far more than the actual likelihood.

    Unemployment is a lagging factor. In a normal recession, unemployment keeps rising even after the economy is recovering. Economists are only anticipating unemployment to rise about 2-3% – from about 7% to about 9-10%.

    Meanwhile, the stock market is a leading indicator and usually rises 6-9 months before the economy bottoms. So, having the market rise for a 12-18 months before unemployment turns around is the normal expectation.

    We think think the market level in early March was just stupid. The rally so far has just been sanity returning after over-shooting on the downside. I don’t know who was selling in early March, but it was obviously investors that focus on trends, and not on normalized valuations.

    Ed

  53. 53. Ed Rempel

    Happy anniversary, everyone!

    We are now 2 full years into the current bull market! It’s strange how many people STILL don’t see it.

    Ed

  54. What I don’t like about this crisis and “irrational pessimism” is that the mass media pops up mainly the bad parts. What’s positive is very little mentioned. We should try build a healthier mentality, an optimistic one. No matter how few are the positive aspects, gathering them all and constantly care for them, we can succeed.

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