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Getting the Real Picture Now?

August 9, 2007 by  


By Bob Wood, Muslim Media News Service (MMNS)

Perhaps by now you are aware that the strength of the U.S. economy is not at all what we’ve been hearing. The financial media’s bullish promoters have worked hard to convince us that the name “Goldilocks” best describes our economy — not too hot and not too cold. But even the Bulls are now recognizing that story as a fairy tale and seeing the economy as it really is, rather than what they needed to make sure we would pay premium prices for stocks and bonds.

Regular readers of this column are aware of my bearishness for the past few months. That stance has reflected my cautious view of domestic markets, though I saw international economies as still healthy. But maintaining my bearish leanings while Dow Industrials reached new highs almost daily wasn’t an easy thing to do.

Fighting such strong trends takes a toll–mentally as well as financially. Those who recognize such temporary tendencies but act upon their views too early tend to garner losses. People often ask me when the real trends will become apparent to others and my bearish forecasts will indeed play out as predicted. As for the timing, that is anyone’s guess. But getting the timing right is less important than being in position to profit when the crowd does wakes up to the idea that they have again been led down the wrong path by today’s bullish promoters.

Now even the most ardent Bulls are having a hard time waving away clear signs of trouble in the economy. How many more sub-prime mortgage lenders need to go out of business before it becomes obvious that troubles in this sector are not “contained,” as the stock market Bulls have been saying and as repeated often by economic luminaries such as Fed Chairman Ben Bernanke or Treasury Secretary Hank Paulson.

A large, well connected investment banker, Bear Stearns, has seen three of its in-house hedge funds blow up, wiping out every last dollar of investor capital in the process. If this can happen to a large entity like Bear Stearns, can you imagine how many other hedge funds are in dire straits right now?

Adding to concerns about how many mortgages will not be paid off as expected, we also see that new loans are now unavailable using the same lax guidelines as those offered in 2004 or 2005 when a borrower’s ability to afford loan terms were not a big concern. So with the housing market already reeling from a clear bust during the Spring/Summer selling season, reduced demand from new buyers will not help.

And in those trying to reassure investors that these housing problems are “contained,” we detect a glaring ignorance of the ripple effects of a housing market that has gone stone cold. New home construction became a prime source of new job creation over the past few years. Home improvement stores like Home Depot and Lowe’s thrived while serving shoppers who enjoyed what seemed like an ATM machine always ready to dispense more money in the form of home equity loans. Meanwhile, we Bears tried to warn investors that all this borrowing would soon become a problem, and now it looks like we were right yet again!

Of course, for every Bear, media outlets like CNBC can always find two promoters who avow that there is little to fear. “And by the way, did you know that stocks are cheap, according to a new valuation metric that we’re just dying to tell you about?”

I hope that what is going on now, coupled with what happened in the late 1990’s, serves to enlighten investors. Some promoters will always be bullish on the markets and our economy. Since they are most likely sellers of stocks or mutual funds, it is in their best interests to be Bulls. People like Ned Riley, Liz Ann Sonders and Larry Kudlow always see compelling reasons to buy stocks.

But what hurts investors’ returns over the long haul is not their missing the upside rallies in stocks. What kills investor returns are the down periods where capital is lost. Once money is lost, ensuing gains must be much larger than preceding losses just to bring the investor back to even. Typically, that takes years to play out.

In the past few weeks, we saw the resurgent S&P 500 reach a new all-time high. But it took seven years for that to happen! And if you have the same amount of money today that you had seven years ago, you have lost seven years of opportunity. And after inflation, you are well behind where you were then!

I believe that Bears do a great service in trying to help investors avoid losing money. Do you remember the late 1990s, when the Bears were right? And they were right, in large part, due to their diligent work in assessing valuations and economic reality, such as the near impossibility of making money when paying premium prices for stocks. Calling the stock bubble looked obvious later, but during the run-up, how many investors believed what the Bears were saying?

Bears were right again in calling the current housing bubble. But two years ago, at what proved to be the housing market’s peak, when the leader of the National Association of Realtors was writing get-rich-quick books on real estate investing, how many were hearing the Bears then?

Amazing to me now is how much money is being lost by large investors, including many of the institutional types. Pension and hedge funds were big buyers of mortgage bonds, which are now being correctly priced. It seems that hope trumped skepticism once again.

This Bear believes the best asset any investor can have is a healthy dose of skepticism. I know full well that someone in my position can sell hope and the thought of “getting rich quick,” and that tack will find more buyers than those of skeptical Bears. But I guess that’s only natural!

But in the real world, investors’ long-term performance positively “stinks,” as shown by studies done by groups such as Dalbar, as previously mentioned in this space. The investor who looks for what is cheap and neglected by the crowds, while paying close attention to valuations and prices paid for those assets accumulated with hard-earned savings, will do better over longer time periods.

But surely a method exists for discerning risk and valuation that goes far beyond what passes for analysis by today’s Bulls. Fatally flawed tools like ‘’The Fed Model,’’ which suggests that we pay premium prices for stocks just because bonds also sell at premiums, is a losing strategy, at best.

Buying high and selling higher, as propounded by market promoters like Jim Cramer and Investors Business Daily, is equally flawed. And buying stocks because they’re going up in price is yet another weak rationale that works until it doesn’t work and ends when the bulk of the crowd has jumped on board.

I know as well as anyone that few want to hear such bearish outlooks for the economy or the stock market. But reviewing what has been advised by the bullish crowd over the past few years illustrates the cost of ever-rosier predictions, especially when fundamentals show clear signs of the opposite.

We Bears are much less fun to hear, and we tend to dash the fondest dreams of hopeful investors in mere minutes. But when the dust settles, caution assures that you’ll still have your money. How many Bulls can make this claim with investor track records to back them up?

Have a great week,

Bob

Bob Wood ChFC, CLU Yusuf Kadiwala. Registered Investment Advisors, KMA, Inc., invest@muslimobserver.com.

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