Listening to the ‘Experts’

Expert opinions and predictions are easy to find in today’s media. It doesn’t really matter what topic—the sports channels have commentators try to predict the winner of football/basketball/baseball games, morning talk shows have guest experts talk about do’s/don’ts on almost every topic imaginable and national news stations have multiple financial and political experts interviewed every day on what they think will happen.  If listened to enough, we can start to believe the predictions will come true, even if the event has yet to happen.  This can be a dangerous way of thinking because not all predictions turn out to be true.

Using a sports analogy, can you imagine if the Colts players believed the ‘expert’ opinions of all the media about how bad they are right now? There is no denying they are struggling, but if they listen to and believe the critics, they are doomed to fail going forward as well. Michael Jordan stated it well when he said “If you accept the expectations of others, especially negative ones, then you never will change the outcome.”  Basically, don’t always believe what others say.

How does this relate to you, as an investor? Well, when the investment ‘experts’ are interviewed on TV or radio, it can be easy to believe them without hesitation because they talk about their credentials or how they predicted something to be true in the past. What they typically leave out is how many times they predicted something and it didn’t happen. Here are some examples of this from ‘experts’:

• Meredith Whitney, a financial analyst frequently interviewed on TV, in 2007 correctly predicted that the U.S. was looking at serious trouble within the banking system. However, in 2010 she came out on national television and predicted major defaults across the municipal bond sector for state and local debt—nothing close to this has occurred.
• John Paulson, a prominent hedge fund manager, made triple digit returns in 2008 by shorting sub-prime mortgages and making the richest profit in hedge fund history. However, in 2011, his fund was down almost 50% year-to-date through September.
• CNBC, CNN and other news stations will have 2-3 experts on at a time getting their opinion on different subjects. Often times, one has a positive outlook on an investment, while the other expert is negative on the exact same investment.  Do you think it is any coincidence that they rarely, if ever, bring them back to see if their predictions came true?

So, should you not pay attention to anything the experts say then? We are not saying that, but it is important to take their comments with a grain of salt and look at the entire picture. Don’t get too emotional just because someone is predicting an outcome—good or bad. This has played out just in the past month with a lot of analysts predicting the U.S. was heading towards a double-dip recession and papers, like the USA Today, having front page articles on how investors had ‘had enough’ and were starting to take money out of equities the first week of October. With 3^rd quarter U.S. GDP growth at 2.5% and the S&P 500 up over 10% in the month of October (as of 10/27/11), how do those ‘experts’ and investors look now?

Investing in an Environment of Extremes₁

Over the past three months, both stock markets and consumer confidence have fallen around the world as investors grapple with a host of questions. Would the U.S. default on its debt or be downgraded? Would the European crisis continue to escalate? Was the U.S. slipping into recession, or, if not, would the decline in confidence and stock prices push it into one?

Since then, some of these questions have been answered but some remain. Meanwhile, relative market valuations remain at extremes, suggesting the need for a balanced approach, even in the face of legitimate concerns about the direction of the economy and government policy.

On the first question posed over the summer—would the U.S. default or be downgraded? –the answer was a split decision. To have defaulted on the debt would have been a tragic, catastrophic mistake and political leaders at the eleventh hour cobbled together an agreement to prevent it. The agreement has been widely criticized as avoiding necessary, tough decisions both on entitlement spending and tax reform, and was regarded as sufficiently weak to warrant a downgrade of U.S. debt by Standard and Poors. However, it did meaningfully cut the projected path for government debt over the next decade. Moreover, despite the downgrade, long-term Treasury rates have moved down in recent months suggesting that Standard and Poor’s didn’t tell investors anything they didn’t already know.

On the second issue, only limited progress has been made on the European debt issue. While Europe is mounting ever greater resources to stabilize some sovereign debt markets and back-stop the banks, they are doing very little to improve the economic situation in Greece. The most pressing problem is that Greece is carrying too much debt relative to the size of its economy. Unfortunately, the Greek economy is still shrinking, a situation which is being made all the worse by the austerity program it has been forced to adopt in order to continue to borrow from the IMF and its European neighbors. Given this, a Greek default is seen as becoming more likely every day, and while some have talked about an “orderly default”, many investors rightly suspect the ability of European policy makers to engineer one.

On the third issue there is some better news. While consumer confidence has yet to show a meaningful recovery from its August lows, September numbers on auto sales, chain-store sales, payroll employment and manufacturing activity all suggest that the fall in confidence has not pushed the economy into recession-at least, not at this moment. With 3^rd quarter GDP growth recently announced at 2.5%, stronger than in either of the first two quarters, the fears of recession have been greatly diminished. This does not, unfortunately, mean that the economy is firmly on an expansion track. Monetary policy has been largely counterproductive as the Federal Reserve’s ever more exotic attempts to lower long-term interest rates have generally undermined confidence and convinced potential borrowers that they could procrastinate-much to the detriment of the moribund housing market. Meanwhile, the Federal Government, while not finding the unity of purpose to propose long-term budget discipline, could actually cause the budget deficit to fall too much over the next year, as temporary tax breaks and stimulus spending expire.  Sadly, the U.S. economy is more threatened by Washington than by its own inherent imbalances.

The volatility of the last few months along with very negative headlines have caused a continued stream of assets to leave equity funds and move into cash and high-quality fixed income assets. However, this has left assets at extreme valuations. Indeed, by the end of the third-quarter, U.S. stocks were selling at lower prices relative to lagged earnings than at the end of any quarter in the past 21 years. Meanwhile, 10-year Treasury yields were running below the core year-over-year inflation rate for the first time in 31 years. This suggests that while volatility may still be present in the short-term, attractive opportunities exist for those with a longer-term investing timeframe.

Source 1: JP Morgan Market Insights Monthly Update October 2011

Did you know?

Price of Gas – The price of crude oil drives 68% of the price of a gallon of gasoline at the pump. The remaining 32% is a function of taxes, refining costs and marketing costs (Dept. of Energy)

Out of Pocket – Retail sales were up $29 billion in September 2011 vs. September 2010. $8 billion of the $29 billion increase was spent at gas stations (Commerce Department)

Stay Positive and Believe in Yourself!

“When doubts filled my mind, your comfort gave me renewed hope and cheer” Psalm 94:19

“The greatest mistake we make is living in constant fear that we will make one”  John C. Maxwell

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