Not so smart on Wall Street

The Thinker by Rodin

I had a feeling that our cruise would occur during an auspicious time. A last minute debt deal at least assured me that I would not be on furlough when I returned home. On the day our cruise set sail for Bermuda, the stock market plunged over six hundred points, the sixth worst point fall on record. Since then the trend has been mostly down, with the Dow Jones Industrial Average down some four hundred points for the day as I write this (August 10, 2011). It feels a like 2008 all over again. Markets are especially nervous about national debts and obligations. The United States is hardly alone. Greece, Spain, France and Great Britain are among those countries that make their creditors nervous. The trigger this time was the downgrade of U.S. treasury bills by Standard and Poors, which last Friday cut our rating from AAA to AA+ status, the first downgrade in our history.

The market is desperately searching for safe harbors for capital, but is finding few of them. Our financial world is riskier than it was. Doubtless with these stock market declines my portfolio has been badly hit. Doubtless I lost my illusory millionaire status. I have no idea if we are plunging into a double dip recession or worse, but the tealeaves that our economy was having difficulty have not exactly been hard to read. Over the last few years, Wall Street has exhibited irrational enthusiasm and drove up stock prices to artificially high levels. It did this largely on hope, probably because recessions typically don’t last too long.

Wall Street obviously discounted the signs that this recovery, at least here in the United States, would be largely an illusion. Yet the signs were clear and unambiguous: an unemployment rate that would budge only grudgingly, a fearful middle class with no extra income, relatively high inflation and political intransigence that ensured that common sense would take a holiday. Standard and Poors finally acknowledged the obvious by lowering our bond rating. It did so not because our ability to pay bondholders was really in doubt, but because our country refuses to find a sensible financial path forward. With the debt ceiling deal, as usual, we pushed problems into the future and did not really fundamentally address any of them. We created a dubiously legal entity called a Super Congress which appears doomed to be dysfunctional. Everyone knows what would really calm the markets: some measure of tax increases to accompany expenditure reductions. This, of course, is exactly where Republicans in Congress will not go. While I am hopeful plunging markets may force Congress to exercise some common sense, it is mostly a fool’s hope. Perhaps the 2012 election will bring clarity, but if I were a betting person I would not bet on that either. So expect the stock market to remain in turmoil for some time.

I remain not too worried for myself as long as I have a decent job. I leave it to my financial advisor to keep me on a sound long-term financial strategy. But I can pretend to be scared like mostly everyone on CNBC, one of the few channels available to us here on the cruise ship. I once opined that capitalism is our true religion. Watching CNBC certainly reinforced this opinion. From watching CNBC, it is hard not to conclude that the financial class is largely a nattering bore, obsessed with the minutia of the moment and largely tuned out to the facts in front of them. There are only a few things that really matter about investing in a company, but you would never know it from listening to these CNBC talking heads. What matters is a company’s track record, how leveraged it is by debt, the opinions of their customers and their ability to innovate products that people want.

Look at the companies that are truly prospering, like Apple Computers. You know that money invested in Apple will probably return growth and dividends over the long run. I have no idea whether their share prices are overvalued or not, but I do know owning shares of Apple means your money is probably not invested down some rat hole. Whereas when you look at other companies, say Bank of America, whose balance sheet is rife with risky subprime mortgages, you can reasonably infer it’s a risky stock in the long term, because it was being managed by short-term profit-obsessed bozos in the mid 2000s when clearer heads were needed. I know I would need a lot of convincing to invest in Bank of America. Fool me twice, shame on me.

Instead, I simply refuse to become obsessed about short term trends in the stock market. To the talking heads on CNBC, that seems to be all that matters. In my opinion, short term investors are basically gamblers. I put no more faith in them than I would on some guy on a winning streak in a Las Vegas casino. Short term investing is a dangerous game. If you have the nerve for that sort of financial life, like many investors tuned into CNBC, go for it, but you are likely to end up losing a lot of money. Instead, us non-financial wizards can save ourselves a lot of angst by investing in companies with the attributes I mentioned above, holding on to them for the long term, balancing our portfolios yearly to meet our financial goals and cashing them in selectively during retirement. These short term market changes always disappear over the long term. The only short term decisions I would make would be to buy solid companies whose stock price is artificially discounted as a result of irrational and wholly short-term fears on Wall Street, but only if I had some spare cash. Presumably my other assets would remain solid for the long term, and I’d want to hold onto them.

I am not a stock analyst. However, I do know a fool’s errand when I see one. Despite the endless blather on CNBC, it’s obvious that even the wizards on Wall Street cannot accurately predict short term trends. In fact, no one can since by definition the future is always unknown. So if you are listening to CNBC analysts thinking they see things you don’t, disabuse yourself of the idea.  Instead, when judging the economy, judge it by the economy you see and experience, which is the one that matters.

The short term market is driven principally by fear and greed, which depend on each other. It’s like an endless game of tug of war and like a Las Vegas casino, the odds are stacked against you by default. Rumors that are widely believed can be as good as gold for a short while, even if they are wholly fallacious. All sorts of short term fools will follow analysts on CNBC and elsewhere and dump perfectly good stocks for potentially risky ones elsewhere. You are likely a better predictor of market trends than they are. After all, these wizards built up stock prices on the hope for a recovery that never really materialized. Once again they have been proven catastrophically incorrect. And yet the economy will truly recover in time. It always has. When it does you want your portfolio to be full of solid and meaningful assets.

Instead, I recommend that you do your best to tune out the daily stock market ups and downs and keep investing in the long term. If you are not someone who wants to waste your time getting into the minutia of stock market analysis like me, then get a trusted financial advisor with the long view who will allocate your investments into funds that are well managed and include companies that have the attributes I mentioned.