A Conversation with Paul

Paul is a client.  He is a very intelligent entrepreneur with a successful business.  He wisely chooses to diversify his principal business by taking profits and investing.  His question is one facing every individual investor.  When and where should he invest?

Paul is frightened.  He reads extensively.  Most of what he reads is, simply put, doom and gloom.  He visits all of the most popular investment blogs and also follows the commentary from the key mainstream sites.

We realize that Paul's approach is not typical of the average reader of "A Dash" or readers of the big traffic blogs.  He is more skeptical and open-minded than most.  He wants real answers.  Here is the conversation.

A Dialog

Paul:  The market looked terrible.  I pulled all of my investments from other funds.  Everyone says that we are on the verge of a deep recession.  The indicators are all negative.  But I am confused.  I have questions.  Why do my favorite sources say that a 300 point rally in the Dow is "confirmation of a bear market?"

Jeff:  The analyst is looking at big moves in what is described as a bear market rally.  It is a way of looking at results and then projecting the future.

P:  Is this a strong method?

J:  We are always nervous when there are only a few cases and we try to make projections.  It is also better to use percentages in evaluating long-term data.  Barry Ritholtz astutely noted some reactions on this theme.

P:  Does it change if there are two 300+ days in a week?

J:  We do not know of any research on a double 300 week, but there is a strong update on the initial question from Bespoke Investment Group.  They noted that the conditions of bull and bear markets were somewhat subjective.  Their conclusion was that the market generally moved higher in almost any time period mentioned.  They did not address the "double 300" situation.  Read the entire article.

P: What if there were another big day?

J:  You are kidding me.  I am trying to explain the bearish perspective for you!  At some point, everyone would recognize a new trend.

P:  OK.  What about oil?  I understood the problem when oil prices were moving higher.  This meant that there was top-line inflation.  It would hit consumers, cut spending, put the Fed in a "box" where higher inflation forced higher interest rates.  Now oil prices are coming down.  The same sources tell me that this is an indicator of "demand destruction" and shows that the global economy is failing.  What's up?

J:  We share your confusion.  We prefer intellectual honesty in indicators.  There is something wrong when the same source tells you that rising oil prices are bad and falling oil prices are also bad.  Will these sources take note of declining headline inflation?  More consumer spending power?  In the past, such sources have used phrases like "oil prices remain elevated."  We shall see.

P:  How about the yield curve?  Is it still inverted?  What does this suggest about a recession?

J:  The yield curve inversion theory is pretty loose.  A year ago we pointed this out, citing the "Will Rogers" of yield curves.  It is supposed to predict a recession, and it may have succeeded.  This assumes, of course, that one allows plenty of latitude on timing.  The curve now has a positive slope.  Those who used it to predict a recession have generally fallen silent on what this means for the future.

P:  Isn't that inconsistent?

J:  Yes.  Anyone who wants to look forward on the economy would use the same indicators.  This might be one way of discovering who is starting with the conclusion and who is starting with data.

P:  These all seem like very simplistic indicators.  Earnings reports are also hard to read.  Financials are bad, energy is good.  How can one decide?

J:  As you know, our indicators shift with the times.  Over the last few months we have been bearish, neutral, and now bullish.  Looking at a wide range of information is better than a fixation on some simple heuristic.

Conclusion

There are no easy answers in forecasting economic growth, profits, or stock prices.  Sometimes the stock price already reflects a pessimistic assumption.  That is what we currently see.

It is a skill that requires knowledge and experience.  Most investors read about the economy and stop thinking.  They never ask whether stock prices reflect opportunity.

Comments

[Alisa]

Very legit questions that are also in the minds of other investors. Great and helpful dialogue.

[oldprof]

Vermont -- I agree. Asking questions about business is useful. I ask everyone, especially when traveling, how business is.

While I believe in data, it often helps to know where to look.

And you are right about the trade impact on GDP, if trade itself is not revised away!

Appreciate the comments.

Jeff

[Vermont Trader]

FYI trade deficit numbers this morning imply that 2Q GDP was understated by about 1% last week......

[Vermont Trader]

I would have asked him how his business is doing and what he expects in the near future..

Who cares about 300 point days. If you spent your days on conference calls and on the telephone with suppliers and customers of your holdingd you would know that business is slowing down all over the world.

How's your biz doing Jeff? Are you bullish on inflows for the next year? Are you buying any new infrastructure?

It's not a stock market, its a market of stocks.

[RB]

Barry talked about this too:
http://bigpicture.typepad.com/comments/2007/10/market-cheat-sh.html

[Mike C]

"We are aware of his comments on the cycle, but frankly do not see any advantage over what we have recommended. Do you?"

I'm not sure I understand what you are asking here.

"But can we stick to the topic of the article? Paul reads a number of sites that interpret everything as negative, including the same indicator whether it goes up or down. Are you saying that I should tell Paul to ignore these sites?"

Since you asked the question, I think my answer would be Yes, he should ignore the various sites because frankly I'm not sure he or many individual investors have the sort of skill set or time to put various arguments into context, and take actions with positive expectancy over time. Obviously, this message has to be delivered in a sensitive way.

I don't want to come across as arrogant, but I just don't think the average individual, even an intelligent one like Paul can read Barry Ritholtz's take on something, then read yours and somehow make sense out of it all. It just leaves them more confused then when they started.

Here's an example. Take yourself and Hussman for example. Both of you are extremely intelligent individuals (obvious from your writing) with PhDs and alot of credentials. Now take Hussman's last 2 pieces, "Nervous Bunny" and "Risk of Conceding Recession". I think I'm not going out on a limb to say there is alot in those 2 pieces that you'd probably be on the opposite side of or take issue with. How can Paul possibly make any sense out of it, and TAKE RESPONSIBILITY for the decisions he makes as a result?

I guess my thought is there is nothing wrong with Paul wanting real answers and having the conversation about these various items, but it probably becomes counterproductive when he sells everything in response to his reading and "analysis".

I guess I went off-topic in my response, but I thought I had a different take on the entire conversation instead of whether rising or falling oil prices is good or bad. Incidentally, I think the answer to that question is depends. Is the falling oil price going to be stimulative to the economy and consumer, or is it perhaps a symptom of a global economy that is in trouble?

[Mike C]

"We are aware of his comments on the cycle, but frankly do not see any advantage over what we have recommended. Do you?"

I'm not sure I understand what you are asking here.

"But can we stick to the topic of the article? Paul reads a number of sites that interpret everything as negative, including the same indicator whether it goes up or down. Are you saying that I should tell Paul to ignore these sites?"

Since you asked the question, I think my answer would be Yes, he should ignore the various sites because frankly I'm not sure he or many individual investors have the sort of skill set or time to put various arguments into context, and take actions with positive expectancy over time. Obviously, this message has to be delivered in a sensitive way.

I don't want to come across as arrogant, but I just don't think the average individual, even an intelligent one like Paul can read Barry Ritholtz's take on something, then read yours and somehow make sense out of it all. It just leaves them more confused then when they started.

Here's an example. Take yourself and Hussman for example. Both of you are extremely intelligent individuals (obvious from your writing) with PhDs and alot of credentials. Now take Hussman's last 2 pieces, "Nervous Bunny" and "Risk of Conceding Recession". I think I'm not going out on a limb to say there is alot in those 2 pieces that you'd probably be on the opposite side of or take issue with. How can Paul possibly make any sense out of it, and TAKE RESPONSIBILITY for the decisions he makes as a result?

I guess my thought is there is nothing wrong with Paul wanting real answers and having the conversation about these various items, but it probably becomes counterproductive when he sells everything in response to his reading and "analysis".

I guess I went off-topic in my response, but I thought I had a different take on the entire conversation instead of whether rising or falling oil prices is good or bad. Incidentally, I think the answer to that question is depends. Is the falling oil price going to be stimulative to the economy and consumer, or is it perhaps a symptom of a global economy that is in trouble?

[oldprof]

Mike C -- Thanks for the pointer to Random Roger, one of our featured sites. We are aware of his comments on the cycle, but frankly do not see any advantage over what we have recommended. Do you?

But can we stick to the topic of the article? Paul reads a number of sites that interpret everything as negative, including the same indicator whether it goes up or down. Are you saying that I should tell Paul to ignore these sites?

As always, I appreciate your comments -- always helpful, constructive, and thoughtful.

Best,
Jeff

[Mike C]

"Paul is a client. He is a very intelligent entrepreneur with a successful business.

Paul is frightened. "

Paul may be intelligent, but he sounds like many individual investors who are essentially slaves to their emotions?

"There are no easy answers in forecasting economic growth, profits, or stock prices. Sometimes the stock price already reflects a pessimistic assumption. That is what we currently see."

Maybe the answers to many of the questions Paul is asking are unknowable with the level of certainty Paul craves?

Maybe (probably?) this is a bear market rally, but like all bear markets, they eventually end and it isn't the end of the world, and maybe the best thing is to stay the course or some hedging of downside, rather then 100% liquidation of all other funds?

I thought Random Roger had an excellent post kinda connected to this subject both in the simplicity and common sense level of the message:

http://randomroger.blogspot.com/2008/08/mid-morning_11.html

I've noted with interest that he has been quite accurate on how the last 12 months have unfolded with respect to the overall market, financials, etc. and it seems to me like it has been due to a focus on simply observing how past cycles have unfolded instead of overanalyzing??? every single economic/market data point to make the case for why this time is different.

Maybe at the end of the day, the message to Paul is not a different way to analyze what he is reading, but to simply stop analzying so much to get the certainty that does not exist?