The frog has boiled
September 15, 2001
You will have to excuse my eagerness to write during these tragic times. However, I had to write in response to some of the disturbing financial commentary and recommendations I have seen in the midst of the on-going media frenzy. This missive is long and not news to some of you, so feel free to skim along or go to your next email!
Back in January, I stated that I felt like the economy (or this country) was like the frog sitting in the pot of water on the stove. The parable says that frogs will immediately leap out of a pot of boiling water, but when placed in cool water, and boiled slowly, they will sit there and get boiled alive, not noticing the slow change in temperature until it is too late. This parable points to human behavior: we do not respond to an environment that changes slowly, but we react immediately to sudden and dramatic changes. After a while, and with hindsight, I thought the boiling water was the energy crisis. I recently stated I believed I was wrong because tried and true market forces swiftly eased many of the pressures the energy crisis created. Sadly, how could any of us have suspected that the water boiling was a bunch of lunatic conspirators looking to disrupt this country (and the world) at its core?!?! Make no mistake about it, these attacks and whatever violence is to follow, whether from us or them, will have profound near-term effects on our economy and financial well-being.
So, let me cut to the chase. The most disturbing advice I have recently seen has been a call to patriotic duty to buy stocks on Monday. This could just be another internet chain letter prank, but I am afraid enough people will believe it to encourage me to send out this warning. Unless you are a speculator or aggressive trader, this is the absolute WORST thing I think you can do with your money. The fundamentals in the economy were weak before this tragedy; the tragedy has not made the fundamentals stronger. As the bubble should have taught all of us, when investing is done without the basis of fundamentals, you lose in the end. Your money will be much better spent with relief agencies and the like than to immediately throw it to the hungry hounds in the markets! History shows us over and over that these kind of shocks do not change the fundamental forces in place before the shock. Here are two examples that I have seen. When the Japanese bombed Pearl Harbor the Dow Jones was in the middle of a slow steady decline. The attack caused a 5% sell-off, but in a month the market had recovered. The commentator showing the graph stopped there (of course, they were trying to make a positive point, not report reality). However, once the market recovered from that shock, it continued declining in the same way it was before. After JFK's assassination, the market experienced a brutal sell-off again. This time, the market recovered very quickly and was soon continuing the strong bullish trend that was in place before the assassination. Again, the lesson is not to ignore the short-term shock, but to not forget the fundamental forces that were already in place BEFORE the shock.
In fact, another financial lesson we should get from this tragedy is that, as an investor, you should not put more money in the market than you are ready to lose in the short-term. Short-term events can damage your portfolio, but over the long-term, you can succeed. Sadly anyone who has short-term money in the market will be forced to sell at the worst possible time to do so. For example, insurance companies that face enormous claim payouts will have to sell lots of stock to generate cash to meet their obligations.
Another troubling movement I have heard is to make shorting (placing bets on a stock's decline) a moral albatross. It is the reverse of showing patriotic duty by buying stocks. If you bet against stocks, you are being unpatriotic. Last week in Europe, word went out that people would not be looked upon kindly for shorting (this did NOT prevent a massive sell-off on Friday --- again, the fundamentals win in the end). While there is legitimate reason for the stock exchanges to limit some shorting to ensure the stability of the markets come Monday morning, realize that shorting is a legitimate tool for hedging against losses in your portfolio. A portfolio that is all "long" (all bets are on stocks going up) is a risky short-term portfolio (again, long-term it is an excellent bet). I myself have used such techniques and will continue to do so. Some will call these shorters opportunists. But I tell you now, the ones who will be successful in the long-run are those "opportunists" who buy oversold stocks that have been leveled by desperate and undisciplined selling.
As you ponder what to do, keep in mind not only the powerful forces that were already in place, but the powerful forces that have also been unleashed. The federal government is returning to deficit spending and pumping tens of billions of dollars into recovery and rebuilding efforts, defense spending, and money to shore up hurting industries like the airlines. The Federal Reserve is pumping tens of billions of dollars of liquidity to keep financial markets stable here and across the globe, and they could be planning to take interest rates down to levels not seen in decades. Consumers are already ratcheting down spending on travel and entertainment. European markets have been selling off. Japanese markets continue their downhill rollercoaster. Commodity prices continue to creep up. And international commerce is slowing down due to all the restrictions in place now on travel. It is difficult from where we stand now to sort all of this (and more) out to make a firm basis for rational planning. One thing is for sure...All this needed government intervention is providing economic stimulus that WILL boost demand for goods and services. It will also make additional money available for consumption and investing. This stimulus is necessary to prevent severe economic crises. But recall that the last bubble began (ended?) as governments pumped in extra liquidity after the Russian, Mexican, and Asian financial crises and the collapse of a large and important hedge fund (these all happened at different times over the course of the 90s). When the economy gets its legs again, all this extra stimulus could spur inflation and/or a new wave of financial speculation in the near-future. These things need not happen, but they are just things to watch out for in the coming months or years.
Finally, you should pay close attention to the interests of the people who offer you advice during these crazy times. The media is full of hype, and people are willing to give lots of advice to a nervous public. For those seeking solace and comfort, they will be willing to listen to any words of reassurance. For those who are bewildered and confused, they will be willing to listen to words of panic, doom, and gloom. This is a time to take a breath and act only after your mind is clear. Just Friday, I watched an interview with the CEO of Merrill Lynch. He pleaded with investors to remain calm and to not react immediately and to seek professional financial advice. But of course he would say this! His company provides financial advice, and its profits depend on the soundness of the financial markets. I have listened to various government officials nearly dare anyone to bet against the American economy. They have legitimate interests in keeping the public calm, but it does not do justice to helping people make well-thought out choices with their money. The most measured words deserving of our ears have come from Mr. Grasso, the head of the New York stock exchange. He openly acknowledges the strong possibility that the markets will face turmoil in the coming days and maybe weeks. However, he based his case of confidence on the long-term health of the American economy and financial systems. He noted that throughout the 20th century, long-term thinking has been amply rewarded.
So, while we may have boiled. We are not dead.
As always, be careful out there....