What We Don't Know about the Markets

It is important to know what you don't know. That may sound like doublespeak, but it absolutely makes sense in this current investment climate. What you don't know can hurt you, and what you THINK you know can as well. I humbly (and believe me, this market has humbled me) offer some of the things we must keep in mind that we do not now know. Then we can act accordingly.

1) We don't know if we are in a recession or a depression. You will hear every possible opinion on this, but the fact is we don't now know. We have reached recession levels, and it is yet to be seen if it deepens further and lengthens.

2) We don't know if this recession/depression will last for quarters or years. One talking head says the economy will turn upward early next year; another says mid '09; another says two years; another says five years of no economic growth. The fact is we don't yet know.

3) We don't know if the stock market has put in a low for this down cycle. Again, opinions by very smart investors/advisors come down on both sides of this issue. The truth is we don't yet know.

4) We don't know if this is the the time to buy stocks or not. You will read one opinion that long-term investors should be buying stocks now. I guess anyone could hide behind several years and say if you hold for many years you stand a good chance to make money. That is hard to disagree with, but who wants to put in new money now, only to perhaps be underwater almost immediately, and then hope to get back to even?

5) We don't know what earnings will look like in '09 and beyond. Again, there are many opinions out there about next year's earnings, but we just don't know.

6) We don't know if any of the rescue efforts of our government and others will work or if they work how long it will take to see improvement. Our government is trying unique ways to restore liquidity and to bolster the consumer. Obviously everyone hopes it will all work, but we just don't know at this point if the actions will perform as intended.

7) We don't know if deflation is taking hold to stay or if it is short-lived only to give way to inflation, maybe hyper-inflation. Economists all read the same tea leaves, but they read them in greatly differing ways. Opinions are cheap, but we just don't know the answer right now.

8) We don't know if stocks will ever bounce back to what they were a couple of years ago. The world is changing. Deleveraging may not take us back to where we were; it may well take us to someplace new. We are so early in this global process that we just don't know what the new world or "destination" as some call it will look like.

I am sure you can add some items of your own to this list of "what we don't know." So what is one to do in this opaque investing climate? To each his own, but I would suggest extreme caution but not hibernation. I would:

1) Have some but perhaps limited exposure to stocks with a diversified portfolio. I am more into value stocks than growth right now. I am exposed to China because if there is any country in the world that has a chance to have growth in its economy, I think that is China. I am prepared to wait. Also, I can't help but nibble on some things that look cheap. I may be years too soon, but only time will tell. I do believe better days are coming; I am just a little fuzzy on the timing!

2) I am overweight short-term bonds. Bonds offer some more stability than stocks (although they bounce around too), and I just can't see stocks returning more than bond yields for the foreseeable future.

3) Hold cash. Preserve funds to buy what you want when you think the time is right. I am no market timer, so I stay exposed to all the asset classes in my allocation; some of the assests are just underfunded at the moment.

4) "Unto thine own self be true." Be honest with yourself about what is known and what is not known. Time can cover a multitude of investing sins, so know your investment horizon and don't violate it. Some (like Cramer) are now saying if you can't hold stocks for at least five years, then don't buy stocks. You have to decide what is right for you.

5) Be skeptical of ANYONE who says he or she knows what is going to happen. I have never seen a thicker fog than we are investing in right now. With such a fragile world economy now, I shudder to think how susceptible we are to a Black Swan event. That is why I hold gold and silver bullion as an asset class.

6) Not everyone will agree with me, but I am using funds more now than making my own individual picks. There is greater diversifcation, I hope they know more about what they are doing, and it is easier to dollar-cost-average as time goes on. Also, it is easier to add foreign exposure in a meaningful way.

Good luck. Be careful. Question everything. I look forward to your comments. We are all in this unique time together. I have gotten some very good ideas from comments here on Seeking Alpha.

Stock position: None.

Comments

[DVW:]

"I just can't see stocks returning more than bond yields for the foreseeable future." -- really? Warren would disagree with you, or rather, he has disagreed. Take a look at why Mr Buffet is buying select stocks. It's not that he expects stocks to go on a tear from here, but that compared to bonds, they will outperform. In an inflationary environment stocks outperform.

Maybe you're right, but what we DO know is the government is printing money. That money most likely will cause inflation once the velocity of money picks up. The FED interest rate is nominally negative now. How exactly is that a bond friendly environment?

Personally I think bonds are the worst investment class going forward (3-5 years). Cash is next worst.

Time will tell. Good luck!

2008 Nov 06 04:54 PM

[JasonC:]

Mostly sane advice, but you also ask "who wants to put in new money now, only to perhaps be underwater almost immediately, and then hope to get back to even?"

I do. I have no problem with it whatever. Someone coming along and offering a lower and lower bid for something I am not going to sell does not distress me. No one can own only monotonically increasing assets --- any such asset either returns only the risk free rate or can be instantly arbed up to a level where it goes unstable again. The whole notion that you can avoid ever holding anything declining in price is a complete delusion.

Who cares how insane the next few offers are? If they get whacky, take your next bond coupons and buy some more.

No one can call directions, anyone can call levels. Lend at the high rates on offer, and average into stocks with the coupons as you receive them.

Simple.

2008 Nov 06 04:57 PM

[Steven Hansen:]

"who wants to put in new money now, only to perhaps be underwater almost immediately, and then hope to get back to even?"

I am a boomer and this is good advise - but recognize that if you are under 40, continuing to invest is a sensible option. even under the most pessimistic scenarios, a 40 year old would be well off at time of retirement.

short term (and this could change any day), cash is king. we are in a slight deflationary cycle. while this cycle remains active, holding cash (especially in mmf) is a good play until an obvious investing situation presents itself. in the mean time, holding cash preserves capital.

i share the concerns about bonds. if interest rates rise, the value of bonds you hold at that time falls. i have been caught twice in my investing career holding bonds at the wrong time. but as a short term measure, if you are buying bonds using mutual funds or etf or some other vehicle - this is also a good short term play.

2008 Nov 06 09:39 PM

[Alan von Al...:]

Good article, timely, well argued. Adding you to my author Watchlist.

2008 Nov 07 02:21 AM

[iknoknot:]

thanks for a good read.

In addition to the rational points you make, I like JasonC's perspective on offers to buy what he won't sell - I liken it to buying a gold coin for 800 and having someone offer me 600 a week later. Even if 600 is 'market', it's only market to me if I need the money near-term. Sure, I hate the perceived loss, but when I bought it, it was worth 800 *to me*, and until my situation changes, I'll only sell it for something near that or more. More like buying a tool than betting on poker.

If I'm speculating, such a price drop would merely prove me wrong in my bet, and I would pragmatically take my lumps, deal me the next hand... But generally I'm not a speculator.

If I'm a value/growth investor, I assume I've somehow assessed some inherent value, rather than trying to predict market whims, and decided that the current value is low and will someday go up. I have to admit, that's not how I've been looking at this nutzo market for the last few months, and maybe that would be a healthy change of perspective, along with your prudent caution and diversification advice.

tnx,

--ikk

2008 Nov 07 03:35 AM

[Larry House:]

I agree with you, JasonC. By "who wants to," I am suggesting it is hard for many people to buy now, but that doesn't mean it is wrong. I certainly hope not, anyway, because I put more money into stock funds yesterday.

2008 Nov 07 10:40 AM

[Duforest:]

Something we know for sure is that the thinking of Obama and the democratic party is definitely marxist.
Emanuel,the chief of staff just apointed is nick-named " The attack dog " for good reason.His life ambition is to destroy private enterprise.
Now make your decision,for my part,I am selling all my american stocks,starting with oil and banks.

2008 Nov 07 06:56 PM