Triumph of Bearish Pundits

by: Jeff Miller

Paul Kedrosky's Infectious Greed has long been one of our favorite daily reads and a recommended site on our blogroll. In a recent column, Paul wonders "Why Bears Always Have the Best Arguments." He introduces the idea with the following statement:

Even though the stock market has rightly been called the triumph of the optimists, with bulls stomping bears over and over for one hundred years, stock market bears not only haven't gone away, but they generally have the most compelling arguments. Their points seem so damn plausible, level-headed, empirical, and reasonable, while bulls come across as starry-eyed idealists.

Not only is the question interesting, Paul has some good ideas for answers and stimulated some excellent comments. Take a look at the entire post and comments, and then our take.

Importance for Investors

This is a very important question for individual investors. Since these investors constitute our primary client base, we are on the front line of what they are thinking. Many of them have been afraid of stocks every since the 2000-01 era. Not only have they missed out on big market gains, many have also over-committed to real estate at exactly the wrong time. Why is this?

How the Most Intelligent Investors React to News

On most subjects, intelligent people are informed by reading about what is happening. At cocktail parties they can discuss the upcoming election, free trade, the Iraq situation, and other current events. When it comes to stocks, they believe that the same criteria for knowledge works just as well. When the average intelligent investor comments to me about a stock, I often ask whether they believe that this information might be reflected in the current price.

Amazingly, the question seems to baffle them. The idea that what they read in the New York Times, or the Wall Street Journal, or on popular blogs might have already had an important effect on markets seems like a novel approach.

Briefly put, most investors lack the ability to determine what is already reflected in the market. They treat what they read as "inside information" that confers some special advantage. As a result, most fail to recognize the possible advantage of buying in times of extreme worry.

Our Own Answer

A major thesis of mine can be summarized as follows: Problems are known; solutions are not.

Paul suggests as one of his own answers, "Bears have the past, and bulls have the future. Bears get to argue from data, while bulls argue from what might happen." Commenter "Doug" wisely writes as follows:

People are pretty good at responding to a problem. Most bearish arguments assume that people cannot adjust, problems cannot be addressed,and things will go on pretty much as they have. Many problems get solved. Go back and read a newspaper from 40 years ago, it is filled with problems that simply never amounted to very much. Most of the bearish problems will end up in the same scrap heap. Good long term investing means figuring out the real issues.

Doug does not provide any identifying information, but our guess is that he is a winning investor.

Media Coverage

The media treatment of business news reflects many questionable concepts. The Business and Media Institute, which audits media coverage of the free enterprise system, writes as follows:

According to a survey by the National Council on Economic Education, 79% of Americans get the majority of their economic information from television. The study determined that an astounding 61% of the general public could not answer questions about basic economic concepts.

The BMI recently released its assessment of "The Media's Top Ten Economic Myths of 2007." In an article well worth a complete reading, they give examples of media coverage and contrast with some solid data.

Their choice as the #1 Myth of 2007? 1. The U.S. Economy is in recession.

This conclusion will be a familiar one for regular readers of mine.

Timely Investment Implication

The most important current issue for investors is the extent of housing problems and the implications for credit markets. The various housing issues -- potential foreclosures, ARM resets, teaser rates, lack of liquidity in structured mortgage products, faltering demand -- have all been extensively documented. While some of the data cited by pundits are open to question, the existence and general magnitude of the problem have been well documented for anyone paying attention.

The potential solutions are a completely different matter. We do not know which of the various proposals might work, nor the extent of the effect. Most bearish pundits focus on the idea that proposed solutions are not comprehensive.

That viewpoint is quite correct, yet unhelpful. Various government agencies (state and federal) are working to address parts of the problem. We do not yet know how successful they will be. Since the market is estimating the effects as near zero -- note especially the reaction to the Fed's TAF facility -- the investor gets a favorable risk/reward.

Government is slow to implement change, much slower than markets would like. Plans are floated as trial balloons, and implemented on a test basis. If the plans work, more will follow. If they do not, something else will emerge. This is the nature of our democratic and pluralistic governmental process.

This is the history of solving problems. It is very difficult to invest on the idea that partially known or even unkown solutions will mitigate known problems. That is why it is so profitable.