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3 investing myths you shouldn't buy into -- Contrarian Chronicles
MSN Money/CNBC ^ | 2/17/03 | Bill Fleckenstein

Posted on 2/17/2003, 3:53:03 AM by arete

There are no truths, only risks. Three down years don't guarantee an up year. Buy-and-hold forever is no guarantee of success. And interest-rate cuts guarantee nothing ... absolutely nothing.

If we could just bundle all those investing myths and send them packing, everybody would be better off. Good riddance to: buy and hold forever; past returns suggest future riches; interest rates down, stock prices up; the market can't be down x years in a row. And not to forget about the economic arena, Alan Greenspan's "productivity" -- his excuse for rationalizing the bubble -- would be first in line for a one-way ticket to oblivion. Sadly, myth has turned to devastating reality.

Last week, the wizard of the Fed appeared before the Senate Banking Committee. Apropos of the damage that he did not own up to, Bob Herbert of The New York Times recently ran a very disturbing op-ed piece "A Crush of Applicants." Had Greenspan been an eyewitness to the spectacle that Herbert described, this is what he would have seen:

"Huge, unexplained traffic jams began building up on the North Side of Chicago last Tuesday morning. Drivers struggled for half an hour or more to travel just four blocks. The police had to close entrance and exit ramps at a couple of spots along Lake Shore Drive. Baffled officers raised their arms in frustration as motorists demanded to know what was going on."

Herbert continued: "The traffic crush was caused by people desperate for jobs. Rumors that job applications for a Ford assembly plant would be accepted at a community college had swept through several of the city's neighborhoods. Chicagoans by the thousands responded, turning out in bitterly cold weather for a shot at gainful employment. The first arrivals showed up well before dawn. By 7 a.m. more than 2,000 people had lined up outside Truman College, and the hopefuls kept coming throughout the morning. They shivered, and tears from the cold ran down some of their faces. It was like a scene out of the Depression. The rumors were false."

Lexicon artist

This is a sad example of the wreckage that has ensued since the mania was fomented by Federal Reserve Chairman Alan Greenspan. So far, he has received a pass for the consequences of his reckless behavior. He does not deserve the pass. He and the other clowns at the Fed ran monetary experiments in the late 1990s while they rationalized all their errors away with productivity and hedonic adjustments. Now we are beginning to see some of the fallout, with the predawn crush of unemployed Chicagoans just one stark, poignant example of how bad things are. Recently, the Fed described our problems as a mere soft spot. To repeat my initial reaction to this phrase, if what we're going through is a "soft spot," I'd hate to see what a hard spot looks like, though I'm afraid we're liable to find out.

This is not to imply that if someone else were running the Fed now, there would be much that they could do. As I said frequently during the mania and since then, bubbles can only be prevented, not cured. Once we've had one, we mostly have to just let time and the markets work off the excesses caused by the misallocation of capital. Attempts by the government and the Fed to fight off this destruction will only make things worse in the end.

The long run is a long shot

Meantime, the mania's aftermath has seen no shortage of investing myths masquerading as truths. But a study by three academics from the London Business School, which was recently reported in a great Wall Street Journal article titled "Long-Term Risk Is Underestimated," goes a long way toward debunking these myths. To begin with, professors Elroy Dimson, Paul Marsh and Mike Staunton dispelled the buy-and-hold notion by observing that "not only can markets take a long time to recover, but also investors generally underestimate what the safe long-run period is to hold stocks."

Many times, I have made the point that for me, a rational long-term horizon is say, three to five years. Often, you can feel like you have some sense of how things might play out over that time frame. But, in my opinion, to think you could have a reasonable basis for a 10- or 20-year investment is kind of crazy. Nevertheless, people sometimes fall back on that to justify holding on to prior losers. Just how dangerous this is can be seen in another finding of the study, which is that "out of 16 major national stock markets, investors from only five would have been guaranteed positive annual returns over every 20-year period during the past century."

That's pretty staggering. Most people feel it's a slam-dunk that they're going to win over 20 years. Of course, that presupposes they won't fall prey to another problem, which is survivor bias. It's quite possible that even if the market worked out over 20 years, the handful of stocks they picked might not, as most people who bought Internet stocks can now see clearly.

Chiseled-in-stone-cold comfort

The professors then highlighted the myth and risk of "basing expectations on past returns." They pointed out that "historical analysis can never reveal the full range of century-long returns that might have been experienced by investors (the emphasis is mine). An individual country confronts many possible futures, but can report only one past." So, this should be food for thought for most people, who automatically assume that things will work out over time. Further, it should alter the fundamental notion of risk -- from the "risk" that the market will take off without you, to the risk that you will make an investment and then be forced to sell at a price considerably less than what you paid for it.

The article also exploded one of the present-day myths that I refer to as arm-waving. You know, the market's been down three years in a row, and therefore it can't decline for a fourth, as posited by so many pundits. The professors' response to that is: "The history of stock market performance shows that across 16 markets, the probability of a fourth down year is 40%. That also happens to be the probability of any other year being a down year."

No Dr. Spock for stocks

Along those lines, I'd like to make the point that there are no ironclad rules of investing. If I had told you three years ago that we would have 12 rate cuts and that they would not inspire the stock market, people would have said I was crazy. Similarly, one of the other big bull arguments is that rates are so low, stocks have to go up. That doesn't happen to be true, either. Obviously, if all things are equal (which they rarely are), and you're buying a stock at 10 times earnings, and interest rates were to be cut in half, there is some chance that you might be willing to pay as much as twice as much for that same stream of earnings. However, there is no law that says this will always be the case. If rates collapsed because the economy was doing poorly, there's some chance those earnings could fall away. This is the situation that exists in Japan, and now here in the United States.

So, falling rates don't guarantee higher prices. Three down years don't guarantee an up year this year. The Fed cutting rates doesn't guarantee that things will get better. There are no absolutes in investing. All one can do is to try to assess the probabilities of what the potential outcomes might be and to incorporate those probabilities, as best the circumstances permit, into managing risk (defined as the chance that you will lose meaningful amounts of money) and reward. We're all going to be wrong in our investments from time to time. The trick is to not get carried out when you make your mistakes.


TOPICS: Business/Economy
KEYWORDS: bankruptcy; bonds; boom; bubble; bust; crash; credit; currency; debt; deflation; depression; dollar; economy; fed; gold; greenspan; inflation; investing; money; recession; reinflation; silver; stockmarket
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Recently, the Fed described our problems as a mere soft spot. To repeat my initial reaction to this phrase, if what we're going through is a "soft spot," I'd hate to see what a hard spot looks like, though I'm afraid we're liable to find out.

There are going to be rough seas and hard times ahead. We haven't seen anything yet.

Richard W.

1 posted on 2/17/2003, 3:53:04 AM by arete
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To: bvw; Tauzero; Matchett-PI; Ken H; rohry; headsonpikes; RCW2001; blam; hannosh4LtGovernor; ...
FYI

Comments and opinions welcome.

Richard W.

2 posted on 2/17/2003, 3:54:23 AM by arete (Greenspan is a ruling class elitist and closet socialist who is destroying the economy)
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To: arete
Herbert continued: "The traffic crush was caused by people desperate for jobs. Rumors that job applications for a Ford assembly plant would be accepted at a community college had swept through several of the city's neighborhoods. Chicagoans by the thousands responded, turning out in bitterly cold weather for a shot at gainful employment. The first arrivals showed up well before dawn. By 7 a.m. more than 2,000 people had lined up outside Truman College, and the hopefuls kept coming throughout the morning. They shivered, and tears from the cold ran down some of their faces. It was like a scene out of the Depression.

----------------------------

The stock market and the basic economy should be analyzed separately although there are variable common to each.

When people are faced with something they don't understand, magic and superstition become acceptable and grasped at as explanations along with everything else. There are preacher of magic and superstition who will both exeracerbate and exploit that confusion.

Some of the advice given here about stocks is valid. The basic economy is a different matter. The economic problems go far beyond Greenspan and have been discussed here before. I hold with my previously stated views.

3 posted on 2/17/2003, 4:22:44 AM by RLK
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To: arete
There are going to be rough seas and hard times ahead. We haven't seen anything yet.

-----------------------

In the next 20 years we will become a third world nation and economy.

4 posted on 2/17/2003, 4:31:15 AM by RLK
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To: RLK
I'm sure more than willing to hear what the bulls have to say, because at this point in time I'm very bearish on the markets and the economy, and I'm tired of being right about this subject. I would dearly love to be proven wrong, and to have someone who knows what they are talking about prove to me that we are going to have an economic rebound soon.

I keep looking for positive news, but the few positives I've heard have been very outweighed by the negatives I've heard. If this economy doesn't pick up in the next few months I do believe President Bush is going to have a hard time in the next election. Unemployed people tend to vote against incumbent politicians.
5 posted on 2/17/2003, 5:19:27 AM by Billy_bob_bob ("He who will not reason is a bigot;He who cannot is a fool;He who dares not is a slave." W. Drummond)
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To: RLK
"In the next 20 years we will become a third world nation and economy."

And that's exactly what Hitlery Clinton was dreaming of in her Wellesly commencement address when she said: "Earth could be fair."

That's exactly what Jerry Brown and Gray Davis have been dreaming of as they systematically sought the destruction of the greatest state in the greatest nation, since Ronnie Reagan beat Pat Brown.

That's exactly what Walter Chronkite has been dreaming of, along with his lesser successor, Dan Blather by constantly condemning American success! Their self-fulfilling prophecy is finally coming true.

We had all better start thinking something positive and stop sitting on the sidelines parroting all the negativity and inspiring each other to compound the negative with further layers of uninspiring negativism. It's as contageous as fear it'self!!!

6 posted on 2/17/2003, 5:35:40 AM by SierraWasp (Snap Out Of It, CA!!! Be Courageous! It's Contageous! Zap Zany Gray!!!)
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To: Billy_bob_bob
have someone who knows what they are talking about prove to me that we are going to have an economic rebound soon

The last guy who could predict the future accurately was crucified 2000 years ago. Everybody else is guessing.

7 posted on 2/17/2003, 5:44:26 AM by Nick Danger (Freeps Ahoy! Caribbean cruise May 31... from $610 http://www.freeper.org)
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To: Billy_bob_bob
No - the prediction that Bush's re-election chances are tied to the economy is another false prediction. In hard times, I claim, we look to leaders whom we trust both to feel our pain and work hard and smart to improve things. We are less tolerant of buffoons, incompetents and the cold hearted.

That's what kept FDR in the White House, and it's what will keep Bush in the White House.

It's what through Coolidge and Carter out.

8 posted on 2/17/2003, 5:59:01 AM by ThePythonicCow (Mooo !!!!)
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To: ThePythonicCow
through threw
9 posted on 2/17/2003, 6:05:14 AM by ThePythonicCow (Mooo !!!!)
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To: SierraWasp
What you say about Hillary, Jerry Brown, and the rest is all true. However, right now we have a bigger problem. George Bush has got religion. He wants to save the world from economic inequality. He wants to save the world from AIDS. He wants to save the world from religious hatred and promote a love-in with Islam. He wants to save the world from mis-trust. He wants to bring us together in global unity. He's prepared to sacrifice this nation to do it.
10 posted on 2/17/2003, 10:00:27 AM by RLK
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To: RLK
He's prepared to sacrifice this nation to do it.

Don't you think that those who believe in this globalism nonsense really believe everybody will be better off for it? Personally, I suspect that globalism is a lowering tide for the most successful nations, leaving us marooned.

I'm more optimistic than you are. Somebody sensible just might come forward and get back on the nationalistic path.

11 posted on 2/17/2003, 12:37:13 PM by grania ("Won't get fooled again")
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To: grania
I'm more optimistic than you are. Somebody sensible just might come forward and get back on the nationalistic path.

It's too late. Fractional reserve banking, structured finance, loss of a manufacturing base and vote buying with tax dollars by politicians have set the stage for the sure collapse of the fiat currency.

Richard W.

12 posted on 2/17/2003, 2:31:04 PM by arete (Greenspan is a ruling class elitist and closet socialist who is destroying the economy)
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To: arete; rohry; dtel; razorback-bert
""Huge, unexplained traffic jams began building up on the North Side of Chicago last Tuesday morning. Drivers struggled for half an hour or more to travel just four blocks. The police had to close entrance and exit ramps at a couple of spots along Lake Shore Drive"

......here's my scenerio:

.....on Sunday the newspaper runs a story about a major local bank that has been making large unsecured loans.....on Monday morning small lines of customers began to withdraw their money.....it gets local media attention....on Tuesday the lines are out the door and into the street....more TV coverage....on Wednesday the lines are around the block and an armored car convoy of cash from the Fed is sent in to try and stem the flow....the media really jumps on that!....on Thursday the lines have become mobs and fist fights break out....on Friday the bank did not open.

...sound fantastic?...think again. This actually happened to my bank in Houston in the early 70s.....the bank was the Sharpstown Bank, the 11th largest bank in the state; which was saying something because Texas didn't have branch banking back then....about a week after the collapse the Fed set up rows of desks in the bank lobby and started sorting things out.....we had to go in with our check books and bank statements to talk to the Fed examiner.....about two weeks later we got a check cut on the Federal Reserve Bank of Philadelphia......we had considerable inconvenience but considered ourselves lucky.....depositors over $100,000 got a check for $100k and an IOU for the rest to be paid when the banks assets were sold......that IOU ended up being worth 11 cents on the dollar.....looking back on it I'm glad I lived thru that....I consider it a very valuable lesson.

Good luck to everyone!

Stonewalls the Ant

13 posted on 2/17/2003, 4:00:40 PM by STONEWALLS
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To: STONEWALLS
This actually happened to my bank in Houston in the early 70s

Yes, and it could very easily happen again. Be careful.

Richard W.

14 posted on 2/17/2003, 4:12:57 PM by arete (Greenspan is a ruling class elitist and closet socialist who is destroying the economy)
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To: arete
Good morning to gloom and doomers worldwide. When we hit bottom please post the news so I can get in.
15 posted on 2/17/2003, 4:29:47 PM by groanup
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To: STONEWALLS
My great-grandfather was head cashier of a small-town Texas bank in the early '30s*. His relatively substantial savings were completely tied up in the bank. That bank was wiped out by a run one afternoon in '32 (I think it was '32.) The family was essentially left destitute. Of course it was small-town Texas and EVERYONE was essentially destitute all the time. Personal gardens and livestock, along with minimal expectations in life, minimized the impact. A nationwide event of similar proportions today would have a catastrophic impact on a completely helpless, dependent population.

* cool historical note: I have a banknote somewhere that has my great-grandfather's sig printed on it. Back then, the money was apparently printed specifically for the bank or region itself.
16 posted on 2/17/2003, 5:02:10 PM by Semaphore Heathcliffe
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To: grania
Don't you think that those who believe in this globalism nonsense really believe everybody will be better off for it?

-----------------------

There are three kinds of people who believe in this:

1) People who want to destroy this country and see this as a method of doing it.

2) People who want to seize the wealth of this country to support themselves, their country, and their life styles or corruption/superstitions.

3) People who really believe sharing and loving unconditionally is a euphoric answer to everything. They are susceptable to the arguments of the first two groups. George Bush is of this third type. He will bring this nation into submission and slavery to the first two groups in a spirit of oblivious idealism. He will destroy this nation is a perverted blind sense of good.

17 posted on 2/17/2003, 5:14:48 PM by RLK
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To: grania
I'm more optimistic than you are. Somebody sensible just might come forward and get back on the nationalistic path.

--------------------------

The only serious intelligent adult running for president in 2000 was Alan Keyes. You saw how far he got.

America need a third political party build on realistic rationality. There is little hope of seeing such a development until 2008. By then it will be too late.

18 posted on 2/17/2003, 5:18:32 PM by RLK
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To: groanup
LOL! By the way, I have it on good authority that we're all going to die someday.

The only truth about investing is that stocks go up, stocks go down, and pigs get slaughtered.

19 posted on 2/17/2003, 5:30:56 PM by Night Hides Not
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To: RLK
The only serious intelligent adult running for president in 2000 was Alan Keyes.

Although you present yourself as a serious, professorial type, your credibility is greatly diminished when you posit such unfounded comments as these.

To infer that George Bush is not a serious and intelligent adult is laughable. I'll let the folks at DU defend Mr. Gore: he may be misguided, but I would not classify him as unintelligent. I'm sure it took a lot of brainpower for him to invent the Internet.

20 posted on 2/17/2003, 5:37:31 PM by Night Hides Not
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