Today, I am analyzing how a conscious effort to track history can serve as an intelligent guideline for future investment behavior. More than 18 months ago, I wrote an article on my investment blog, the Underground Investor, called The Coming Investment Crisis: Beware the Turbulence that Lies Beneath the Surface. Since my commentary in this article regarding the foolishness of calls for a new bull market materializing back then, even taking into account this latest market rally, the DJIA is still down 40.87% while the S&P 500 has lost 42.99%. I have not changed anything about the below article that I wrote on October 15, 2007, so as you read it, please remember that this article was referring to the state of the US markets on October 15, 2007, NOT the state of the US markets today.
Still, the important point I want to make by republishing one of my old articles is that many times, many relevant lessons can be applied to today's markets by studying past market behavior. It is very difficult to ignore the parallels and similarities between the optimism stated by the bulls on October 15, 2007 and today. It is also very difficult to ignore the parallels and similarities between the extremely morbid fundamentals of the US markets that existed on October 15, 2007 and today. Thus should we conclude that the outcome today will be markedly different than what ensued after October 15, 2007? I think not. In any event, without further ado, here is the article I am referencing for your review below. Again, comparing the many similarities in the statements of the financial pundits more than a year and a half ago as compared to today is an exercise of high utility that can prevent future investing mistakes.
October, 15, 2007 - I've often mentioned that the U.S. stock market can APPEAR healthy even when the underlying economy is in worse shape than an alcoholic on a kidney dialysis machine. And this is just one of those instances right now. As markets continue to climb higher on manufactured, political-agenda serving government statistics and interest rate cuts, rally cries from all the bulls (aka sales people, I mean company men and women) that this is a bull run of historical proportions and that you better come along for the ride started already a couple of weeks ago. And how soon people forget the dot.com crash in March 2000 that subtracted trillions of dollars from the personal financial statements of investors. Back then, the exact same statements were being offered to the public masses that will once again be offered in the very near future as the political juggernaut no doubt will try its best to manufacture one last bull run into the 2008 Presidential elections. Remember from the dot.com rally, that irrational movements higher can last an irrationally long time- this, I don't dispute. I also have no doubt that any rally that is artificially manufactured with loose credit and low interest rates will experience a terrible ending (just look at how the artificially manufactured housing boom in the U.S. is playing out now). Peaks artificially manufactured by bankers are much different than the peaks of normal cycles that occur in the free market. Peaks that are artificially manufactured by bankers will always end up terribly.
During the meteoric rise of dot.com stocks at the end of the 1990's, all throughout the U.S., money managers goaded investors into investing into a tech market and ignored the fact that dot com stocks were trading at outrageous multiples to earnings or at impossible multiples to non-existent earnings. This time around, especially if the Feds cut interest rates again on October 31st, the messages from those whose job it is to get you to part with your money will be the same - Don't miss out on this bull run, and so on. And given that the effects of interest rate cuts typically take several quarters to visibly appear in the economy, another interest rate cut instituted at the end of this October may be all that is needed to carry the U.S. economy for a while, thus giving confidence to world economies into the next U.S. Presidential elections (which of course, is the incumbent government's desire- If all falls apart after then, then it is the problem of the next cabinet, not ours!). However, two points here. (1) I can't see how the Feds can possibly keep this stock market afloat into next year's U.S. Presidential election. With so much wrong with the economy, that's a really long time to keep things afloat. And (2) Even as the talking heads will be urging you to invest money in the markets, you can still come out ahead-as long as you don't invest the majority of your money in traditional stocks. Several asset classes in particular will skyrocket from this growing crisis even before it rears its ugly head, but most people will not receive the proper advice to do so.
From feedback I've been receiving from speeches I've been giving on this very topic, I've discovered that most people have not changed their investment behavior and are content on riding the rally higher until it bursts. Prior to the Fed's decision on September 18th to cut interest rates, Federal Reserve Governor Frederic Mishkin stated in a speech delivered at New York University that the Fed is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets. Again, such statements reassure the thundering sheep herd of investors that all is well in Kansas and that Toto won't be sucked away by an economic tornado. If the Feds do indeed slash interest rates again at the end of October, you can be sure that the thundering sheep herd of investors will once again rejoice in this decision, not understanding how this will stack the house of fragile cards even higher. Interestingly enough, in a speech given in Chicago on September 28th, 2007, Mishkin stated, We have also seen how governments, in their role as providers of emergency liquidity, can intervene to help put the financial system back on its feet and prevent a financial crisis from spinning out of control. I disagree. The Feds, in fact, have been undermining the foundation that is the glue of the world economy, the U.S. dollar, and have deployed their best SPIN CONTROL to merely DELAY, not prevent, a financial crisis. And unless they hatch an elaborate scheme to replace the dollar with a singular North American currency, it can not end well. This time around, for those that wish to play irrationality again, not shifting your assets into the RIGHT types of assets before the irrationality ends will end up being a much more painful experience.