We aren't past the halfway point of this recession
My sense is that we probably aren't even past the halfway point yet of this recession, the credit losses or the house price deflation. Looking at whether equities may have bottomed or not on an intermediate basis, maybe the recent action to the negative side was an important inflection. In terms of what I do, which is trying to tie the macro into the markets, I have a very tough time believing that we have reached anything close to a fundamental low, either in the S&P 500 or in the long-bond yield, for that matter.
300-point rallies in the Dow happen in bear markets
We're in a very confusing atmosphere. People didn't really know what to make of a 300-point rally in the Dow the other day, but my main message was that 300point rallies from the Dow don't happen in bull markets. In fact, they never happened in the bull market from October '02 to October '07, but it has happened 6 times in this bear market and happened 12 times in the last bear market. You don't get moves like that in bull markets. As Rich Bernstein has said time and again, "This is the hallmark of a recession and a hallmark of a bear market."
Profit as a share of GDP was at unheard of levels
The next question, of course, is what levels are we talking about? Again, I'm going to take what I do, which is earnings, and then talk about the appropriate multiple. What is the appropriate multiple at the low in a recession? In terms of earnings, I think that we have to understand where we're coming from in this cycle. We're coming from a situation where, because of all the leverage in the system, profits in the share of GDP went into this recession and bear market at 14% of GDP, which is unheard of. That's never happened before. A lot of the reason why profits soared was because everybody turned to financials. There was this tremendous amount of leverage, and that accounted for half of just about everything in the cycle from GDP growth to employment to profits.
The profits share of GDP, again, as a proxy for margins, is now down to 12%. Think about that for a second. This terrible earnings recession so far has taken the share of profits from 14% down to 12%. The question is, if I'm right on a recession, where does the profit share of GDP go to at a recession trough? Well, consistently it goes to 7%.
Tuesday, August 19, 2008
Monday, August 18, 2008
Aspects of Investor Psychology
Beliefs, preferences, and biases investment advisors should know about.
Decision theorist Howard Raiffa [1968] introduces useful distinctions among three approaches to the analysis of decisions. Normative analysis is concerned with the rational solution to the decision problem. It defines the ideal that actual decisions should strive to approximate. Descriptive analysis is concerned with the manner in which real people actually make decisions. Prescriptive analysis is concerned with practical advice and help that people could use to make more rational decisions.
Financial advising is a prescriptive activity whose main objective should be to guide investors to make decisions that best serve their interests. To advise effectively, advisors must be guided by an accurate picture of the cognitive and emotional weaknesses of investors that relate to making investment decisions: their occasionally faulty assessment of their own interests and true wishes, the relevant facts that they tend to ignore, and the limits of their ability to accept advice and to live with the decisions they make. Our article sketches some parts of that picture, as they have emerged from research on judgment, decisionmaking and regret over the last three decades. The biases of judgment and decision making have sometimes been called cognitive illusions. Like visual illusions, the mistakes of intuitive reasoning are not easily eliminated. Consider the example of Exhibit 1. Although you can use a ruler to convince yourself that the two horizontal lines are of equal length, you will continue to see the second line as much longer than the other. Merely learning about illusions does not eliminate them.
The goal of learning about cognitive illusions and decision-making is to develop the skill of recognizing situations in which a particular error is likely. In such situations, as in the case of Exhibit 1, intuition cannot be trusted and it must be supplemented or replaced by more critical or analytical thinking – the equivalent of using a ruler to avoid a visual illusion.
Providing timely warnings about the pitfalls of intuition should be one of the responsibilities of financial advisors. More generally, an ability to recognize situations in which one is likely to make large errors is a useful skill for any decision-maker.
We follow a long tradition in discussions of decision-making, which distinguishes two elements: beliefs and preferences. Decisions theorists argue that any significant decision can be described as a choice between gambles, because the outcomes of possible options are not fully known in advance. A gamble is characterized by the range of its possible outcomes and by the probabilities of these outcomes. People make judgments about the probabilities; they assign values (sometimes called utilities) to outcomes; and they combine these beliefs and values in forming preferences about risky options.
Judgments can be systematically wrong in various ways. Systematic errors of judgment are called biases. We start by dealing with a selection of judgment biases. Then we discuss errors of preference, which arise either from mistakes that people make in assigning values to future outcomes or from improper combinations of probabilities and values. In both cases, we introduce each bias with a question that illustrates the bias and conclude with recommendations for financial advisors to help mitigate the harmful effects of these biases.
We conclude the article with a checklist that advisors can use to measure their effectiveness at dealing with these biases.
Decision theorist Howard Raiffa [1968] introduces useful distinctions among three approaches to the analysis of decisions. Normative analysis is concerned with the rational solution to the decision problem. It defines the ideal that actual decisions should strive to approximate. Descriptive analysis is concerned with the manner in which real people actually make decisions. Prescriptive analysis is concerned with practical advice and help that people could use to make more rational decisions.
Financial advising is a prescriptive activity whose main objective should be to guide investors to make decisions that best serve their interests. To advise effectively, advisors must be guided by an accurate picture of the cognitive and emotional weaknesses of investors that relate to making investment decisions: their occasionally faulty assessment of their own interests and true wishes, the relevant facts that they tend to ignore, and the limits of their ability to accept advice and to live with the decisions they make. Our article sketches some parts of that picture, as they have emerged from research on judgment, decisionmaking and regret over the last three decades. The biases of judgment and decision making have sometimes been called cognitive illusions. Like visual illusions, the mistakes of intuitive reasoning are not easily eliminated. Consider the example of Exhibit 1. Although you can use a ruler to convince yourself that the two horizontal lines are of equal length, you will continue to see the second line as much longer than the other. Merely learning about illusions does not eliminate them.
The goal of learning about cognitive illusions and decision-making is to develop the skill of recognizing situations in which a particular error is likely. In such situations, as in the case of Exhibit 1, intuition cannot be trusted and it must be supplemented or replaced by more critical or analytical thinking – the equivalent of using a ruler to avoid a visual illusion.
Providing timely warnings about the pitfalls of intuition should be one of the responsibilities of financial advisors. More generally, an ability to recognize situations in which one is likely to make large errors is a useful skill for any decision-maker.
We follow a long tradition in discussions of decision-making, which distinguishes two elements: beliefs and preferences. Decisions theorists argue that any significant decision can be described as a choice between gambles, because the outcomes of possible options are not fully known in advance. A gamble is characterized by the range of its possible outcomes and by the probabilities of these outcomes. People make judgments about the probabilities; they assign values (sometimes called utilities) to outcomes; and they combine these beliefs and values in forming preferences about risky options.
Judgments can be systematically wrong in various ways. Systematic errors of judgment are called biases. We start by dealing with a selection of judgment biases. Then we discuss errors of preference, which arise either from mistakes that people make in assigning values to future outcomes or from improper combinations of probabilities and values. In both cases, we introduce each bias with a question that illustrates the bias and conclude with recommendations for financial advisors to help mitigate the harmful effects of these biases.
We conclude the article with a checklist that advisors can use to measure their effectiveness at dealing with these biases.
Friday, August 15, 2008
Bruce Berkowitz Stays In The Sunshine
Bruce Berkowitz must be disappointed that the current Olympic Games program doesn't include professional money management in the competition. If it did, the veteran stock picker's neck would be weighted down with gold right now.
Berkowitz is CEO of Fairholme Capital Management in Miami, which oversees about $9 billion, most of it in the value-oriented no-load Fairholme Fund (FAIRX), of which Berkowitz himself is lead manager.
The 50-year-old Berkowitz started Fairholme Fund in December 1999, and he's consistently crushed the competition. The five-star, large-blend fund has clinched the No. 1 spot in its Morningstar category for the one, three and five-year periods. Through Aug. 12, Fairholme's five-year annualized return of 16.51% bests its peers by 7.54 percentage points.
Forbes.com recently checked in with Berkowitz to talk about his take on the market, his strategy and his top stock picks.
Berkowitz is CEO of Fairholme Capital Management in Miami, which oversees about $9 billion, most of it in the value-oriented no-load Fairholme Fund (FAIRX), of which Berkowitz himself is lead manager.
The 50-year-old Berkowitz started Fairholme Fund in December 1999, and he's consistently crushed the competition. The five-star, large-blend fund has clinched the No. 1 spot in its Morningstar category for the one, three and five-year periods. Through Aug. 12, Fairholme's five-year annualized return of 16.51% bests its peers by 7.54 percentage points.
Forbes.com recently checked in with Berkowitz to talk about his take on the market, his strategy and his top stock picks.
Saturday, August 2, 2008
Korea's No. 1 Money Manager Says Genghis Khan Model for Funds
Park, founder and chairman of Seoul-based Mirae Asset Financial Group, the biggest mutual fund company in South Korea, has just given up on his plan to open a branch of Mirae in Los Angeles despite its large Korean-American community.
He's seen firsthand the swoon in U.S. markets triggered by the subprime mortgage crisis. Recalling the flight, he says he took out his laptop and spent the next three hours writing a somber memo to his 16,900 employees.
``We may be passing through the darkest point of the tunnel right now,'' Park, 49, wrote. ``We must have the insight to anticipate the future with long-term perspective and strategy.''
Friday, August 1, 2008
GMO Quarterly Letter (Jeremy Grantham)
Meltdown! The Global Competence Crisis
I thought things would be bad enough but they turned out to be a lot worse. I thought a year ago we were looking at the “fi rst truly global bubble” in asset prices. The credit crisis looked to be so predictably powerful and unstoppable then that I likened the experience to “watching a slow
motion train wreck,” and I predicted that “one major bank (broadly defi ned) will fail within 5 years,” for which I got considerable grief as a doomsayer, as the less optimistic strategists usually do. Well a year later one bank failure looks positively quaint as a prediction. Ironically for a “perma bear,” I underestimated in almost every way how badly economic and fi nancial fundamentals would turn out. Events must now be disturbing to everyone, and I for one am offi cially scared!
Living Beyond Our Means: Entering the Age of Limitations
How many times over the last 200 years have gloomy economists predicted limitations to growth? And always they were wrong. Science and human ingenuity always came to the rescue. Instead of rising steadily in price, raw materials and food fell in real terms. And since hourly
income rose, raw materials became ever more affordable as the specter of starvation, although always around, steadily retreated. Food, for example, fell from 70% of a typical American’s budget 200 years ago to about 10% today. And, every time a warning was redundant, the idea
that science always wins and that the human brain and talent are boundless and can conquer all took deeper root. We have learned in the stock market not to underestimate the power of repeated events to create a consensus. Humans are just plain eager to see patterns, and 200 years of increasing plenty in the face of recurrent pessimism is serious reinforcement indeed. It is hardly surprising, therefore, to fi nd ourselves in a position where faith in our ability to rise above the planet’s limitations is complete.
Thanks to Vinod from MSN BRK Shareholders Board
I thought things would be bad enough but they turned out to be a lot worse. I thought a year ago we were looking at the “fi rst truly global bubble” in asset prices. The credit crisis looked to be so predictably powerful and unstoppable then that I likened the experience to “watching a slow
motion train wreck,” and I predicted that “one major bank (broadly defi ned) will fail within 5 years,” for which I got considerable grief as a doomsayer, as the less optimistic strategists usually do. Well a year later one bank failure looks positively quaint as a prediction. Ironically for a “perma bear,” I underestimated in almost every way how badly economic and fi nancial fundamentals would turn out. Events must now be disturbing to everyone, and I for one am offi cially scared!
Living Beyond Our Means: Entering the Age of Limitations
How many times over the last 200 years have gloomy economists predicted limitations to growth? And always they were wrong. Science and human ingenuity always came to the rescue. Instead of rising steadily in price, raw materials and food fell in real terms. And since hourly
income rose, raw materials became ever more affordable as the specter of starvation, although always around, steadily retreated. Food, for example, fell from 70% of a typical American’s budget 200 years ago to about 10% today. And, every time a warning was redundant, the idea
that science always wins and that the human brain and talent are boundless and can conquer all took deeper root. We have learned in the stock market not to underestimate the power of repeated events to create a consensus. Humans are just plain eager to see patterns, and 200 years of increasing plenty in the face of recurrent pessimism is serious reinforcement indeed. It is hardly surprising, therefore, to fi nd ourselves in a position where faith in our ability to rise above the planet’s limitations is complete.
Thanks to Vinod from MSN BRK Shareholders Board
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