Letter to Our Clients - January 21, 2009
January 21, 2009
Dear Client and Friends:
How did we get here? More importantly, where do we go from here?
Bad news on the economy and the financial markets continues unabated. It is so dramatic that it seems like it must have been predictable.
More than one client has wondered why we did not see this coming and take steps to protect against the downturn.
Now, I read a lot, and I attend more investment conferences than most advisers, by far. I do not go to these conferences for the golf or beaches. I usually fly in, attend the sessions and then come home. I go because I want to try to understand what is happening, what is likely to happen and what to do about it.
In March of 2008 I was at a conference in New York with very high-profile money managers speaking, and in May of 2008 I was at a Morningstar conference in Chicago with other money managers, writers, commentators and government officials all as speakers. In both cases there were warnings about a slowing economy, reduced consumer confidence, etc., and yet also a sense that we were in a very normal market with an equal chance of 10% up or 10% down by year-end.
Since that time I have read and heard how people at the highest levels have been absolutely blind-sided by the paralysis of the credit markets and the devastation this has caused for investors and for the economy. I wish I had seen this coming. I always considered myself to be skeptical of the pack and to discount the messages I was hearing. It was not enough.
Looking back now, we see there were certain people who did predict this. However, there are always prophets who warn of doomsday and who eventually may be proven correct but who are wrong for so long. A humorous expression is that economists have predicted 18 of the last 5 recessions.
In the Fall of 2007 and into 2008 I warned that the markets were due to pull back. The reason I gave was that the bull market which began in 2003 had gone uninterrupted for a record-long period of time. I felt a 10% or even a 20% drop in market values was due to happen, some time,
sooner or later. I also said, mistakenly as it turns out, that I did not see any serious economic reason to justify a 20% pull-back. Rather, it seemed to me that it was just prudent to expect one to occur, just as it is prudent to expect that the markets will recover as they always have in the
past. Also, the financial market-place is littered with advisers who have been whipsawed by going to cash too early, back to stocks and bonds too late, two or three times in a row. Such behaviors can really lock in significant losses to a portfolio.
Because I did not see the economic weakness which has now been exposed, I did not make a market call that we should sell our positions and go to cash. I suggested we should all confirm our long-term goals, and we should question whether our existing strategy was still appropriate for these long-term goals. If our goals had changed, or if our strategies were no longer appropriate, I encouraged people to contact me so we could make whatever adjustments were necessary.
I feel the same way today.
However, behavioral finance studies confirm that people are more optimistic, and therefore more accepting of “risk” (however we define that term) when markets are moving upward, while they change and become pessimistic and more risk-adverse when markets are moving downward. That is why people want to put money in “safe” investments now and wait until the market has recovered before coming back in. I worry this is bad for people’s financial health.
The Fundamentals of Investing 101, if there were such a thing, would say behavior should be just reversed. Warren Buffett and the other legendary money managers urge investors to buy when there is panic in the streets. But, that is so hard to do!
Why? According to behavioral scientists, 80% of decision-making of all kinds, including financial decision-making, is based upon emotion. Only 20% is based on logic. Those numbers are too slick for me, and I believe different people have different emotion/logic ratios. My own experience, however, is that all of us make financial decisions based more on emotion than we would expect. Here is where science comes in: studies have shown that the portion of the brain which reacts to financial loss is the same portion of the brain that is activated in mortal-risk situations. This is why a loss has much more impact than a gain.
There is much to worry about, but most of it we cannot control. There is much about which we can be optimistic. Surprisingly, there is more of that which we can control. For example, if we focus on what we have, we can be grateful for so much. If we focus on what we can do to adjust successfully to changed circumstances, we can avoid being stuck on what might have been. If we make it a point to help each other, we will find we help ourselves.
Regarding the financial markets, I believe we have a very difficult recovery and restructuring ahead of us. I also think it will make us more stable in the future.
I believe each of us will be well served by looking carefully at our goals, our circumstances and our resources, and – as logically as we can, developing or confirming investment and spending strategies which give us a strong likelihood of reaching our goals. It is equally important, however, that when we agree upon a strategy, based upon our current situation, that we not change the strategy just because the economy and the markets got better, or worse. We should try to control our optimism, because markets can turn in a hurry as we have seen, and we should not get mired in pessimism, because, again, markets in the past have always gotten better.
My final thought is to repeat a statement I made a few letters ago. Investing is harder work than it seems, harder than advertisers represent it to be. Successful money management requires discipline and patience. It also requires two things I have not thought of before. It requires a tolerance for discomfort when things seem not to be working, and it requires an ability to avoid over-confidence when things seem to be going well.
We can’t control whether 2009 will prove profitable to the investing world. Regardless, I do hope we can all end up feeling 2009 turned out to be a very good year, whatever our reasons might be.
As always, thank you for the opportunity to work with you. Please call me if there is anything you would like to discuss.
Robert K. Haley, JD, CFP®, AIF®