Market Review: Good Things Always Happen In Threes

"Wall Street will say don’t worry about it, but shareholders should think again," says Strategic Investment contributor David Tice in USAToday. As if investors needed any more news of the Enron persuasion, "we are going to get confirmation that hundreds of billions of dollars in shareholder capital has been wasted or destroyed," Tice says.

"Dozens of once-hyper-acquisitive companies are expected to admit publicly in coming days," the USAToday piece offers by way of an explanation, "that they gambled and lost billions on big deals executed at the height of the bull market. The final price tag could exceed $1 trillion."

That’s trillion… with a ‘t’.

But that enormous sum is only one hint this week that investor and consumer sentiment may be on the verge of a serious turn for the worse.

Friday, the BLS also announced the unemployment rate jumped to a higher-than-expected 5.7%. If the ’91 recession is any guide, you might expect to see unemployment continue to rise in coming months, as companies continue to work through bad debt, overcapacity and largesse accrued during the bubble years. Some economists are predicting we’ll see more than 6% unemployment before we’re through.

If your editors were the gambling sort, we might be willing to lay down a fiver that skyrocketing unemployment figures are more likely to make Mr. & Mrs. Wiley Consumer think twice about breaking the seal on their latest 1.9% introductory rate platinum Discover card than any other factor.

And yet, without the ever-confident US consumer charging his way blissfully into the future… who or what will fuel the recovery 3-out-4 Fed chiefs polled say is just around the corner? Hmnn, good question.

Foreign capital, perhaps?

Well, as I pointed out in yesterday’s DR, foreign capital inflows into the U.S. have slowed considerably in 2002. Portfolio inflows into dollar-denominated assets slowed to just $11.3 billion in January. Remarkably lower than average monthly flows of $44 billion recorded in 2001.

This week, in a fine bid to top the Weekend Edition’s round up of goodly news, the Fed released a study that suggests, on average, when the trade deficit of a developed nation widens to over 5%, the currency of that country begins to fall. The currency then typically drops 20% over three years, as the trade balance recovers.

Right now, the US trade deficit is running roughly 4.3% of the GDP. (A Morgan Stanley report projects the deficit will to continue to rise to 6% in 2003… almost $2 billion per day.) So if the Fed study has any teeth, we’re just this side of a momentum shift with regard to the dollar.

When the fall begins, its velocity will, no doubt, surprise more than a few passive observers. In 1987, the last time we witnessed any serious challenge to dollar supremacy… it plunged 37%.

The Dow dropped 132 for the week. The Nasdaq lost 75… and the S&P shed 24.

Hope you’re taking advantage of a lovely spring weekend,

Addison Wiggin
The Daily Reckoning
April 06, 2002 — Paris,  France

THIS WEEK in THE DAILY RECKONING
by Bill Bonner

04/05/02 DARWINISM…AND OTHER NONSENSE

"…There are two forms of knowledge, said Nietzsche before he went mad. There is the knowledge you get from personal experience… which he called "erfahrung"…and there is "wissen" – which is the knowledge you get from the newspapers and from the abstract ideas you learn inschool…"

04/04/02 A GRAND ILLUSION

"…Peek into the average brain and what you find is a collection of empty phrases and hollow ideas – strung together as though they were Christmas lights…illuminating about as much. A man may say that he is "for free trade", or "against political correctness", or that he believes in democracy or value investing…but what does thatmean?…"

4/03/02 THE BARE FACTS
Guest Essay by Eric Fry

Compelling evidence of a link between bikini-clad super models and stock market performance. Really…it’s an indicator we feel you’ll want to keep an eyeon

04/02/02 OSTENSIONS

"…’The Ostensions of Le Dorat have been celebrated for hundreds of years,’ explained the priest in his sermon. French clerics rarely get a chance to speak to more than a handful of gray-haired old ladies. But, here was an entire town of sinners…including the mayor himself! A captive audience…the priest intended to hold them in bondage for as long aspossible…"

04/01/02 WEALTH AND POVERTY

"…At some point, the extra calories or additional horse manure becomes worthless. You have all you need. Beyond that point – more is less. You would actually be better off if the additional éclairs and horse apples didn’texist…"

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FLOTSAM AND JETSAM: Investors Behaving Badly

6 Reasons Why Investors Fail
by John Mauldin http://www.2000Wave.com

"…Gavin McQuill of the Financial Research Center sent me the full $5,000 report called "Investors Behaving Badly." He was the author and he did a great job.

I reported last week how the report showed investors chased the hot mutual funds over the last decade. The higher the markets went, the less likely it was that they would buy and hold. Investors consistently bought high and sold low. Investors made significantly less than the average mutual funds did.

The thing that struck me as I read this report is that all the data was from periods prior to March 2000. I would expect more churning after the bear market crash in the NASDAQ, but this study shows that investors were becoming increasingly short-term as the bull market went to new heights. McQuill focused on six emotions that causes investors to make mistakes.

1. "Fear of Regret – An inability to accept that you’ve made a wrong decision, which leads to holding onto losers too long or selling winners too soon." This is part of a whole cycle of denial, anxiety and depression. Like any difficult situation, we first deny there is a problem, and then get anxious as the problem does not go away or gets worse. Then we go into depression because we didn’t take action earlier, and hope that something will come along and rescue us from the situation.

2. "Myopic loss aversion (a.k.a. as "short-sightedness) – a fear of losing money and the subsequent inability to withstand short-term events and maintain a long-term perspective." Basically, this means we attach too much importance to day-to day events, rather than looking at the big picture. Behavioral psychologists havedetermined that the fear of loss is the most important emotional factor in investor behavior.

Like investors chasing the latest hot fund, a news story or a bad day in the market becomes enough for the investor to extrapolate the recent event as the new trend which will stretch far into the future. In reality, most events are unimportant, and have little effect on the overall economy.

3. "Cognitive dissonance – The inability to change your opinion after new evidence contradicts your baseline assumption." Dissonance, whether musical or emotional, is uncomfortable. It is often easier to ignore the event or fact producing the dissonance rather than deal with it. We tell ourselves it is not meaningful, and go on our way. This is especially easy if our view is the accepted view. "Herd mentality" is a big force in the market.

4. "Overconfidence – People’s tendency to overestimate their abilities relative to individuals possessing greater expertise." Professionals beat amateurs 99% of the time.

In sports, most of us know when we are out-classed. But as investors, we somehow think we can beat the pros, will always be in the top 10% and any time we win, it is because of our skills and good judgment. It is bad luck when we lose.

Commodity brokers know that the best customers are those who strike it rich in their first few trades. They are now convinced they possess the gift or the "Holy Grail" of trading systems. These are the people who will spend all their money trying to duplicate their initial success, in an effort to validate their obvious abilities.

5. "Anchoring – People’s tendency to give too much credence to their most recent experience and to show reluctance to adjust their current beliefs." If you believe that NASDAQ stocks are the place to be, that becomes your anchor. No matter what new information comes your way, you are anchored in your belief. Your experience in 1999 shows you were right.

We expect the current trend to continue forever, and forget that all trends eventually regress to the mean. That is why investors still plunge into index funds, believing that stocks will go up over the long-term. They think long term is 2 years. They do not understand that it will take years – maybe a decade — for the process of reversion to the mean to complete its work.

6. "Representativeness – the tendency of people to see patterns within random events." Eric Fry did a great tongue-in-cheek article this week in the Daily Reckoning (Wednesday). He documented that each time Sports Illustrated used a model for the cover of their swimsuit issue that came from a new country which had never been represented on the cover before, the stock market of that country has always risen over a four year period.

This year, it is time to buy Argentina stocks. Fry evidently did not do a correlation study on the size of the swim suit against the eventual rise in the market. However, I am sure some statistician with more time on his hands than I do will brave that analysis.

Investors assume that items with a few similar traits are likely to be associated or identical, and start to see a pattern. McQuill gives us an example. Suzy is an English and environmental studies major. Most people, when asked if it was more likely that Suzy would be a librarian or work in the financial services industry will choose librarian.

That would be wrong. There are vastly more workers in the financial industry than librarians. Statistically, the probability is that she will work in the financial services industry, even though librarians are likely to be English majors…"