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November 29, 2004

All That's Wrong with Mainstream Financial Reporting
by Chuck DiFalco

Paul Farrell writes for cbsmarketwatch.com. His recent article, "Yogi Berra on Dent vs. Prechter Dow 40,000? Dow 400? Best strategy is asset allocation," is a prime example of what's wrong with mainstream financial reporting. Fallacies, misleading statements, and poor advice litter the article. My apologies go to Martin Hutchinson of UPI, Steven Pearlstein of the Washington Post, and Stephen Roach of Morgan Stanley, as they (with mainstream organizations) are realistic about the gathering global economic clouds. These article authors, however, are vastly outnumbered by the "Don't worry about it" crowd of market commentators like Mr. Farrell. I shall counterpoint his article line by line.

The title of the article makes reference to two market prognosticators. Harry Dent is known as a superbull, and Robert Prechter is known as a superbear. It is obvious who predicts Dow 40,000 and Dow 400 (that's right, four hundred) in the not too distant future. "But a choice between two extremes?" the article states. Here Mr. Farrell uses the so-called straw man fallacy. This type of argument dismissively takes on an easy target, such as a wild extreme and/or extremist, and shoots it down. The argument is purely for effect, and nothing is learned. And no, I'm not doing the same thing to Mr. Farrell, because some of what he says has an element of credibility, such as a 60%-40% equity-bond asset allocation, which is much better than the 100% equity recommendation of stopped-clock bulls such as Joe Battipaglia.

"Forecasting is not a science -- it's entertainment." writes Mr. Farrell. No, sir, economic/market forecasting is a science that is only now getting some good tools. Decades ago, mainframe computers (aided by satellite photography) began turning weather forecasting into a science. If you don't believe me, compare the death toll in the four Florida hurricanes of 2004 with the single Galveston, Texas hurricane in 1900 that killed 6,000 people. Now, personal computers are allowing researchers, both in universities and in private financial services firms, to apply increasingly powerful algorithms (aided by huge databases) to the prediction of market and economic systems. Technical analysis and herding theory are only two facets of the burgeoning science. No palm readings here.

"The bad news is that ... 46 percent [of a reader poll] actually liked some of what either Dent or Prechter said..." On the contrary, that's good news. For example, we can learn much from Prechter. He is an Elliott Wave follower. Other Elliott Wave followers argue that Prechter's 400 does not take inflation into account, and that 400 adjusted from 1929 to now is about 3000. I don't care much for Prechter's endless Fibonacci numbers, but he has two important lessons for us "realists". First, market economies, and stock market indexes that measure them, rise and fall in cycles ranging from a minute to a millennium. Second, he reinforces how important psychology is to stock markets, and how this psychology manifests itself in the popular media. The most important point about forecasts, particularly those that shock many people, is that the forecaster is forced to back them up. Then, the rest of us have the opportunity to compare ideas, particularly to our own. It's the most basic part of analysis. As Quato told Mr. Shwarzenegger, "Open your mind. Open your m-I-I-I-I-I-I-I-I-I-I-nd."

Next, Mr. Farrell quotes a reader who calls upon us to follow the advice of Warren Buffett, John Bogle, Bill Gross, "guys who expect single-digit [stock market] returns through the rest of the decade." Now quoting Mr. Farrell himself, "you don't have a clue about the future of the market." No, sir, I think it is YOU who doesn't have a clue about the future of the market, despite all your education and experience. Just as everyone should do when they travel, people should be situationally aware of where we are in market history. Failure to do so gets wallets emptied. "What will 2010 will look like?" OK, so here's my forecast: in 2010, the price of gold and oil will be much higher than now, interest rates will be much higher than now, and the dollar will be much lower than now. Realists will make more money in this allocation of Vanguard mutual funds: 40% Inflation Protected Securities, 30% Energy, and 30% Precious Metals and Mining than they will in the allocation of otherwise excellent Vanguard funds listed in your article. I won't complain if an investor wants to allocate some of the 60% equity stake to Vanguard Health Care Fund and Vanguard Emerging Markets Stock Index. Not specific enough? OK, another way of stating my main point is that avoiding a forecast is giving excuses so as not to be held accountable. The Standard and Poor's 500 Index (near 1200 as I write) will reach 800 before it reaches 1600. What Buffet, Bogle, and Gross are trying to tell everyone is that stock market rewards will be relatively small compared to the risk you take on for several years to come.

Sometimes being a realist means realizing that things can get worse before they get better. As I wrote in "Get Religion with Secular Bears", it doesn't really matter whether the current cyclical bull market in stock markets that began in late 2002 ends this year or next year. We are in a medium-term bear (secular) market in equities, which began in 2000 and could easily last to 2015. To state it more simply, the US stock markets are in a bust period following the boom period of the 1980s and 1990s. Stock market index money will be dead money for years. I don't have the space here to post a bunch of numbers; what is important is understanding the big economic picture, and working your way down. The Great Recession is upon us. Only time will tell if it is bad or ugly. For charts and graphs of market cycles, a good read is Lance Robert's article "Secular Markets & Long Term Investing". His article can be found at http://www.streettalklive.com. For a more fundamental view on global economic imbalances, read Stephen Roach's articles written over the past three years. There's so much good analysis out there that "the impossibility of predicting the unpredictable" turns into possibilities.

"Unfortunately, market-timing and day-trading fail for the average investor." This line from Mr. Farrell is misleading. In one stroke, market-timing is associated with day trading. How about selling all your stock index funds for money market funds, and going away from the market for ten years? Get cash, "which is just as good as money" (thanks Yogi). Pay down debt - all of it, including your mortgage, more quickly than you planned to or even want to. If the average investor does not want to get into the work involved in researching capital preservation assets such as gold, TIPS, and foreign currencies, that's my advice. Or go hire a financial consultant who REALLY understands what is capital preservation. And I'm not talking about capital preservation as a function of age. If you're 65 or 25, you need to just stay afloat long enough to take advantage of the next secular bull market in stocks that must inevitably follow.

"The idea that I can see what no one else can see is an illusion" is a quote that Mr. Farrell uses. In fact, there were a few people who timely predicted the stock market crash of 1987. One of them, Marty Zweig, did so on national television on the show "Wall Street Week" just the weekend before! The quote is from a Nobel prizewinner in economics. I remind you that Nobel prizewinners in economics lead the investment firm Long Term Capital Management into insolvency in 1998. The risk to the global financial system was so severe at that time, that the United States Federal Reserve, headed by Alan Greenspan, engineered a bailout of LTCM. I put stock in people who got it right, not necessarily in who got credentials.

"If you spend more than 14 minutes a year worrying about the market, you've wasted 12 minutes." Mr. Farrell quotes the legendary investor Peter Lynch. I read one of Mr. Lynch's books. He is a guy who admits that, while on vacation with his family in Ireland in October, 1987, he was thinking much more about the crashing markets than on sightseeing. Obviously, Mr. Lynch was at an extreme in worrying about the market, even though he was had a lot of responsibility. Indeed, not too long after that, he decided to quit as manager of Fidelity Magellan fund. Seems clear to me that Mr. Lynch is talking more about getting a life than worrying about the stock market for only 2 minutes a year.

I thoroughly enjoy flip comments. My favorites occur in the movie "Ocean's Eleven." Towards the end, George Clooney walks out of prison with the disheveled tuxedo he walked in with. He greets Brad Pitt, who flippantly comments, "I hope you were the groom." Mr. Clooney, not to be outdone, sees Mr. Pitt's outrageously colored clothes, and retorts, "Ted Nugent called. He wants his shirt back." However, Mr. Farrell in his article quotes a flip comment by Peter Drucker: "Anybody who tells you that he understands the American economy ought to be sent to teach modern dance." What's that supposed to mean? How is that line going to help me in my asset allocation? It's way too flip. If you're going for that, at least make it funny.

The bottom line is that reading too many mainstream articles like "Yogi Berra on Dent vs. Prechter" lulls the average investor into a false sense of complacency. Wake up, folks. Get the fear of the economic future into you. Some of you will either freeze with panic, and others will put your head in the sand and hope it all goes away. For you, football, George Clooney, and/or "Ocean's Twelve" help to avoid thinking about it. Others of you will translate fear into a plan of action. Don't be afraid to prepare for the future like Noah. Figuratively, I mean. Go visit national treasures like the actual Declaration of Independence, and enjoy it. And keep reading the economic and market contrarians out there.

Chuck DiFalco

Living in League City, Texas, Chuck DiFalco is a software engineer by day, and an unconventional thinker and writer by night. He can be reached at cdifalco@houston.rr.com.

Copyright © 2004-2007 by Charles Joseph DiFalco. All rights reserved.

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