Obsessing Over the Inevitability of Unforeseen Catastrophes.

October 3, 2016

Blindly groping his way to the toilette one late night, Nostradamus crushed a toe against the door frame. "Damn!" he cried at the top of his lungs. Whereupon his wife, children and half the village of Saint-Remy-de-Provence hid in fear. So respectful were they of his uncanny powers of prescience.
500 years hence, we inhabit an age in which a multitude of fools, frauds and filchers make a living by aspiring to claim the predictive powers of the great French seer. Forecasting a tragic inventory of inevitability. To be lapped up by the spoonful by society's pessimists, cynics and stooges.
Because the only certain speculation is that there's a sucker born every minute.

The optimist, said Winston Churchill, sees opportunity in every danger. The pessimist? Danger in every opportunity. And whereas we were once a nation of optimists, today we wear pessimism as Batman does a utility belt.
56 percent of Americans believe their children will be worse off than themselves. The number of investors currently bearish registers 22 percent above the historical norm. The density of forecasters espousing the nation's inevitable decline could the sink holes that will be the legacy of California after it fall into the sea. Or so they say.
Overt pessimism. It's the chic new brand. Ensuring that we're presciently aware of the worst case scenario. In each and every situation.
Once we were "along for the ride." Now, we're "along for the wreck." Wracked by an inner sense of foreboding. A sixth sense that constantly warns, brace for impact.
During most client conversations, as the chatter transitions from utility to small talk, the inevitable occurs. Where the client squints his eyes, cocks his head and asks, "So when's this thing gonna fall apart?"
Idle banter? Meet the apocalypse.
Since the Great Recession's end in June 2009, the media has been awash with the prognostications of some two-bit pundit forecasting the next catastrophe. Invariably espoused to be just around the corner. Which can, unfortunately, be quite profitable for said two-bit pundit. As the business of speculating on the apocalypse has become immensely profitable. For those capable of girding their souls against the interminable predictions of financial ruin and human suffering.
Of course, there's also the second tier of that cottage industry. Main stream media types seeking to peddle potential pandemonium in order to push an agenda. Or to keep naïve eyes glued to the boob tube in hopes of learning the secret to survival.
Which, from a purely financial standpoint, leaves most investors in constant dread of the next bear market. One that will tear the door of the hinges, a la The Shinings "Heeeeerrrre's Johnny!", as we careen helplessly into the inevitable, cataclysmic, life-changing, nest-egg-eroding and surely-just-around-the-next-bend-in-the-road recession.
Here, there is good news and bad.
The bad? There will very possibly be a recession in 2017. The good? Or there will not. And while reality holds that most precipitous market declines do coincide with these periodic economic contractions, fact remains that most recessions have not historically been the run-for-your-lives catastrophe they've recently been sold as.
The National Bureau of Economic Research (NBER) holds the official role of determining when the nation is in periods of expansion and contraction. Accordingly, the NBER defines a recession as "a period of temporary economic decline during which trade and industrial activity are reduced, generally classified by a fall in GDP in two successive quarters."
Doesn't sound too ominous. Perhaps because the definition includes the phrase "temporary economic decline." Not permanent economic decline. Which ranks as entirely more pleasing than world-ending destruction. Which is how many view it.
Recessions, and the coincident bear markets that accompany them, represent a systemic facet of the economic cycle. One that has persisted since Washington crossed the Delaware. And accordingly to financial author Nick Murray, we find that the closer we look, the less we have to fear.
-There have been 11 recessions since the end of WWII. The average recession lasted 11 months.
-Since 1945, the U.S. economy has been in recession 122 out of 854 months. A bit more than fourteen percent of that period.
-The average postwar recession saw the economy contract by 2.2 percent. Though the recent Great Recession dragged the economy 4.3 percent lower. Which may explain all the post-traumatic stress.
Historically, Murray concludes, postwar-era U.S. recessions tend to be 1) temporary, 2) relatively shallow, 3) and relatively short. Especially in contrast to the 86 percent of the time during which the U.S. economy has been expanding.
But, you might be wondering, doesn't it only take one bad bear market to change my financial fortunes?
Well, let's consider the intrinsic nature of bear markets over the last century.
From 1900 through 2013, there were 123 market corrections (S&P 500 dropped 10 percent or more). About one per year. As well as 32 bear markets (S&P 500 dropped 20 percent or more). Or one every 3.5 years.
During the average correction, the market fully recovered its value within an average of 10 months. While the average bear market lasted 15 months. And sent stocks lower by 32 percent. Though the 2008 bear market spanned 17 months and shaved 54 percent from the Dow Jones Industrial Average. So contributing to today's abnormally high level of negative psychological dispositions.
What causes markets to drop into bear territory?
Bear market catalysts range from external shocks like energy crises or political events, to run-of-the-mill recessions whereby economic fundamentals can no longer support current stock valuations (like the 2000 tech bubble).
And of course, investor psychology never helps. As investors attempt to guess the future reactions of other investors. Which often leads to a negative feedback loop. Where selling simply breeds additional selling.
Investors and pundits alike often tout the idea that we're well overdue for a bear market. And technically, they're correct. As the last one occurred eight years ago. Twice the average duration between bear markets over the last century. And even the we experienced a correction in 2011 during which the S&P 500 dropped 21.6 percent, the Dow Jones Industrial Average dropped only 19.5 percent. Avoiding, by definition, a broad-market bear correction.
Fact is, you don't have to be a doomsday proselytizing Nostradamus acolyte to forecast when the next recession and bear market will transpire. The answer is simple. Sometime in the future. 10 months? Two years? Nobody truly knows.
Till then, investors should keep their noses down and work their investment plans. Setting trailing stops behind their risk-oriented positions. Periodically trimming their position sizes. And reallocating to the underweight facets of their portfolios.
As opportunities present themselves, use options to gain market exposure and garner income while maintaining larger cash positions. Buy companies with attractive price-earnings-to-growth ratios. And above all, never move in lockstep with the herd. Though it may feel as if there's safety in numbers, more often than not, the herd simply runs in a unified fashion right over the cliff.
No less a market authority than James Paulsen of Wells Capital recently explained that today's markets are not overvalued. Not priced for crisis, as many have said.
"Despite being one of the longest and strongest bull markets of the post-war era, as shown in Charts 1 and 2, the U.S. stock market is still at worst fairly priced and even cheap relative to its post-war trendline. By comparison, the other two major bull markets since WWII (i.e., during the 1950s-60s and again in the 1980s-90s) both ended only after U.S. stocks rose significantly above trend for several years.
Indeed, the total U.S. stock market is currently priced comparably to the early-1950s or the early-1980s. Perhaps equally important, even the popular S&P 500 index is not nearly as richly-priced today as it was in the 1960s or the 1990s."
In regards to the aforementioned pessimistic malaise? I would argue that the antithetical sentiment is called for. That any sense of doom and gloom is misplaced.
By any measure of human development - poverty, life expectancy, infant mortality, freedom, level of violence, exposure to disease, etc. - we exist in a golden age. One that is unprecedented in humanity's history. We have unprecedented exposure to world shrinking travel and communications technologies. Increasing access to life-extending medical technologies. Extreme poverty has dipped below 10 percent of the global population. Mass famine has been nearly eliminated. Mass literacy and education is increasingly the rule, as opposed to the exception. And today's average person is less likely to die a violent death than at any time since our earliest ancestors first migrated out of Sub-Saharan Africa and across Eurasia roughly one million years ago.
Reason enough to raise a collective cocktail and toast our aggregate fortune?
If not, then you may rank among those souls not seeking a way to live among life's problems. Those whose problems prevent them from ever truly living.

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