The Butterfly Effect... (video)

My business requires me to stay in tune with the financial market narrative du jour: If only to help our clients---through my written commentary as well as during face-to-face meetings---see through the media haze and maintain what I view to be a healthy long-term perspective. As personality after personality offer up their predictions (and, thus, their portfolios' positions) through the financial networks, I find myself asking the TV; "How the heck can you possibly know that? By what magic can you know at what level the S&P will close out the year? Aren't there way too many variables?" Of course, were I actually addressing those self-anointed gurus, my questions would be purely rhetorical: I absolutely know that they absolutely cannot know. For me to believe otherwise would be detrimental to the investors who rely on our services.

With that in mind, I have re-posted below an article I wrote exactly a year ago today titled The Butterfly Effect. If you at all listen to the prognosticators, I  suspect that you can't help but wonder if maybe, just maybe, the one who claims to have forecast that we'd be precisely where we currently be has it all figured out. If so, please read the following in its entirety. I found the video to be particularly interesting:

 

THE BUTTERFLY EFFECT, July 15, 2012

I have expressed here in numerous articles my belief, I should say “the empirical truth”, that the near-term directions of economies and markets are impossible to predict. There are infinite and ever-changing variables at play. Think of a feather drifting in the breeze; the slightest invisible current can alter its direction without warning. A butterfly in India can flap its wings and set off a chain of events that will one day destroy a neighborhood in Midwestern United States. Think of seven billion individual human beings, each pursuing his and her own separate interests, each setting off chain reactions affected by invisible currents too numerous to count and too ephemeral to follow.

Economists and gurus of all stripes will (virtually) never cop to their (of course it’s everybody’s) cluelessness. For economists, it’s forever the counterfactual. The champions of fiscal stimulus told us that without the $800+ billion spending package unemployment would go north of 8%. Well, with the package, the jobless rate went north of 10%, and remains north of 8% today. Of course, to them, this only proves that we needed the stimulus even more desperately than they originally forecast. They now claim, in arrogant I-told-you-so fashion, that without it, unemployment would've gone into the teens. Shame on us for ever doubting them.

But the market gurus take the cake. They’ll make 200 guesses over 10 years, get lucky on 81, then feature one or more of those 81 in every article and ad selling their newsletter subscription, newest book or, worse (and scariest) yet, their money management services. The sad thing is, a few of these guys and gals have some decent insights to offer.  But they forever kill it with me the moment they claim to have foretold (for example) back in the early 2000s just how the last ten years would play out—as yet another (my 81 out of 200 example—who has 1.5 million subscribers to his newsletter) tried recently. I have yet to Google even one of these prognosticators  (there are newsletters that record and track their every prediction) without finding him or her to be sorely misleading (by professing predictive prowess) his or her readers. Not that the claim in question isn't valid, it’s just that for every one lucky guess I’ll discover three others where he or she entirely missed the mark. I mean think about it; if they indeed could accurately forecast anything, why the hell would they forecast it for you and me? They’d be trillionaires. And they’d confine their predictions to their own trading accounts (for their strategies wouldn't work if everyone followed them), while on their yachts sipping Dom Perignon and/or curing world hunger.

So what are we, as investors, to do? In my too-humble-to-forecast opinion we default to the cyclical nature of all things, to fundamental fiscal values and to fundamental valuations. Cyclicality, in economic terms, would be the movement between expansion and contraction—intensified or muted in both directions by man’s (our elected and appointed officials’) efforts to control nature, and, at times, by Mother Nature herself (see video). In financial markets that would be your bull and bear markets—intensified in both directions by man’s greed (tech in the 90s, real estate in the mid 00s) and by his fear (tech in the early 00s, real estate in the late 00s). Fundamental fiscal values—the values of fiscally sound families, companies and countries—come into play when we’re talking public policy: Policymakers simply can’t borrow beyond their countries’ means, centrally plan their economies and subsidize the efforts of their cronies without ultimately exacting great suffering onto those who naively voted them into office (think today’s Europe). Fundamental valuations for stocks would be the price of shares relative to earnings, earnings growth, book value, free cash flow, dividends, liquidity and interest rates. For bonds it would be simply where yields sit (historically speaking) relative to maturities and credit quality.

Today’s snapshot:

The global economy recently suffered what’s been dubbed the “Greatest Recession Since the Great Depression”. Current pace notwithstanding, I don’t suspect man has yet entirely circumvented the economic cycle. Egregiously poor public policy is playing out in Europe (shame on us here in America if we can’t recognize where they went wrong and keep from making the same mistakes). Stocks have rebounded measurably from their 2009 lows, yet valuations remain relatively (historically speaking) compelling while bond prices are trading at valuations I never imagined (prices extremely high, yields extremely low).

All that said and you’re still desperate to know: When will stock prices trade where earnings (by historical norms) would put them?  And when’s the bond bubble going to burst?

Okay you win. Against my better judgment I’ll offer my forecast, but I’ll need a little time to formulate, then get back to you. And while I’m at it I’ll figure out precisely when the next hurricane will hit the Midwest, and how the world economy will fare as seven billion personalities allocate their diverse resources in the weeks and months to come.