Monday, June 1, 2009

A Word of Caution.....

“Those who do not remember their past are condemned to repeat their mistakes.” - George Santayana

“Fool me once, shame on you. Fool me twice, shame on me!” - Wise Fool


Anyone who had money invested in the stock market likely saw their portfolio plummet late last year as international markets imploded. Frustrated investors were popping up everywhere, decrying the systemic risk involved and threatening to simply throw in the towel. Confidence was thoroughly shaken, and getting people to invest money was like pulling teeth. Now, eight short months later, the market has rebounded nicely and all of our problems are over, right??

Well, not quite. We’re still subject to exactly the same systemic risk as before, only this time the market is much less stable. Before the crash, markets were over-leveraged and over-priced. We had seen unsustainable growth in the years prior, fueled by low interest rates, excess debt, and the belief that prices would keep going up. Human emotions succumbed to greed, and billions of dollars were added to the fire in anticipation of ever greater returns. Unfortunately, people got burned. Now, only eight months later, I am seeing a similar pattern of irrationally fast growth. Although I cannot predict the specific event that will trigger the next collapse, there are many economic risks embedded in the system. Another shock in oil or food prices could have devastating consequences, and both have been overly volatile lately. Likely, it will be something that nobody sees coming...

The Dow Jones Industrial Average has rebounded 28.9% to 8500 points since its low on March 9th. The Toronto Stock Exchange has outperformed, gaining 37%. If markets continue to rise at this pace, then we will be back to pre-crash levels by the end of September. In my humble opinion, this is unlikely to occur. Sure, prices probably dipped too low in March as the apocalypse was priced in, then was avoided; and there’s still plenty of money left on the sidelines that could start buying to push prices up. But when I see that markets are up another 2.5% today with no real rationality behind it, I can’t help but shake my head skeptically. Are these markets priced correctly?? Almost certainly not. So the question remains, are they going up or down in the near-term?

Since day one, I’ve been told that to really make money in the stock market you can’t follow the herd mentality. You have to buy when others are selling, and sell when others are buying. Easy to say, this strategy is extremely tough to implement. The pull of collective psychology is very powerful. It requires conviction, trust, and a nice pair of cajones to buy when prices are low because everyone's afraid and to sell when confidence is soaring so they’re high. It’s easy to fall into the trap of riding a winning rally too long, especially when you’ve just suffered a big hit. I won't try to give advice in these volatile markets, but I'm selling off a portion of my virtual portfolio and am creating sell-stop orders to protect against another meltdown.

If you’re young and don’t intend to cash out anytime soon, then you really have nothing to worry about. But if you’re counting on your investments for income or earnings, then you might want to ask yourself how much risk you’re willing to accept. These are challenging times, and I’d hate to see my friends get burned again.

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