Lessons Learned and Soon Forgotten
But how much good does all this new knowledge now do for us? There is very little real reform underway or on the table. We can argue about whether this is due to lack of intestinal fortitude on the part of the administration or the continued overweening power of the financial system, but the facts on the ground are simple: our banks and their “financial innovation” have not been defanged.
In fact, they are becoming more dangerous. The “Greenspan put” has morphed into the “Bernanke put”, to use the jargon of financial markets, where “put” means the option to sell something at a fixed price (and therefore to limit your losses). The Greenspan version was always a bit vague, involving lower interest rates when a speculative bubble ran into trouble; the Bernanke version is huge, involving massive cheap credits of many kinds (as well as interest rates set essentially at zero).
Bernanke’s Federal Reserve has shown that, when the chips are down, it can save the financial system even in the face of unprecedented global panic. But this will now just encourage more reckless risk-taking going forward. In the absence of full re-regulation of the financial system, the Fed’s policies are asking for trouble.
Cautiously, Small Investors Edge Back Into Stocks
Now, some of the money that fled stocks for safe harbors like money-market funds and government bonds last year is beginning to return. Even with trillions still sheltered on the sidelines, some $56 billion has poured into equity funds since April, according to the Investment Company Institute.
Of course, making money again can do a lot to bolster anybody’s confidence.
Over all, the average Vanguard 401(k) balance grew by $3,300 through the end of June, up about 6 percent for the year — not a great return, but better than before, according to the firm’s most recent numbers. In the first six months of 2008, the average Vanguard account lost $6,898, or nearly 9 percent, of its value.
As of Thursday the Standard & Poor’s 500-stock index was up about 10 percent for the year. But the index is still down a third from its peak, and investors are uncertain whether stocks will continue to rise in a fitful recovery hampered by high unemployment and sluggish consumer spending. Even with 10 percent annual returns, it would take typical stock investors close to three years to recoup the funds they had at the beginning of 2008.
Indeed, markets are essentially the net result of the behavior of crowds. When asked why stocks were going down, the old trading desk joke is “More sellers than buyers.” That is as good a definition of a crowd as I’ve seen.
To better explain contrary thinking, I like to describe Wall Street and Markets as a sports stadium filled with fans. The better the team does, the louder the crowd cheers. The louder they cheer, the better the team does. Hence, markets have a large degree of self-fulfilling prophecy in the way they respond to crowd behavior.
Call it what you like — sentiment, reflexivity, feedback loop — for most of the time, the crowd not only determines market direction, IT IS market direction.
The secret to being a true contrarian is identifying when this excited (but orderly) crowd of cheering fans becomes a an unruly mob; Determining the point at which the fanatics become hooligans. Not throwing paper cups on the court, but overturning cars; When the Wisdom of Crowds becomes the Madness of Crowds.
That is when you short a raging bull market, buy into a crash. You hold your nose and make the purchase.
And, it is typically an uncomfortable, outlier position.
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To put it another way, your best possible move (contrarian) lies closest to your worst possible move (groupthink).
To put it another way, your best possible move (contrarian) lies closest to your worst possible move (groupthink).
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