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MAKING CENTS OUT OF THE NEWS
Blog #20
(May 21st, 2009)
YOU CANNOT HEDGE THE WORLD
By Tom McAllister, CFP™
Paul Volker, former head of the Federal Reserve Board and current Obama advisor, said it best: “You cannot hedge the world”. Volker explained that “If you’re living on this planet, you can manage risk, but you cannot eliminate it!”
Wall Street “whiz kids” and CEO’s may have thought they could eliminate risk, and we now see the results of their inability to do so. Sometimes, there is no place to hide from risk.
In an earlier blog post I remarked that volatility needed to calm down before the investment markets could return to normal. At that time, last winter, market “lurches” of 5% or more had become commonplace. The effect was to cause panic, even among many financial professionals and government officials. That panic, in turn, led to even more market volatility.
Taking a look back over 2008, we find there were no extreme market moves from January through August of that year. Then, between September and year-end, a total of 85 trading days, there were no fewer than 18 instances of extreme market moves (5% up or down) in stocks and commodities, with 48 in the REIT (real estate investment trust) markets.
Was this extreme level of activity unprecedented? No, it was not. However, it did fall outside the 95% “norm” that market observers use to make decisions, meaning that 5% of market movements, plus or minus, fall outside the norm.
From 1926 through 2008, the Standard and Poor’s 500 index fell below the norm three times, in 1931, 1937, 2008 respectively. No, FDR and the New Deal did NOT bring us out of the Great Depression - World War II did! Keep these things in mind as Congress and the Obama administration attempt Roosevelt-like nostrums to "cure" our economy.
Our traditional models of stock market value did not predict the 2008 market. There was an obvious bubble in home prices in California, Florida, and the East Coast. This bubble in turn caused concern about mortgages, particularly sub-prime mortgages. Still, equity markets were not overpriced, using conventional valuation techniques, in contrast to, for example, 1999-2000 overvaluations.
In observing the housing bubble, I believed the economy could easily handle the mortgage problems. I failed to foresee, as did virtually all other market observers, the effects of the credit bubble. I was not aware of the extreme leverage being employed by the five or six top investment bankers. I did not see the dangers to which markets were being exposed through complicated credit swaps. I could not conceive that Wall Street leaders could be as foolish as they turned out to be. Along with all market participants, I have certainly learned some lessons.
I like these axioms: "You will be issued one human body. You will be given lessons to learn. Lessons will be repeated until learned. Lessons continue throughout life." And this one, “The wise person learns from experience. The wiser person learns from the other persons’ experience.”
With all the rapid changes in our economy and in the investment markets, there are many investors who would benefit from more consistent guidance. We are currently accepting new financial planning and investment clients, and would appreciate your referrals.
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