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Island Investing

Riffs, rants, and the upside of investing from way off Wall Street


Why We’re Buying In This Market: Part Four

The rest of this series can be found here.

The Big Picture

Here is my attempt to frame the current macroeconomic angst the country is experiencing:

Our economy, compared to a year ago, is in good shape. Compared to what it was before the Great Recession, however, it’s still in rough shape. Pundits, armchair economists and politicians from both ends of the ideological spectrum have abnormally high levels of confidence about how to best fix this problems. Some are still peeved they were ignored last year. All tend to broadcast their opinions loudly. Their approaches vary dramatically. None can be tested empirically, though, because economics is not a real science. Thus, there is much noise.

Our economy is recovering weakly from a brutal recession. Numerous risks remain that demand watching closely. We have a huge long-term challenge ahead of us in terms of our federal deficit. Nonetheless, the economy is in a recovery. It’s important to distinguish between the slowing of a previously high rate, and a definitive downward trend. And right now, no data supports that latter conclusion. In fact, if you look at each of the significant macro data trails over quarters instead of months, the recovery becomes much clearer.

Many stocks are cheap again – if nothing else, than at least in the relative sense. As I write, the yield on the Dow Jones Index is higher than on Treasury bonds. This is good for long-term investors.

It doesn’t feel like we’re in a recovery yet, however, and that is the problem. Behavioral economists (the cool ones) call this ‘recency bias.’ People systematically and predictably project their current circumstances into the future. We put too much weight on recent events. Think of the gambler doubling down after winning the last two hands. The odds have not changed, but the perception of them has.

Recency bias played a key role in the recent housing bubble. The vast majority of the population of this country believed home prices would keep going up, simply because they had been going up. Recency bias also probably has a good deal to do with the long run-up in stock prices last year. I believe it’s affecting the stock market today, too, in the opposite direction. The jarring market drops of 2008 and early 2009 will forever be etched in the minds of anyone who was paying attention. The uncertainty created by recent economic data is leading many people to jump to premature conclusions based on some very unpleasant recent experiences.

When it comes to the economy lately, high unemployment and poor housing data are the numbers most of us tend to latch on to. Although we’re probably through the worst of it, housing will likely continue to be a drag on the economy the rest of the year. Unemployment will stay uncomfortably high. This oil spill is going to seem like it will go on forever. Each of these will cause continued angst. None should be confused, however, with things that will derail the ongoing recovery. That’s because big business is going to save us.

You’re welcome, economists.