Welcome to the Amusement Park, Part 3 - The House of Mirrors
I spent a week in China on business about 25 years ago. It was my first visit to Asia and I was surprised by many of the things I encountered. Since China is a socialist country, I had expected to see a fairly even balance of men and women filling various roles but the team of engineers and managers I met was as homogeneous as was then common in the US. My hotel room offered its own surprises, including marble baseboards abutting unfinished wooden floors, an embroidered velvet cover over a TV that received no channels and an ornately engraved mirror which offered only distorted reflections.
That mirror leads me to the third stop on our tour of the amusement park, the house of mirrors. Sometimes known as the fun house, this is a building which contains a maze. Naturally, the object is to find your way to the exit but it’s not necessarily easy. The path is disguised by a series of mirrors arranged to provide confusing views of the room. In one, you might see an elongated or foreshortened view of yourself. In another, the reflection of someone else in front of a different mirror, perhaps doubly distorted.
In some ways, life in this century has begun to resemble a house of mirrors. The great increase in the availability of information is basically a good thing but it can easily leave us more confused than informed. Twenty-four-hour news channels regularly apply a “breaking news” label to their stories, even as they are repeated. I recently noticed a crawl highlighting “urgent” breaking news, apparently meant to distinguish a story that actually was breaking.
Although staying current is important, constant news updates can have unintended consequences. According to NPR, the Times Square bomber was able to follow the progress of those searching for him by paying attention to the news. At one point, he knew not to enter a home because he saw reporters and camera crews outside, apparently hoping to provide live coverage of his arrest.
In the same way they guided the bomber’s actions, news outlets have gained significant influence over markets. As up-to-the-minute reports try to provide inside glimpses of what’s going on, they can easily increase market volatility. Viewers often hurry to buy or sell ahead of other investors based on the very latest information. Sometimes those reports turn out to be simply rumors and the subsequent rush to undo those trades makes things even more volatile.
On May 6th, we experienced an extreme example of a market in chaos, when US stock markets briefly crashed. After more than a month spent in contemplation, regulators still don’t know just what went wrong. Among the likely suspects are the increasingly popular all-electronic exchanges which are able to execute large buy or sell orders within milliseconds. Since human beings can’t react at such speeds, competitors are using computerized trading strategies. This involves programming computers to place orders instantly under certain conditions. Although this tactic is intended to complete transactions when trading becomes intense, it too adds volatility. On the 6th, several brokerage firms simply backed away from the markets during the fall, withdrawing liquidity and hastening the plunge. A similar crash occurred back on May 28th 1962 and, to this day, no one knows what caused it. No doubt congressional hearings will have begun by the time you read this article. Whether or not the causes of this crash are ever identified, the hearings themselves are likely to be reported upon as breaking news.
In fact, no single news story should mean much to an individual who is an investor instead of a trader. But even those who are following a plan face the risk of becoming lost in the house of mirrors when things get unusually exciting. During the 2008 market correction, there were widespread reports of investors panicking and calling their brokers to sell, although we received very few such calls. Perhaps our efforts to educate our clients about investing for the long term have borne fruit, or maybe our clients are simply more thoughtful than average.
Regardless of how many news stories an investor follows in an effort to keep up, it is simply not possible to predict the future. As professional asset managers, one of our jobs is helping our clients stay safely away from the house of mirrors. Corrections - even crashes - have always been part of long-term market gains. Selling into any of them at low prices holds very little appeal to us but no matter how exciting the markets become, we will not withdraw from the action. We will be here to answer the phones.
Welcome to the Amusement Park, Part 2 - the Roller Coaster
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We began our tour of the amusement park by paying a visit to the teeter-totter. This week, we’ll venture deeper into the park and take a look at the roller coaster. Personally, I have no interest in getting on any sort of device intended to scare riders. My wife, who shares my aversion, always says “Why would I want to pay to be frightened?” Since the world includes individuals who are much more adventurous than I, the amusement park offers scary rides for those who prefer them. When I imagine a roller coaster, I envision a hilly structure supporting cars and their riders as they take an up and down journey. The ride often includes twists, turns and even upside-down sections before returning car and riders to a gentle stop at the platform. In side view, a roller coaster track resembles your choice of numerous financial charts. Whether the ups and downs of the stock market as a whole, the rise and fall of interest rates or the recent headline-grabbing fluctuation of the value of the Euro compared to the dollar, the rolling configuration is obvious. As an example, here’s a chart showing the value of the Euro compared to the US Dollar since 2000 (courtesy of MSN):
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Introduced in 1992 at about $1.18 per Euro, its value had fallen to 85¢ by 2002. Following the replacement of local currencies with Euro bills and notes, its value began to rise, reaching a peak of nearly $1.60 in the summer of 2008. No doubt concerns about our currency during the mortgage crisis played a role in the Euro’s rise. As you are probably aware, Greek debt problems have hurt the Euro’s value relative to the dollar and, at this writing, it is worth about $1.23. I have commented about relative currency values several times before, most recently in late 2007′s What Goes Up Must Come Down, when I compared US and Canadian dollar values. That time we noticed the US dollar weakening but, as is apparent from the various roller coaster-type charts, a stronger dollar always remained a possibility.
Much of the current turmoil in global markets is being laid at the feet of the Greek debt situation and the potential for Germany and other strong economies to spend Euros propping up Greece and possibly other countries with weaker financial systems. Although our own economy has experienced some shocks since 2008, right now investors seem to believe the dollar is the better currency of the two to own. This, of course, is subject to constant reevaluation as situations change. It is possible to invest in such a way as to profit from a further fall of the Euro or from its return to strength. The chart shows a couple of times in the past when the value seemed to stabilize at around its current price. If that happens this time, the Euro might rise again in value. However, there are increasing concerns that Spain’s economy (much larger than Greece’s) may also falter. If that happens, the Euro could easily drop further. I mentioned earlier that a roller coaster always bring riders back to their point of departure but that’s not necessarily what happens to investors. Instead of coasting back to a gentle stop right where their journey began, investors lock-in their gains or losses when they decide to sell. Actually, I think investing would be of very little value if all it accomplished was getting us back to the place we started. The problem, of course, is deciding when to end the ride by selling. At Warren Ward Associates, our investment philosophy always begins with broad diversification among various asset classes, occasionally tweaked by adding small investments in the more volatile sectors of the market. There is no one right way to invest, as every person’s situation is unique. For those who can tolerate the additional risk, this might be a good time to place a small currency bet. |
