With a market correction well underway, it makes sense to analyze how you are making investment decisions as the risk trade unravels. There are lessons to be learned even in today’s unsettled market.
Respected economist Nouriel Roubini mentioned in an interview last week with CNBC that he thought a 20% equity market drop was in the cards. Dr. Doom commented on the trials facing economies around the world as the foundation for his prediction. Earlier this week, I commented in a CNBC blog that a 20% drop in the markets was unlikelydespite global economic challenges.
I received numerous comments from readers that they appreciated my rational arguments. Some stated that I was fully delusional to think that the market would not drop an additional 40%. Virtually all comments indicated that readers are highly anxious watching the markets and global news and valued my thoughts. To all who commented, thank you. And my appreciation to all of you who read my thoughts.
I’m no Dr. Doom to be sure.
In fact, in a recent appearance on CNBC Asia, anchor Martin Soong referred to me as the "Zen Master" (!) because of my “rational, calm, balanced analysis.”
Kind words and reflective of my view that a measured perspective (with a healthy dose of cynicism) is prudent when making investment decisions.
Learning mode is more instructive than dogmatic thinking.
That shapes my investment philosophy and leads me to ask many of the same questions you do as you develop your own investment strategy.
So, as a reader, how do you make sense of conflicting predictions and arrive at your own conclusions about where the market is headed?
Here's a guide on how to do just that:
- Understand that markets are not rational. The left brain thinkers of the world will tell you how things should operate based on rational thinking. While certainly one should not deny facts, don't think for a second that the market always operates on facts. Fear and euphoria drive market movements as well and cannot be ignored. Just look at the banking sector. Companies like Citigroup and Goldman Sachs trade not only on rational data but are impacted by huge swings in investor sentiment.
- Information will always be conflicting. Yesterday's consumer confidence numbers showed record gains on the same day the market dropped and housing values fell according to the S&P Case-Shiller home price index. A healthy acceptance that conflicting signals will always be present will ease some of the natural confusion as you read the headlines.
- Sentiment changes quickly. In the last two months, we've gone from fear to optimism, to euphoria, and back to fear. Often investor perspectives are shaped by what the markets are doing on any given week and using this as an investment guide is dangerous. Look at the changing sentiment on oil companies like Transocean and BP . Just one year ago they could do no wrong. Now, negative sentiment weighs heavily on these assets; how quickly things change.
- Digest and think for yourself. By now you know this is a common theme in my writings. While listening to respected strategists is helpful, remember you've got ideas as well and should not hesitate to integrate your thinking into the ramblings of investment strategists in the media. Use these opinions as inputs but not as gospel. Too often blind trust has led investors down a dangerous path.
- Monitor the economic signals you feel are most important and make them your guide. Our major signals for the economy are unemployment, housing values, inflation, and credit conditions. Signs we look for in investor sentiment are consumer confidence, technical and emotional market thresholds, and the general perception by the media about economic and global conditions. Choose your own data points; it will help you in making judgments. Be selective and watch these signposts carefully.
- Understand that the unexpected can still occur even if it is ....... unexpected. The last 10 years in the market and economy have clearly shown that virtually anything is possible. I would imagine most people would be stunned to see where Fannie Mae and AIG are currently trading. The tails of the distribution curve are in play in today’s world.
As awful as corrections can be, they provide an opportunity for reassessment and reflection.
And these are the moments that can lead you to a better strategy moving forward.
Ask yourself what you think will occur in the future taking into account current conditions, disparate opinions, and your own rational conclusions. Be careful not to let your own panic and fear get in the way. Don't ignore it, just don't let it drive your decisions.
The old expression remains true that if you keep calm while others around you panic, you will be far better off.
This is true in investment strategy as well as life .
Michael A. Yoshikami, Ph.D., CFP®, is Founder, President, and Chief Investment Strategist of YCMNET Advisors, Inc., a registered investment advisory firm (www.ycmnet.com). He oversees all investment and research activities of YCMNET. He is a respected lecturer speaking frequently on market issues, tactical asset allocation, and investment strategy. Michael and YCMNET were ranked as one of the top 100 investment advisors in the United States for 2009 by Barrons. He appears regularly on CNBC and CNBC Asia and can be reached directly at firstname.lastname@example.org.