Brain Damaged Capitalism

The distinction between facts and feelings...

ONE CAN think of the last five years as a series of financial car wrecks, writes Daily Reckoning Australia editor Dan Denning.

Repeated head traumas have damaged the cognitive functions of politicians, policy makers, and bankers. Their minds are stuck in a pattern of thinking where there's only one response to every crisis: take more control and spend more money. This is brain-damaged capitalism.

In any event, the mere fact of making an announcement about something succeeds in changing the narrative for a few days, until the next reality check comes. In the meantime, feel free to completely ignore the European Union summit later this week. It means nothing and you will learn nothing valuable from wasting any thought on it.

The price action in the market can tell you far more about to expect from the share market.But let's take a step back today. It's a Monday, so we're in the mood to get the lay of the land. Sometimes it pays to put the paper down and just think. Where are we? Where are we going? Can general theories about the world help you as an investor?

Great scientific theories have explanatory AND predictive power. But of course in markets, you can never predict what's going to happen next. To the extent that markets are like life, tomorrow is usually like today, and today is usually like yesterday. Most of life's events fall in a fairly normal distribution in which there isn't a huge amount of variety or volatility.

But as Nassim Taleb pointed out in The Black Swan, all the really interesting things that matter most to your life come out of the blue. You meet your future wife while waiting in line for a coffee. You get a call on the phone on a Tuesday afternoon that your father has cancer. You find out you've landed a huge business deal or got your dream job while eating a bowl of cereal watching Jeopardy.

You just never know when life will surprise you. But it's almost certain that the most important things that happen to you ARE surprises. It's the way of the world. But you certainly don't want it to be that way in financial markets.

For about twenty years, you were lucky enough to invest in a stock market that was as close to predictable as you get in finance: stocks went up day after day, week after week, year after year. It's what the experts call a 'bull market'. Are we in a bull market today?

Well, in some ways it doesn't matter. You still have to do something with your money regardless of what anyone calls the market. But the underlying assumption about asset prices DOES matter. That is, you have to know where you are in the investment and business cycle to be a good investor.

We're in a deleveraging and deflationary (for financial asset prices) period. For conservative investors, this means you should probably be pretty conservative. The simplistic investment strategy would be to favor 'income' over 'growth'. Asset allocation investment strategies and portfolios would change accordingly. You might even be able to front-run this allocation shift to the extent that the general public is usually two years behind big events (another theory for another time).

But all this sounds suspiciously like having a 'feel' for where things are headed. Feelings are not facts. They aren't data. They aren't ideas. They're just neuro-chemical hunches. That's no way to make an investment decision, is it?

Well, no...of course not. If you're going to invest or trade based on an understanding of human psychology and cycles, then you had better have a good idea of how human action shows up in price action.

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