Sunday, October 12, 2008
Here is an interesting quote from Jeremy Grantham in Barron's.
"So although the fair value of the S&P today may be about 1025, typically bubbles overcorrect by quite a bit, possibly by 20%. That is very discouraging."
Clearly the interview was done a few days after the worst carnage of the week. A 20% 'overcorrection' works out to SPX 825. The low on Friday was 839.
The dilemma faced by market participants right here is the battle between reason and fear.
Colgate (CL) will still sell plenty of toothpaste, Proctor & Gamble (PG) will still sell plenty of detergent, most of the companies that service where you work will continue to do so, most people will keep their cellphones, you will have a bank account somewhere and so on. And you know this.
Also on the side of reason, there have been panics. crisis and bear markets before. There is no fear that you have now that someone hasn't had before in a past episode. You know this as well. From a big picture stand point there is very little that is new. Bank crisis, poor response to the crisis, misuse of leverage, bear market, this time is different, the bond market not functioning properly, enormous corporate failures and so on. The details are different this time but the details are different every time.
And it is the details where the fear comes in and, for some people, trumps reason. What if this time is different? What if the stock market doesn't come back? What if the rescue plan does not work? What if all the banks go under? What if the government fails? What if it devolves to martial law?
People have these fears but of course people have had them before.
Dr. Brett recently wrote about something I believe is called hindsight bias. The general idea is that something becomes more predicable after it happens. For example of course the failed UAL LBO in 1989 did not have long term importance and stocks should have been bought with both hands in the mini-crash that ensued.
I chose that as an example because many people forget about that one but there was real fear that it would be 1987 all over again. People look back at every panic and say of course I should have been buying stocks but how many actually did?
To me, the biggest variable is how long it takes to start to recover and how long it takes for people's emotion to ratchet back down.
The picture is the Colorado River at the floor of the Grand Canyon near Phantom Ranch.