Wednesday, February 25, 2009

It’s Different this Time

Looking at history we have a tendency to see certain events as inevitable, but they didn’t seem inevitable at the time. We can agree now that the tech boom of the late 1990s was destined to crash, but the crash didn’t seem inevitable to most of us while we were living through the boom. This provides a lesson for our present difficulties.

As is often the case, the truth is somewhere in the middle. We are too confident in our ability to see the reasons behind past events. But we also have too great a tendency to believe that our present situation will persist.

Many believed that the tech boom would continue indefinitely taking us to a glorious new future. This turned out to be very wrong. On the other hand, many of us now see the tech crash as inevitable. However, another plausible outcome could have been for tech stocks to remain flat for 20 years while their value caught up with their prices. The markets have more than one way to get back in line.

History tells us that the stock market runs in cycles and that good times and bad times don’t last forever. However, while we live through events, there is a tendency to believe that “it’s different this time.”

There are many reasons we can give to explain why the current stock market drop really is different this time. China and other emerging markets will eat our lunch. We’re running out of oil. Global warming will change everything. Crushing debt will kill the U.S. economy. Canada is tethered to the U.S. and will be dragged down as well.

I just don’t buy into the idea that stock market underperformance will be a permanent part of our future. I look to the past and see that things will eventually turn around. I can’t say when, though.

A few years after the economy improves, we’ll have many reasons why it was inevitable that the turnaround happened when it did. We’ll just as wrong then as we are now in thinking that the decline is permanent.

5 comments:

  1. Hi Michael. I believe in passive index investing, but I have a hard time explaining the Nikkei. Do you have any thoughts on that?

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  2. Patrick: I've read some analyses of the Japanese economy that claim that it isn't sufficiently competitive because there tend be be only a few large participants in markets. I haven't looked at this enough to have an opinion myself.

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  3. I think outrageous initial valuations were a huge factor. I read somewhere that Japanese p/e ratios were 80 and dividend yields were ultra low. A lot of the pain can be explained simply by the change in valuations.

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  4. CC: I agree that valuations were completely out of control and were the main reason for poor returns going forward. What I'm not so clear about is how the valuations got so ridiculous and why the bubble didn't burst sooner.

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  5. It often does seem different this time, and in a way it IS always different. Our current recession is a lot worse than the recessions almost any of us have seen first hand, and each cycle looks a little different.

    I agree with your point though, each boom and bust has similarities to the previous ones. The Internet boom was similar to the airplane boom or the automobile boom. This recession has similarities to 1973-74 and 80-81.

    I guess we are conditioned to believe that current trends will not change. I don't think too many people predicted the depth or length of our current recession.

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