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by Sy Harding

Missing the Rallies By Worrying About 'The Big Picture'! (December, 2001)

The phrase "Missing the forest for the trees" was coined to caution against getting bogged down in the details of a situation and not paying attention to the big picture.   The opposite approach can cause just as much difficulty in investing.

This year, like most years, is a good example. We've seen (and participated in) two significant rallies this year, that of April-June and that of September-December. Most years, in bull or bear markets, have several. Yet many investors are being held back from enjoying the trees by analysts who are looking only at the forest, the big picture, and advising that it's not assured that the economy will recover next year, or that one can't make money in a market which is still selling at record high Price/Earnings ratios, or that the Kondratieff Cycle is about to hit, or any of a hundred different long-term potential dire situations.

That big picture approach has two major problems.

The first is that life is what happens while you're making long-term plans. So such analysis periodically gets caught in a time warp, continuing to tell investors the market won't rally, or even that it   can't rally, even as it is doing so in a significant way. When rallies finally end, as they all must, and corrections set in, of course the word becomes, "I told you so". But meanwhile significant profits have been taken by those watching the trees rather than the forest.

The second problem with spending too much time looking at the big picture is that while it's possible for the market to tell us when it has become intermediate-term overbought or oversold, and for momentum reversal indicators to indicate when the market has made an intermediate-term change of direction, it is impossible, by either technical or fundamental analysis, to determine what the economy, or market, or politics, will be even a couple of years ahead. That's because the longer you give a situation to change the more likely it is that it will change.

In Riding the Bear I used several examples of situations in which the experts, by analyzing conditions, were able to supposedly know the distant future. One was how in the 1940s it was scientific fact that by the year 2000 the U.S. would run out of land and water by which to grow food for its growing population. But by hindsight we now know that instead, farmers learned new soil management, new cattle feeding and breeding techniques. Science developed healthier seeds. Farm machinery manufacturers developed more efficient equipment. Oblivion was not only avoided and the trend reversed, but the problem cycled to the opposite extreme: food surpluses, overflowing government food warehouses, gifts of surplus grains to foreign countries, even subsidies to farmers to leave their fields unplanted.

In the mid-1940s, as World War II entered its final victorious stage, economists warned that the pending demobilization of more than 10 million men and women serving in the military would send unemployment into double digits and the economy into a serious recession, probably a depression. They warned that "when the war ends the government can't just disband the military, close down munitions factories and stop building ships. The result would be disaster". And they sure made it sound convincing, pouring out statistics from previous similar situations. But that's just what the government did. And by hindsight we now know that instead of disaster, one of the most prosperous periods the country ever enjoyed began. It turned out that returning servicemen, anxious to get their lives started again, had increased confidence in their abilities, and their wives had discovered they could also earn money. With two members of the family working they could afford homes and cars and appliances and all the things they dreamed of, demand for which more than replaced the manufacture of munitions and ships.

In the 1950s well-known mathematician Norbert Wiener foresaw a terrible economic future just ahead, and his views were picked up by numerous influential analysts. To Wiener it was "perfectly clear" that automated machinery coming into increasing use in factories would produce joblessness that would "make the Great Depression seem a pleasant joke." And his statistics and presentations were very convincing. Again by hindsight we now know that instead, yes, automation meant more goods could be produced more quickly at lower costs, but that as a result employers were able to bring in the 5-day, 40-hour week and still pay workers more. The workers, with more idle time to enjoy, and more money to afford things to fill that time, created whole new leisure time products and industries, and employment actually grew.

In the early 1980s the big picture analysts were convinced the stock market as a place for investments was a thing of the past. The Dow had been trying to break above 1000 for 16 years and couldn't do it. A Business Week cover story in 1979 pretty well summed up the situation. It was titled The Death of Equities. Even the President (Carter) warned that the prosperity U.S. citizens had enjoyed in the past could not return, and that the country should plan for and get used to having less. Gold, which had soared to $880 an ounce in times of such dire economic circumstances (runaway inflation, a stagnant economy, etc.), was the place to be, predicted to be headed for $2,000 an ounce. But it didn't happen. In fact in 1982 the stock market took off into the biggest bull market ever, leaving behind those mesmerized by the dire outlook of the big picture analysts and their doomsday outlooks.

In the late 1980s, the big picture economists warned that the powerful, unstoppable Japanese economy would surpass the economy of the U.S. by the year 2000. Numerous books were published on the same theme. Famed MIT economist Lester Thurow wrote that "Japan's exceptional economy is going to force major changes in how capitalism is played around the world". It was convincing, plausible, and we all believed it. But instead, the exact opposite scenario took place when just a year or two later Japan's economy began sinking into a 12-year recession, one of the worst periods suffered by any economy ever. So now, rather than being named as the situation that would cause the economic downfall of the U.S., Japan is given the opposite role, (but of course with the same doomsday result). It is now recited as an example of how not   to run an economy, and as an example   of the fate that supposedly still lies ahead for the U.S. 

In the late 1990s, the U.S. budget deficit had been worsening for a couple of decades, to such an alarming degree that economists competed with each other with dire forecasts of how soon the country would be bankrupt. Their arguments were so well presented and documented that we all believed it. However, government spending cut-backs, combined with a big surge in tax revenues (thanks to the booming economy and explosive stock market in 1998 and 1999), not only produced a balanced budget, but a budget surplus  for several years that seemed to indicate that even the national debt could be paid off in 10 years.

That condition was immediately jumped on in 1999 by big picture economists, who determined it was a new era of economic prosperity. Congress responded by laying out a schedule for spending the surpluses expected for the next 10 years, spending them before they were even in the bank. Of course that expected long-term scenario didn't play out either, with the arrival of the 2000-2002 recession and a return to budget deficits looking more and more likely if the economy doesn't soon begin recovering.

And now we have numerous big picture economists warning that our lives will never again be the same for a variety of reasons associated with the terrorist attacks, that the economy cannot recover, cannot escape further disaster because of the record high debt load of both business and consumers, that the next bull market cannot begin with the S&P 500 still selling at 31 times earnings, and so on. And they may be right. But while waiting for the long-term scenario that might take place to arrive (or not), rallies and corrections are taking place that provide repeated opportunities from both the long and short side for those who are looking at the trees and not the forest.

Of course, it's important to keep potential problems for the long-term in mind. We certainly did with the 1999 publication of Riding the Bear, warning investors there was a serious bear market right around the corner and that they needed to get away from a buy and hold approach, and adopt some type of market-timing strategy while there was still time. But we didn't try to time the market based on that big-picture scenario, but continued to invest 100% in the favorable seasons, follow our normal market-timing, etc., (watching the trees for our investments, and the condition of the forest only for a measurement of the risk and the kind of approach it called for).

This year 'big-picture' analysts have continued to be predominantly bearish, interested only in when it will be safe to buy and hold again (5 or 10 years from now seems to be the consensus), warning of disaster ahead from one or the other of possible long-term doomsday scenarios, while missing out on significant gains repeatedly available by focusing on the trees, the intermediate-term and its rallies. 

So we get all these warnings that the rally that began in September was a 'head-fake' (a favored term when missing a rally) to be avoided. Avoided? A gain of 21% in the Dow and 37% in the Nasdaq? They said the same thing of the super April-June rally, a 'head-fake' to be avoided. 

If these rallies are 'head-fakes', whatever that means, give us as many more as possible.

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