My Two Cents - "This time it's Different"

12/01/2006

I found the above passage on the Internet. I am not going to tell you until the end of the piece what time period in American history it refers to. By then, the point I'm trying to make will have been made. This piece is intended to be an expose on human nature and how we as humans provide the hands that ultimately craft our own destruction. This piece is about complacency.

As the DOW continues to stretch to nominal record high on top of nominal record high barely pausing to take a breath, I seem to hear more and more that this time it will be different. This is the time we really go through the roof and never come back. Part of me wishes it were true.

We have seen many times in the world of investing (and countless other areas) the damage complacency can do. But we never quite learn our lesson do we? We are like the dog and the invisible fence. He knows that if he takes that extra step he's going to get zapped but he takes it anyway. The biggest difference between humans and dogs though is that the poor dog eventually learns to stay within his boundaries and is able to roam happily without fear of the zapper. Humans, however, never seem to learn where their boundaries are. Time and time again we get zapped and yet we continue to push the envelope, unsatisfied with taking the safer of two alternatives. Certainly this quality is not always a bad thing. We would not have the level of innovation present in the world today had it not been for some daring individuals taking risks. The difference, however, between calculated risk taking and pure complacency is rather dramatic.

Another shining example of complacency has to do with driving. We will drive a car faster and more recklessly until we finally have an accident. For a while afterward, we will reduce our speed, maybe put down the cell phone and coffee and try to drive safely. But eventually, the lessons learned fade from memory and we resume the habits that got us in trouble in the first place.

With stocks, we did it in the 80's and got burned to a small degree in 1987. We did it again in the late 90's and lost hundreds of billions of dollars because we bet the ranch on etoys and the like. We were manic, driving our investosarus at 900 miles an hour down an unpaved road in the dark with no lights. When we finally crashed it, we got out, rubbed our temples a bit and saw the bright, shiny mortgageosaurus sitting right down the road. We hopped in that one and low and behold the now the wheels are falling off. Each time, we say "This time it's different. This time we're really going to get rich. This time we can get something for nothing. This time the lunch is free". Mob mentality at its finest. This is human nature, and we can't change it. Hopefully though if at least some of us can understand it, maybe the next burn won't be as bad or at least as much of a surprise.

One only needs to look at the growing number of hedge funds to understand the appeal of risk. Hedge funds are often based on taking huge risks, with no safety net and super leverage. It is a miracle that more of these funds have not imploded. The Amaranth meltdown a few months ago was by far the most significant since Long Term Capital Management in the late 1990's. The point is simple: There is a huge appetite for risk otherwise we wouldn't be seeing so many of these types of investments coming into existence. Obviously, there are some very smart people running these funds, but at the end of the day, they are just people, and I have yet to find one that is perfect. There is no such thing as a sure thing, and the perception that it exists is extremely dangerous. Unfortunately, the success of these funds in general has sown the seeds of complacency and it is that complacency which will ultimately cost investors.

For stocks, there is no better measure of complacency than the $VIX index. It measures volatility in the markets and save for a recent brief upswing is very near its 52-week lows. A few commentators have made note of this, adding that the market is ripe for a correction.

So take heed: If you've made a bunch of money on this recent 'rise' in the market, inflation notwithstanding, maybe consider taking some of your money off the table. Sure, it's not daring, nor is it courageous, but it sure is prudent. Incidentally, the passage at the beginning of the column was used to describe the manic period of the late 1920's; right before the bottom fell out. Some things never change, do they?

Editor's Note: In a developing story that has gotten precious little exposure, the US dollar continues to be under severe pressure as of the release of this commentary. While much of this latest move has been attributed to comments by Chinese central bankers and anemic economic data in the US, it is my opinion that this is part of a broader long-term move downward. The fact that the mainstream financial press gives this recent precipitous fall such little play means we all need to be paying very close attention to the developments over the coming days and weeks and employing capital preservation strategies accordingly. For some general strategies, please see my column from October 20th (linked below).

The Survival Guide - Read Here

Graham Mehl is a pseudonym. He is not an ‘insider’. He is required to use a pseudonym by the policies of his firm when releasing written work for public consumption. Although not an insider, he is astonishingly bright, having received an MBA with highest honors from the Wharton Business School at the University of Pennsylvania. He has also worked as an analyst for hedge funds and one G7 level central bank.

Andy Sutton is a research and freelance Economist. He received international honors for his work in economics at the graduate level and currently teaches high school business. Among his current research work is identifying the line in the sand where economies crumble due to extraneous debt through the use of economic modelling. His focus is also educating young people about the science of Economics using an evidence-based approach.