Recency Bias

One reason that people cannot see the very negative effects of our current economy is the Recency Effect or Bias, although in this case it is more of a fallacy. Free Dictionary defines it this way

the phenomenon that when people are asked to recall in any order the items on a list, those that come at the end of the list are more likely to be recalled than the others

So when the Dow Jones reaches an all-time high this is given more recall, and also given more importance, than the recent difficulties. It is also forgotten—even if remembered, it is forgotten in a de facto way—that it took 12 years to get this high. And you only broke even, in real terms, forgetting that there was inflation in the last ten years. Of course there were also dividends to help balance inflation, but in general, assuming that you believe the stated inflation rate, if one had invested 12 years ago in the stock market, you broke even over ten years. 

Yet the current stock price is being hyped like it was the Second Coming. This is not to say that those that bought stocks after the crash of 2008 did badly, they did not. But most people cannot market time their purchases. 

Recency bias looks at the near present and expects it to continue. Thus the 2000 Tech Bubble is not foreseen because recently tech stocks did so well. The 2007 real estate bubble is not seen because recently real estate had done well up to the time it didn't. Nor will whatever bubble we are in now be easily seen. Looking backward is like the little sign on your rear view mirror, "objects may appear closer than they are." We think we see clearly but we do not. 

This principle can be applied in many ways. 

Economically, the recent past is not always a good indicator of the future. The fact that things appear to be improving does not mean that this will continue. Personally I think it will for the near term, but there is really no way to know. 

The Bible even talks about the recency bias. 2 Peter 3 tells us. 

^3-4 First off, you need to know that in the last days, mockers are going to have a heyday. Reducing everything to the level of their puny feelings, they’ll mock, “So what’s happened to the promise of his Coming? Our ancestors are dead and buried, and everything’s going on just as it has from the first day of creation. Nothing’s changed.”

Yes, the good times will continue, no need to worry. Stocks will continue to rise. Unemployment will continue to decline. No need to worry. But as the old Henny Youngman joke went, "The economy is so bad that men are having to leave their girlfriends, and go back to their wives." No need to worry. 

An economic Judgment Day is coming. 

A political Judgment Day for America is coming. 

We still have time to get our own personal houses in order. Do not waste whatever time remains. On a religious level God is merciful, giving us time to change.  

^8-9 Don’t overlook the obvious here, friends. With God, one day is as good as a thousand years, a thousand years as a day. God isn’t late with his promise as some measure lateness. He is restraining himself on account of you, holding back the End because he doesn’t want anyone lost. He’s giving everyone space and time to change.

¹⁰ But when the Day of God’s Judgment does come, it will be unannounced, like a thief. The sky will collapse with a thunderous bang, everything disintegrating in a huge conflagration, earth and all its works exposed to the scrutiny of Judgment.

In the metaphor I am drawing here, we still have time to repent, and spend no more. 

There is another bias that we need to be weary of. I call it the Apocalyptic Bias, and I will talk about that tomorrow. 

I.O.U.S.A.

I.O.U.S.A. is a very good documentary, but it is somewhat dated as it was done in 2007. So take all the horror and double it to understand where we are today. Remember that in just a few short years the horror will grow even worse.

Rate Free Risk

It is generally regarded that short-term government bonds define what the risk-free rate is. In fact as the wags point out, what we have right now is rate free risk.

As I have been pointing out, the risk of increasing interest rates is a lot higher than is commonly understood. As the following chart points out, it is not just that interest rates are low. It is not just that interest rates are very low. Interest rates are as low as they have ever been in history.



A simple road map to successful investment. What is not well understood by the average person is the effect of rising interest rates on investment values. Let’s say that the rate of return on an investment in real estate is 5%, maybe the storage units that Eddie mentioned in the comments recently. If the risk-free rate goes from the current 1% to 3% then the rate of return demanded by potential buyers on your storage units will go up. That means that the price has to go down. Let’s say the new rate of return is 7%. Assuming your rents and your vacancy rates stay the same, that means a decline in market value of almost 30% in what you can get if you decide to sell your property. If your down payment was 20%, well ...

This does not necessarily mean you should not buy. But if you do you need a fixed rate over the full term of your commercial loan so you can hold the property until your loan is paid off. Or you need to pay cash for your rental storage units. If you purchase a REIT, a real estate investment trust, you need to make sure the REIT has no debt or has a good fixed rate of interest on any loan it might have.

Remember that rising interest rates reduce the value of all investments, including stocks.

I do not think I am going out on a limb by saying that interest rates will go up. My guess is that interest rates will drop some more before they rise. It will be a bumpy ride. Prepare as best you can.

The Stonecutters Song

I too am a Stonecutter. Normally admitting this would be my death sentence, but since everyone will think it is a joke i will be safe. 

This Is Not Capitalism

I remember a story from my philosophy professor in college. He mentioned one of his socialist professors who refused to call the Soviet Union a socialist nation. His reasoning was that he disagreed with the Soviet Union, therefore it could not be socialist. This is a form of the no true Scotsman fallacy.

While I want to avoid this error, I hope you can agree with me that this is not capitalism.

In a survey of 60 central bankers this month by Central Banking Publications and Royal Bank of Scotland Group Plc, 23 percent said they own shares or plan to buy them. The Bank of Japan, holder of the second-biggest reserves, said April 4 it will more than double investments in equity exchange-traded funds to 3.5 trillion yen ($35.2 billion) by 2014. The Bank of Israel bought stocks for the first time last year while the Swiss National Bank and the Czech National Bank have boosted their holdings to at least 10 percent of reserves

If one cannot trust the government measures of GDP or inflation or economic growth how can one invest? In this case if the government is buying stocks, how can you trust the stock prices? If the government is buying bonds and house mortgages then you can't trust their price either. All market prices are of little value as signals for investment. In this situation investment is impossible. One can only be forced to speculate. But first, get out of debt. I am personally in this stage. The current sucker's rally gives us all a little breathing room. Use that time wisely.