LOS ANGELES – Bull or bear, optimist or pessimist, if you follow financial news closely you know you're being bombarded by hundreds of news items every day. Relentlessly, from cable, print, newsletters, broadcast, online, blogs. It adds up. Annually your brain processes an estimated 42,000 recommendation in ads and news stories, all loaded with contradictions.
To avoid going into overload our brains hardwire filters in their circuitry. Filters simplify the job of selecting the "right data" in making decisions. Our brains desire efficiency. So bears systematically delete bullish data and optimistic hype, focusing on conservative information. Conversely, bulls delete conflicting pessimistic data, focusing on upbeat advice. Either way, bulls and bears focus on stuff that reinforces preexisting ideas, strategies and opinions, biases and prejudices.
Unfortunately, your brain is handicapped in picking the "best" information to use in making financial decisions. Optimist or pessimist, bull or bear, most of the time you're relying on old, limited filters. Moreover, you're views are based on outdated experience. So, while we know that "past performance is no guarantee of future results," our brains routinely ignore that warning and rely on old data, most of which is biased.
Here's a recent example of the extreme contradictions currently overloading our brains from the news media. First, the bull's vision of the future, then the bear's. Both highly credible sources. For a few minutes, please suspend judgment, just observe the huge gap between these two world views and imagine what this total contradiction might do to a brain with no biases one way or the other.
Bulls vision: Turning point, solid rally in 2007
First, we read in an early September Barron's that "Wall Street's top strategists say that the market is approaching a key turning point, with most expecting a modest rally" this year and a "solid rally in 2007 as inflation fears abate." Shortly thereafter, more new numbers were released, supporting the strategists: Surging stocks, dropping oil, inflation eases, Fed stands pat, pre-election political news flashes a happy-face everywhere.
Further reinforcing this upbeat trend, Merrill Lynch just released a research report decoupling the global and domestic economies: "A sharp slowdown in the U.S. economy in 2007 is unlikely to drag down the global economy with it." So, even if the domestic economy does run into trouble, "the good news is that there are strong sources of growth outside the U.S. that should prove resilient to a consumer-lead U.S. slowdown."
Bears vision: Global recession into 2008
You'll see a vastly different vision of the future in economist Gary Shilling's September "Insight" newsletter. He "has been forecasting the collapse of the U.S. housing bubble" for over a year. "Now it's happening." His entire 30-page newsletter is devoted to the collapsing housing industry and the coming bear market and global recession. He says "stocks abroad are vulnerable to another leg down in a renewed U.S. bear market as are emerging country stocks and bonds."
Shilling's bearish forecast was reinforced within days when economists from four major housing industry associations testified before two Senate Banking subcommittees; the National Association of Home Builders, the Federal Deposit Insurance Association, the National Association of Realtors and the Office of Federal Housing Enterprise. These economists agreed that the slowdown in housing sales and building won't bottom until mid-2007 "before recovering in the latter part of 2008." That's a long two-year slump, not a "solid rally."
Bulls and bears 'see' totally different scenarios
Now, what would a bull's brain do when processing this incredible rally-or-recession conundrum? And would a bear's brain act any differently? No: From a psychological perspective, the bull and the bear will react exactly the same. Both will take the path of least resistance. Given a choice between these two segments of information, a bull's brain will focus on the optimistic vision of Barron's "Wall Street strategists." And a bear's brain will filter out the optimism and focus on the warnings of NAHB, FDIA, NAR and OFHE.
We all have biases. Bulls, bears and journalists. Mine are heavily influenced by events during the 1970s oil crisis and bear market. I was working on Wall Street as a real estate investment banker. Our Morgan Stanley team spent a lot of time cleaning up the messes. We helped one national developer reorganize in bankruptcy. We analyzed mega-portfolios of bad loans for several big banks and REITs. I advised the U.S. Dept. of Housing and Urban Development after 10 developers defaulted on government guaranteed New Towns Development Debentures.
America went through a tough recession for those five years from 1973 to 1978. And today, my experience tells me we're on the leading edge of another one. Yes, I'm bearish, but my bias is not some random mental handicap; it comes from five years experience as a Wall Street strategist. So my advice for the next couple years is very simple: Hunker down, get very conservative, minimize risks, protect assets and avoid losing money.
Of course, if you're a savvy trader with solid cash reserves and a keen eye for value investments, ignore me and go bargain hunting. But if you're just an average investor, one of the vast majority of America's 95 million investors with an average portfolio under $50,000, pray that Barron's Wall Street wizards are right.
Moreover, whether you're an active player or passive investor, here's what can you expect in the months ahead if a recession unfolds and the bear growls. Shilling summarized his vision of the future in 13 "Investment Themes:"
Dividend-paying stocks: as capital appreciation falls U.S. Treasuries: favorable during flight to safety North American energy: less vulnerable to global threats Apartment REITS and factory-built homes Health care: primarily those focused on cost-containment
Domestic U.S. stock market; headed into bear market Conventional home builders, though possible value buys Brokers, investment bankers and money managers Subprime lenders: expect increasing foreclosures and defaults Consumer discretionary spending: Auto, appliance, luxury goods, etc. Global stocks and bonds: as domestic consumption drops Higher-risk lenders: junk bonds, emerging market debt, etc Commodities deflation as the global recession spreads
And as always, be forewarned, when you see the bulls on Mars and the bears on Venus, keep your feet firmly on Earth. And my brain says the best way to hedge your bets to capture both sides of this bull/bear conundrum is with a well-diversified portfolio of low-cost, no-load index funds.
Copyright (c) 2006 MarketWatch, Inc.