AAMG - Past Market Views - Those Who Ignore The Past Are Doomed To Repeat It

AAMG's Past Market Views
Those that Ignore the Past are Doomed to Repeat It

Recently, a client who had a respectable portfolio gain in 2001, called and asked where we thought the market would be at year-end. She also wanted to know how much her portfolio would gain this year. Gosh, if only our crystal ball was that farseeing and we could give her an accurate answer. The fact is, no one, and we mean, NO ONE, can give a guarantee as to what will happen in the next minute, let alone for the rest of this year. No one can guarantee anything in this market, but one thing we have learned, as students of the market, is that those who ignore the past are doomed to repeat it!

Rather than try and predict the future outcome of our financial markets, we are inclined to study what is going on in the here and now. Our philosophy is to examine the present in light of past events. For example, as we are coming out of this recession, should the Federal Reserve raise interest rates as a means of preventing the economy from expanding at too rapid a rate? If they do, the market may correct to the downside six to nine months after the interest rate increase. In fact, this is an historical truism going back many market cycles. And this is exactly what happened after the Fed increased rates in June of 1999. By November of that year the Fed had raised rates three times, yet the market continued up until January of 2000 at which point the Dow closed at it's all time high of 11,722.98. Yet, the news media seemed quite surprised that by March of 2000 the market was losing ground. They were reporting that we were in a retrenchment period within the new paradigm and it would have little, long lasting affect. That was about 1500 Dow points ago. Interest rate hikes were not about to stop a "good thing," even though rising rates had brought rising markets to an end many times in the past. The bull market ending in March 2000 came exactly nine months after the first Fed rate hike in June of 1999. This was one of many lessons that a student of the market learns, i.e. raising rates can lead to a dramatic decline. Once learned, lessons can be applied, unemotionally, to the management of security portfolios.

One long standing Wall Street principle that should be examined for authenticity is the idea of "I am in for the long run," or more succinctly put, the "buy and hold" methodology. This idea has been bandied about for many years; one must always be invested in the market, 100% of the time, and always in equities. We hear this from every "talking head" that appears on CNBC. To be a true American you must believe that "in the long-run the market is always the best place to be regardless of what is happening." There are many caveats to this particular principle. The following is just one example of how the "buy and hold" philosophy does not always work to your advantage.

The Dow, in January of 1966, traded for the first time in history at over 1000 (intraday) and closed at a record high of 994.20. Over fifteen years later, on June 22, 1981, the Dow again closed at that precise figure. But during the intervening years the Dow Industrials had, in four major advances, gained over 1350 Dow points. A policy of entry and exit from the market at exact points would have been immensely profitable. A "hold for the long run" philosophy, as measured by the Dow, would have netted a zero gain.

This example came to mind when our client, mentioned above, recently called. It is a fantasy to dream that anyone could have captured both sides of the two-way swings in the 1966-1981 trading market (akin to predicting the future, as she assumed we could). But, if we can draw similarities from the 1966-1981 periods and aptly apply its lessons, we can still improve portfolio performance in a directionless market. We can apply what would have worked well then, to a market that had a zero net gain.

A friend's father retired in 1966 at the age of 65. In 1981 at the age of 80 he was frustrated that the market had done him "no good" in his retirement years, according to his daughter. Could the current time period be similar to the 1966-1981 period? And if it is, where does this leave the investor?

This fluid example proves that always being in the market can be hazardous to our financial health. Methuselah may disagree, but most of us do not have the luxury of his very long financial life.

We are seeing similarities that portend another static era on the Street which are: (1) The Great Society spending programs of the 1960's are akin to the recent budget spending requests to beef up national anti-terrorism efforts within "Homeland Security", while still calling for a tax stimulus package. (2) We were at war in Vietnam from 1966 to 1975, fighting an un-seen enemy under the canopy. Today it is an enemy we can't see in Afghanistan. Weapons were needed for a foreign war then and for our foreign war now, including weapons for our law enforcement officers to protect our shores.

If we are looking at big picture events that can drag out our current recovery and lead us to "zero net" market performance, we need look no further than the creative accounting shenanigans over the past few months; To name a few, Tyco, Global Crossing, PNC Financial, the Williams Companies, AOL and Enron. Inventory rebuilding is good news and a sign of a growing economy, but can be bad news for the markets. We have seen eleven rate cuts since January 2001. The next move could be higher rates with similar results described above. Low wages in China and its heavy exports lead to direct competition with its Pac-Rim neighbors, resulting in an eventual devaluation of their currencies if they are to remain competitive against China. This would lead to the continuation of the worldwide recession, which will continue to be a drag on our domestic markets.

As students of the market we have stayed away from the Disneyland mentality that was so pervasive during 1995-1999. That ride is over. Step further back into the study of market history from 1966-1981 and be cognizant of the longer view. Markets and stocks are "trend less" 70% of the time, on average. We have just had a huge move down from that record high recorded in January of 2000. You be the judge. In all probability, given where we just came from, what is the next likely move in our U.S. equity markets? If you said, "Sideways," congratulations! You are not doomed to repeat past mistakes.

Gordon B. Lamb
Carl C. Perthel
March 1, 2002

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