Recessions Occur More Often. Here's Why!

Happy Holidays!! Like how I used the P.C. version? Anywho, here's the deal. As we, or I actually, discussed last time concerning the economic cycle, there is a disturbing trend. In our roughly 200 year history of the stock market, we had been averaging a recession/depression every 25-30 years. Over the past 35 years, we have been averaging a recession/depression approximately every 10 years. Why and how did that happen? Economists and financial academics have been trying to figure that out for the past couple of decades. I'm sure these guys are very intelligent, perhaps too smart; they are thinking far too hard on the subject.

Since, I'm not too smart, I've figured the problem out. Here's the deal kids. The problem is the rise in the number of mutual funds, hedge funds, availablity of deferred compensation plans [i.e. 401(k)]; basically investing by the middle class. Back in the day, investing was only done by people who had significant disposable income. Everyone else was stuffing money in matresses. About 50 years ago, 80% of a household net worth was the equity in their home. Buying stocks was considered gambling; especially prior to 1933, since the whole stock market was unregulated. I've got to slow down here, I've used 3 semi-colons already.

Everyone and their brother has some sort of stake in the stock market and the number of mutual funds and hedge funds (I'll tackle what these are exactly soon) has multiplied several times over in the past 20 years. Pensions are out and 401(k)'s are the drug of choice for both private and public companies. Mutual funds and hedge funds are in the game to attempt to make as much money as possible for their share holders. The reason is that their compensation is mainly related to how well their fund performs. In order to maximize performance, these funds are almost entirely invested (nearly all assets are invested) and in the case of hedge funds, they are leveraged to the hilt. When someone transfers money out of a mutual fund and invests it into another mutual fund, two things happen; first the mutual fund you have must sell off some of its investments in order to cover the redemption and second, the mutual fund accepting the transfer invests all or most of the funds coming in. This affects the market because when a stock is sold, the price goes down, because the amount of float shares available for purchase increases (supply and demand) and when a stock is bought, the price goes up for the opposite reason. What this creates with more people and more mutual funds, hedge funds and institutions investing is a more volatile market. Not to mention the fact that people are stupid (present company excluded) and they tend to buy when the market is rocking and sell when the market is sinking. Obviously, that is the opposite of what you should be doing. With all of this market volatility, the spending habits of the public is affected. When the market is down, people feel they have less money, when in fact they have the same amount of cash no matter what the value of their porfolio is. Hence, they spend less. The increase in the number of people investing has sped up the economic cycle, so that the peaks and valleys occur more often and for shorter periods of time. The main cause of that is the speed that information reaches people. New news doesn't exist anymore. Once you hear news or read news, it is already old news. This makes it much more difficult to time the market (which you should never do) and day traders (idiots) go from rich to poor on a daily basis. Day traders are the rabbits and the smart folks who tip-toe in and tip-toe out of the market are the turtles and we all know who wins that race.

The whole point of this post is to let you all know that good and bad times are going to occur more frequently and for shorter periods. Remove emotion and react to the things that matter in the market. Resist the herd mentality and if you feel like you need to buy or sell, sleep on it and then do your homework and if you can rationalize the feeling, then you know that you are making a solid decision. The main problem with the volatility is that even if you make an informed decision, it could still be wrong, because the market is irrational. However, if you do your research, your decisions will be rewarding more often than not. As for next time, I'll be talking about specific companies I am invested in and I'll explain why. I'll also highlight companies that look good, but are not. Peace and I'm out!!