I sat with a senior advisor and partner at my firm last week. The topic of the conversation was "bubbles", and the usual action/reaction process that takes place when they "pop". He was an advisor back in the 1970's, and he's quite astute when it comes to this particular subject. (This is also proven through his uncanny ability to miss each bubble-bursting that his taken place since... I.E. Dot Com, 9-11, LTCM, etc...)
Firstly there is a predictable behavior when bubbles reach their peak... That is, no matter who you are, whether you are a novice or an investment professional, the story ALWAYS sounds good and convincing. For example: In the dot-com bubble, anything "tech" related was a great story. "This company specializes in this", and so on... Eventually, everyone starts to see it as a very compelling idea. It is a trick on our emotional nature that, even though our rational minds are telling us: "OK, this company is run by two college kids, went public last week, no proven revenue, but is located in California and specializes in something computer related... This is crazy to even consider, BUT, Greg my neighbor has made 200% so far... And the technology they are developing is cutting-edge as they say... I'll do it! Sell the tractor, back up the truck!!!"
Bubbles:They start as a reasonable, but unproven idea at a reasonable price.
They end as a sound proven idea, but at an unreasonable price.Sound familiar? Look at the "potash" story. Great story. Feeding off of the "world food glut" problem. It also fits in nicely to the China and India story, whereby, China has the largest population in the World, and has a quickly developing middle-class who will demand higher grades of protein (beef, chicken, etc...) Imagine the economics that goes in to matching this increase in demand. It blows your mind. So, the developed world gets wind of this and follows the supply chain right back down to agriculture and of course the fertilizer companies. POW. You have a small fert company in rural Saskatchewan that suddenly becomes a heavy-hitter on the world stage, and a very large weighting on the Canadian Stock Exchange. (Eerily familiar to what Nortel did during the dot-com era... Look at Nortel now. Once worth a few hundred dollars per share, now in the pennies.)
Of course times are different now, and China hasn't even begun to wake from it's long slumber, so the story remains strong. (But, that doesn't mean we wont see future bubbles forming in this sector. We just have to be much more active in how we manage our investments. Passivity will surly lead to personal destruction in this new and interesting economic environment.)
After the recent "correction" we've experienced in the markets around the globe, the number one focus should be on recovery. The 5 year plan... Probably the most important 5 years your assets will experience for a life time. Let's look at 2 possible recoveries and the conditions that need to be met to succeed:
V-shaped Recovery: “When a downturn in growth is followed by steep upturn”
Historical Precedence:Zarnowitz Rule: Deep recessions are almost always followed by steep recoveries.
This was exhibited over the last four recessions. The shallower than average recessions of the early 2000’s and 1990’s were followed by shallower than average recoveries. The deep recessions of the early 1980’s and 1970’s were followed by steep recoveries.
Conditions needed for a V-Shaped Recovery:Sustained recovery in U.S. consumer spending, including housing, autos and other durable goods with no significant increase in household savings. Significant Government spending and investment stretched out over several years. Significant increases in private investment. Strong export growth resumes, trade deficit shrinks further.
L-shaped (sideways) Recovery:“When a steep downturn in growth is followed by several years of sluggish recovery”
Historical Precedence:Financial & Global Recessions: An IMF study found that recessions caused by financial crises tend to be followed by slow recoveries. Similarly, recoveries from globally synchronized recessions are generally weak. After Japan’s real estate and stock market bubble burst in the 1990, its financial system was crippled. Economic growth averaged 0.5% over the next 10 years. This was dubbed the “lost decade".
Conditions needed for an L-Shaped Recovery:Very sluggish recovery in U.S. consumer spending with a significant increase in household savings. Significant Government spending and investment stretched out over several years. Modest increases in private investment. Export growth resumes and trade deficit stabilizes.
Be Proactive Regardless of What You Expect from the Market:What performed best going into the bottom will not likely perform the best coming out of it. Make sure you are comfortable with your asset allocation and security/fund selection. AND, if the story of something becomes too convincing, take a step back, maybe some profits as well, and watch for the inevitable bubble to grow and burst. With "preservation" being a key element to ones retirement future, having a bullish yet contrarian mind to these things may prove vital to your recovery. 'Luck.
