Underestimating the Next Boom

There are two types of investors: those who bet against Goldman Sachs and those who realize that Goldman Sachs is smarter and has better information than anyone else.

I'm in the latter camp. So I listened up when Goldman CEO Lloyd Blankfein talked about the market this week:

I can think of a million things that can go wrong, but what people underestimate, or under-assess, is that things can also go right. There's a lot of things that are going right, and the equity market may have it right. ... the situation in energy, which is not only going to drive manufacturing in this country, and ultimately will lead to jobs in the country, the turnaround in housing.

We have had a lot of problems. We haven't chewed through all of them. We haven't even chewed through all of part of them, but we've chewed through a lot of it, and you know, nobody sounds a gun or blows a whistle when things have gotten better. Sentiment is lagging, it's still slow, but I think the market as a whole is looking ahead and saying, "With these advantages, I think we could be on the threshold of a bull market."

Look what happened in the early 1980s. We came off a period of very poor sentiment for a long time. No one would have forecast a 20-year bull market cycle, and I can't even do that now, but I can tell you, the fact that sentiment is negative will have no bearing on what will happen.

Keep in mind what he didn't say here. He didn't say the market will keep rallying. He said people might be underestimating the odds that it could.

This, I think, is the smart way to be thinking about today's economy and market. At turning points, the biggest risk is running with the herd. In 2007, the biggest risk you faced was excessive optimism -- assuming that home prices would rise forever. That left you crushed when the tide went out. Today I think it's the other way around. The biggest risk now is excessive pessimism and the belief that economy will be stuck in a recession-like state forever. That could leave you (and has already left many) floundering in cash or overpriced bonds as the market rallies.

In both cases we're dealing with risks and probabilities, not certainties. What's important is knowing which way those probabilities lean. Despite some obvious threats, it's not hard to make the case that the odds lean in favor of a strengthening economy. 

Since 2008, the biggest drags on economic growth have been:

  • The decline in home prices.
  • The decline in residential investment.
  • Consumer debt deleveraging.
  • State and local job cuts.

All four of those are turning. Home prices have stabilized, and 1.3 million fewer homeowners are underwater on their mortgages than were in 2010. Housing starts are rebounding at a rate of 40% per year. Consumer deleveraging is likely nearing an end, and government job cuts have leveled off. We don't even need to talk about a new boom. Just the end of the headwinds could be enough to push the economy back toward normal growth.

Any number of things could happen to throw that off. Europe could implode. Interest rates could spike. A war could erupt. There will be more recessions in the future -- some of them will be big, and you won't see most of them coming.

But as financial advisor Carl Richards once wrote: "We focus so much on protecting ourselves from negative surprises (job loss, disability, divorce, death ... the whole catastrophe) that we forget to factor in the positive ones (a raise, a business that works out, a new career, a new bull market) that can sometimes change our entire outlook."

Five years after the start of the last recession, I think people are still underestimating the odds of goods things happening. Worse, I don't think most of them realize that underestimating those odds poses a threat to their wealth. 

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 14, 2013, at 3:03 PM, mdk0611 wrote:

    Are you betting against what GS is saying or what they're doing? And how do you find out what they're doing?

    http://www.zerohedge.com/news/2013-02-14/guess-who-was-buyin...

  • Report this Comment On February 14, 2013, at 3:40 PM, astuber9 wrote:

    Ray Dalio recently said something to the effect that there is a bubble in cash positions (and bonds), and his opinion is that it will move to equities in the next couple of years.

    My brain for some reason tends to connect better with the pessimistic themes that the bears talk about more often, but it is good to read differing viewpoints all along the continuum. If you don't, as Morgan points out it can be hazardous to your wealth.

  • Report this Comment On February 14, 2013, at 9:11 PM, Dyengii wrote:

    "Since 2008, the biggest drags on economic growth have been:

    The decline in home prices.

    The decline in residential investment.

    Consumer debt deleveraging.

    State and local job cuts.

    All four of those are turning. Home prices have stabilized, and 1.3 million fewer homeowners are underwater on their mortgages than were in 2010. Housing starts are rebounding at a rate of 40% per year. Consumer deleveraging is likely nearing an end, and government job cuts have leveled off. We don't even need to talk about a new boom. Just the end of the headwinds could be enough to push the economy back toward normal growth."

    Or the sequester could just crud things up again! :)

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