By DAVID MOON, Moon Capital Management, LLC
February 12, 2012
It is human nature to become complacent when things are going well, yet this is often the time at which the greatest risks are present. Don’t berate yourself if you’re guilty of this. So are the smartest economists in the world.
Even after the housing bubble had reached its apex in 2006 and prices had already begun to decline, the members of the Federal Reserve Board completely underestimated – dismissed, actually – the possibility that falling housing prices could have a negative impact on the overall economy.
The economy had been so strong for so long it was hard to imagine anything else.
At his first meeting as Fed Chair in March 2006, Ben Bernanke acknowledged that housing prices had begun to decline, but overlooked any real negative fallout from the bursting bubble. “I agree with most of the commentary that the strong fundamentals support a relatively soft landing in housing…I think we are unlikely to see [economic] growth being derailed by the housing market.”
Six months later it was obvious that housing prices were falling fast and hard. Bernanke’s “soft landing” scenario was wrong. Then president of the Federal Reserve Bank in New York and current Treasury Secretary Tim Geithner, speaking of the possibility of the bursting housing bubble to deflate other parts of the economy, said “we just don’t see troubling signs yet of collateral damage and we are not expecting much.”
This bulletproof, cavalier attitude about the economy was building throughout the previous couple of years – the end of the Greenspan era as Fed Chair. One obviously bored researcher recently went through years of minutes from Fed meetings and found that as the housing market crept closer to its peak, the incidents of recorded laughter and joking around in the Fed meetings increased.
These guys were sitting at the helm of a ship that had already crashed into underwater rock and was taking on water. And they were completely oblivious.
In 2000, the Dow Jones Industrial Average was 11,000, after increasing from less than 1,000 in the previous 18 years. We had suffered only one very mild recession during those almost two decades. Like the housing market in 2006, the perceived risk in stocks was virtually non-existent.
Yet this was the point at which the greatest actual risk to stock prices existed since the 1920s. We were on the precipice of a 12-year period in which stock prices would return zero.
The perceived risks, however, were almost non-existent.
Like housing cost per square feet, stock prices per earnings were exorbitant in 2000. The P/E of the overall US market was more than twice its historic average.
The market’s P/E today is about 14, or just slightly below its long-term average. Yet investors are highly skeptical of the stock market today. The perception of risk is significant.
If our emotions tend to expect a continuation of the most recent past – even in the face of evidence to the contrary – what conclusions should we draw about the actual risk in stocks today?
And in what areas do unseen, easily-dismissed risks exist in abundance?
David Moon is president of Moon Capital Management, a
Knoxville-based investment management firm. This article
originally appeared in the News Sentinel (Knoxville, TN).