Wednesday, December 30, 2009

Are homes cheap now? Relative to what?

This is an excellent article, and a good reminder, by Calculated Risk that is titled "Are homes now cheap" that describes the trap for buyers today who have a short to mid-term holding time frame. In this article, he shows that the purchase today of a home with a 5%, 30 year mortgage, would allow the buyer to have a mortgage of $186,282 with a monthly p&i of $1,000. The buyer plans to sell this property in seven years and expects mortgage rates to be 7% at that time. The new buyer has the same $1,000 payment in mind and finds that with interest rates now at 7% the maximum mortgage amount is only $150,308. For this property to sell in seven years something will have to change. Unless the employment rate improves a lot from today, it will be the sale price that most likely gets the change, to a lower amount. Be careful out there.

Tuesday, December 29, 2009

Risk receptive or risk averse? What is risk?

Today I am reading an article by John Hussman titled "Clarity and Valuation" that, among other things, describes very simply his definition of risk and when he feels receptive and averse. John Hussman is a mutual fund manager and so his point of view has daily value to him and his investors. He is analyzing the probability of risk as opposed to forecasting risk based on fundamental analysis.

What is risk, first of all? When describing risk to a client I would say, the historic returns for this investment over a certain time period are this number. The relevant index for the same time period resulted in this number and the potential for a different number, higher or lower, is the 2X standard deviation number, normally a big number. The larger the standard deviation, the higher is the range of potential returns. What Hussman does is reduce the expected returns to the typical outcome associated with the conditions observed in the economy at this point in time, and includes a range of other possible outcomes as well. Here is more from the Hussman article described earlier...

Monday, December 21, 2009

Why bond mutual funds?

I have reported that bond mutual funds have been getting the majority of new dollars from fund investors, according to Strategic Insights. So what are the expectations from a portfolio of corporate bonds. Here are a couple of charts from the St Louis Federal Reserve illustrating current yields on two types of bonds, high quality (Moody's AAA) and medium quality (Moody's BAA).

Click on graph for a larger image

As you know, bond yields and prices move in opposite directions to each other. So as yields have come down, prices have moved up. And many would say that the opportunity for big double digit returns from bond funds, as we have recently enjoyed, is a once in a lifetime opportunity. These graphs seem to illustrate that too. As you can see, yields have dropped to near recent historic low levels, not leaving much hope for still lower yields and higher prices. In this environment, mutual funds that use a buy and hold strategy can expect no more than the coupon (dividends). On the other hand, funds that employ trading strategies to take advantage of apparent mispricing could add to the total return of the fund. Scanner

What about the US financial system? Inflation, Deflation or Stagflation?

No one will ever forget that the financial crisis began to take on frightening proportions that was creating a self-sustaining death spiral, when it became clear how much trouble the big banks and non-financial lenders were in. We witnessed the failure of Bear Stearns, the demise of the GSE's, Fannie and Freddie, and the rest... you know.

The banks are the source of credit that consumers and commercial borrowers need to be functioning in order for the US economy to recover. So far, the consumer is missing in action in the economy, placing all the pressure on both commercial and government balance sheets. Commercial balance sheets are doing everything possible to restore financial health, including cutting expenses by laying off workers and paying off debt. Most businesses do not have pricing power, so prices are holding the line. The lenders are lending too little to assist with economic recovery and expansion. The only entity stimulating our economy is the US Treasury, by printing new dollar bills.

Many of the 2010 outlooks I read are concerned about the timing of Fed tightening. Tightening is a way of describing an undefined process (policy) of getting the money out of circulation. How the Fed, will do it is unclear and there is not widespread confidence that they can do it without increasing inflation expectations that could also become self-sustaining and fulfilled. The result is a vote of no confidence so far, which is reflected in the dollar index. The widespread assumption is that tightening is going to happen and that the Fed will make mistakes in their implementation of it. The question is seldom will there be a need for tightening. What's up with that? I wonder about the wisdom in this assumption. Are people forgetting how we got here and what has happened to make things appear to be improved, the condition we desperately want to believe.

Sunday, December 20, 2009

Don't trash our US Treasury reserve holdings, or else...

Another gem found on Safe Haven is written by Clive Maund, a gold bug. His article is making several observations that are important to be alert to. He is in a small number of market watchers calling for a much higher dollar. Most interesting, is the discussion that the stock market is subordinate to the Treasury market and is therefore a sacrificial lamb anytime protection of the dollar is needed. Finally, his article includes an interesting technical analysis of gold and it lends support to his other points, such as a strong dollar. This is certainly effective at helping me better appreciate the job in front of Bernanke.

Big overseas Treasury holders such China and Japan are believed to have "strong-armed" the US in the recent past behind the scenes and essentially said "You either quit undermining your currency and defrauding us with your zero interest rate policy or we are going to dump them, big time, and collapse the Treasury market." The Treasury market is the "aorta" of the US, which involves swapping essentially worthless paper for the goods and services of countries that are dumb enough to buy them, thus allowing the US to live way beyond its means running continuous massive deficits. It is viewed by the administration as infinitely more important than the stockmarket, which is small in comparison. It is thus clear that if it is necessary to sacrifice the stockmarket by raising interest rates to rescue the Treasury market, then that is what's going to happen.

Saturday, December 19, 2009

Still bond mutual funds over all others

Strategic Insight is reporting that November mutual fund flows are still moving into income paying bond mutual funds, probably leaving maturing CD's. Here is their summary...

Flows into bond funds in November, although somewhat off from the blistering pace of the prior three months, were very robust at $38 billion. Driven by continued strong demand for income in a near-zero cash yield environment, bond fund flows have reached extraordinary levels in 2009. In contrast, notwithstanding a 4.8% rise in NAVs on average (asset-weighted) in November, stock/hybrid funds received only small inflows over the month, because of continued concerns about the sustainability of the global economic and stock market revival.

2010 Outlook from a dollar watcher

Axel Merk manages mutual funds specializing in currencies. He too has posted an article on Safe Haven to describe his analysis of the statements coming in the follow up analysis of the recent Fed Open Market Committee meetings. His article is brief and to the point. Read it here.

Axel Merk is saying what I think is most likely, assuming no unexpected financial shocks. The expected ones (CMBS, RMBS, other defaults) are still coming! And he is using his world wide perspective.

As a result, it seems that the Fed may indeed halt the massive balance sheet expansion at the end of the first quarter of 2010, but such a break is not indicative of tightening, but a pause at an extraordinarily accommodative level.

In our assessment, the Fed is continuing to ease at a time when the European Central Bank (ECB) has already withdrawn liquidity and central banks ranging from Australia to Norway have raised interest rates. It seems rather unlikely to us that the Fed will have a tighter policy than the ECB in 2010. Of course, the eurozone faces challenges in Greece, Ireland and Spain, amongst others; but the U.S. will also face substantial headwinds, for example, commercial real estate. Ultimately, the global tightening wave many market observers are predicting in 2010 may be far weaker than priced into the markets.

2010 Economic Outlook

It's time to post some economic outlooks from sources not affiliated with mainstream investment companies. The mainstream can be readily identified by their marquis brand names and reputation for being on the speed dials of the Bernanke and Geitner phones. Is it possible that there is someone employed by a high profile employer, who would acknowledge the conflict of interest that employment places them in so that objective analysis is plausible? Yes it is possible, but I am not interested.

Today, I am reading the work of Paul Kasriel, Director of Economic Research at Northern Trust Co. He has posted his economic outlook on Safe Haven and a link to it is here. I find his analysis to be a little more optimistic than many of the opinions I am reading. His forecast, in my opinion, assumes there are not going to be economic shocks during 2010 and that the modest improvements we have noticed during the past few months will be sustained, leading to no improvement in unemployment. So it is not rosy by any means. Here is a sample from his outlook to give you a flavor of his GDP outlook and inflation forecast.

Thursday, December 17, 2009

Housing Starts, a leading indicator

This was found at Bloomberg yesterday:

Housing starts looked good for November but most of the gain was largely a comeback and then some in multifamily starts-a volatile component. The single-family component posted only a partial rebound. Construction companies picked up the pace of groundbreaking for new homes as housing starts in November rebounded 8.9 percent, following a revised 10.1 percent plummet in October. The November pace of 0.574 million units annualized came in right at the market forecast for 0.575 million units and was down 12.4 percent on a year-ago basis. The latest comeback was led by a 67.3 percent rebound in multifamily starts, following a sharp 29.5 percent plunge in October. Meanwhile the single-family component edged up 2.1 percent after a 7.1 percent fall the month before.

A housing start is registered at the start of construction of a new building intended primarily as a residential building. The start of construction is defined as the beginning of excavation of the foundation for the building.

Wednesday, December 16, 2009

Scanning for more US$ knowledge

Merk Funds specializes in global bonds and currency investing. They offer an example of what might cause downward pressure on the dollar in light of today's environment. Their web site provides much more depth for inquiring minds.

Numerous factors affect the value of a currency. Although financial pundits within the media give a reason(s) for every move, it is usually not possible to pinpoint exactly why a currency has moved. What we can do, however, is to look at the big picture: we can analyze large forces weighing on the markets.

In explaining the fall of the U.S. dollar, one factor we focus on is the current account deficit. The current account deficit is the difference between what Americans earn from other countries (exports, services, investments abroad) and what we pay out to other countries (imports, services, loans). This shortfall in trade and investment income between the U.S. and the rest of the world amounted $673.3 billion in 2008. As a share of gross domestic product (GDP), the deficit amounted for 4.7% in 2008. Foreigners must absorb this shortfall by buying about $2 billion worth of U.S. dollar denominated assets every single day, just to keep the U.S. dollar from falling.

Tuesday, December 15, 2009

Bernanke fires back with answers to Senator Bunning's questions

Senator Bunning has received responses to 70 questions posed to the Fed Chairman recently at his reconfirmation hearing. This is a quick read, and I recommend it. The questions cover a wide array of topics. Those that surface often concern inflation, AIG, the price of gold and the Fed's role in the financial crisis, to name a few. Here are some sample questions and replies:

6. Time and energy in macroeconomic analysis is spent attempting to measure business and consumer confidence. Confidence measures are part of macroeconomic forecasting and directly impact monetary policy decisions. Likewise, certain market movements reflect investor confidence or lack of confidence. Gold is at an all-time high because investors have lost confidence in policymakers' handling of fiat currencies. How is the Fed incorporating this market information into its analytical framework? Does the lack of confidence in fiat currencies have the potential to impact monetary policy?

Scanning for Knowledge on the US$

The following is a press release from the Treasury:

December 15, 2009


Treasury International Capital Data for October

The U.S. Department of the Treasury today released Treasury International Capital (TIC) data for October 2009. The next release, which will report on data for November 2009, is scheduled for January 19, 2010.

Net foreign purchases of long-term securities were $20.7 billion.

Net foreign purchases of long-term U.S. securities were $43.4 billion. Of this, net purchases by private foreign investors were $28.8 billion, and net purchases by foreign official institutions were $14.6 billion.

U.S. residents purchased a net $22.7 billion of long-term foreign securities.

Net foreign acquisition of long-term securities, taking into account adjustments, is estimated to have been $8.3 billion.

Industrial Production measures are updated today

The Federal Reserve has updated it series on industrial production today. A quick look at the updated graph of the index value and we can see there is life returning in this leading indicator. Keynesian's say this is also one of the leading indicators of inflation.

click on the graph for a larger view

Yahoo News is reporting on the Fed update, here is a small piece of their report:
 Stronger activity at mines led last month's increase in industrial production, rising 2.1 percent. The manufacturing sector — the biggest chunk of industrial output — rose 1.1 percent. Utilities fell 1.8 percent, according to the Fed report.

The portion of industrial capacity in use rose to 71.3 percent, from 70.6 percent in October. It shows that factories, mines and utilities are using more of their plants as the recovery takes root. But capacity use remains far below the 80 percent level that existed for part of the past decade.

This update does not show me a reason to change my current outlook position, which is slow to no economic growth and unemployment remaining above 10% for most of 2010.

Monday, December 14, 2009

Dollar relationship to financial assets

You may have puzzled over the relationship of the US$ to the stock, commodity and bond markets. The relationship has been very difficult for me to rationalize. If I were to briefly describe my understanding in simple terms, here is what I would say. The dollar value is a reflection of the sentiment of other governments, with different currencies, toward the US economy in relation to their currency. In other words, if in the eyes of a foreign investor, there is more risk for investing in their local currency and markets than for the same investing in US markets, they will buy dollar based assets even with a less valuable currency, increasing their cost. Now, as other currencies around the world deal with the financial crisis the way they need to, observers evaluate the result of their action and determine the risk it creates on investments and the stability of their currency. The result is sometimes a move to safe investments, sometimes the addition of risk investments. Since the US$ is still viewed a safe currency, the move to safety stimulates an upward change in the dollar while the move to risk does the opposite, stimulates a downward change. Some would describe the upward move as strengthening and the downward move as weakening. These adjectives carry connotations that are misleading. The weakening of the dollar is not necessarily a sign of a

Sunday, December 13, 2009

What do Tiger Woods and Ben Bernanke have in common?

They each have us guessing about the definition of their open-ended period for the timing of their next decision. The next decisions will be of great importance for everyone who follows these two market movers and shakers. Bloomberg has two articles about these two topics today. Here are a couple of snapshots from each.

Fed Chairman Ben S. Bernanke said Dec. 3 he doesn’t rule out using monetary policy to prevent unfounded increases in asset prices, though he said financial regulation is a better approach. Bernanke said this week the U.S. economy continues to face “formidable headwinds,” signaling the Fed will keep its benchmark interest rate near zero for an extended period.

“They need to be very early in executing their exit strategies,” Roach, a former Fed economist, told Bloomberg Television. “I take Mr. Bernanke at his word that he’s looking for an extended period of monetary accommodation, which, quite frankly, I find very worrisome in assessing the prospects of a next bubble and the next crisis.”

“We’ve obviously done golf tournaments without Tiger before,” Sean McManus, president of CBS Sports and News, told the New York Times. “We’ll adjust, but I guess a lot of it depends on what the definition of the word ‘indefinite’ is.”

Geoff Ogilvy, the 2006 U.S. Open champion, said at the Australian PGA Championship that all golfers had a stake in Woods’s story.

“If Tiger Woods indefinitely doesn’t play golf,” Ogilvy said, “that’s not good for us.”

Friday, December 11, 2009

The Conference Board Economic Forecast for the U.S. Economy

December 8, 2009

Rough road back to solid growth

Growth has returned to the U.S. economy. With our forecast of 3.4 percent growth in Q4, up from 2.8 percent in Q3, the year will end on significantly better footing than how it began. However, the underlying drivers still very much reflect an economy rebounding from a deep contraction, which can be seen in particular from the slowdown in the depletion of inventories (likely to be the biggest contributor to Q4 growth). The Conference Board Consumer Confidence Index® has been moving sideways for several months, and in October we also saw The Conference Board Leading Economic IndexTM (LEI) for the United States level off following six months of sharp increases. The question now is how rapidly can the more sustainable sources of growth take over. Consumption is weak and is forecast to drop off somewhat after the holidays. Investment remains badly affected by the commercial real estate market, and opportunities for new investment in equipment and software remain subdued. Exports show some positive growth, with the low dollar providing some help. But the United States’ biggest export markets ─ other advanced economies ─ are not growing rapidly either. Growth in 2010 is likely to be disappointing, with rates hovering around 1.5-2 percent, not enough to push down unemployment, which will likely peak at 10.5 percent by spring.
Source: The Conference Board

2010 is going to be one miserable year for nearly everyone

Today, Mish is writing about the steepening yield curve . He points out it has reached its steepest slope since 1980! He does not stop there and by the end, Mish has made a sweeping prediction for investors in 2010. Please be seated.

"In the absence of a war outbreak in the Middle East or Pakistan -- and/or Congress going completely insane with more stimulus efforts -- I think oil prices are likely to drop, the dollar will strengthen or at least hold its own, and the best opportunities are likely to be on the short side," he writes. "2010 is highly likely to retrace most if not all of the ‘reflation' efforts of 2009. If things play out as I suspect, 2010 will be the year of the great retrace as the economic recovery disappoints."

If his outlook plays out, I expect to use short equity strategies and high grade corporate bonds with durations on the 1-2 year range. Commodities will get some time off, and gold may take on a new purpose. Jurrien Timmer, a market strategist and portfolio manager at Fidelity has said that if we are in a deflationary market environment, he would move to just money markets, treasuries and gold. Might it come to that? Stay tuned, it's not time to rest. Scanner

Wednesday, December 9, 2009

Fight the Fed (Treasury)?

The AP is reporting this morning on Geitner's decision to extend the duration of the TARP and widen its scope to include smaller banks with commercial real estate exposure and programs to slow the rate of home foreclosures. The article includes some analysis of how well TARP has measured up to intentions of Congress when it was authorized. Elizabeth Warren, the chair of the Congressional Oversight Committee is reported in the article to offer these remarks...

In a report Wednesday, a TARP watchdog panel said the fund helped ease last fall's financial panic, but was less successful in meeting other goals Congress set — including reducing foreclosures and unfreezing credit for consumers and businesses.

"Congress set goals for the TARP that went well beyond short-term financial stability, and by that measure problems remain," said panel chair and Harvard Law school professor Elizabeth Warren.

Tuesday, December 8, 2009

Heads-up for "January Effect"

This observation was found on Financial Sense, written by Robert McHugh.

Stocks are approaching a typically Bearish seasonal time, from the last few days of December through the end of January. This new wrinkle for the "January Effect" is reason for caution. Measureable declines, several of which were significant, have started the last week of December, or in January, in 8 of the past 10 years, with a ninth top occurring in early February in 2007. If you include 2007, that is 9 out of the past 10 years.
The article is titled A New Wrinkle for the "January Effect" in Stocks .

Meredith Whitney on CNBC, The Fed is "Out of Bullets"

This lady is a voice you have to pay attention to, despite her gloomy tone. She was right about the credit crisis and called it early. She was right about the condition of the big banks and predicted stock prices collapsing before they did.

The government is running out of ways to help the economy as the US faces major issues regarding credit and employment ahead, banking analyst Meredith Whitney told CNBC.

"I think they're out of bullets," Whitney said in an interview during which she reinforced remarks she made last month indicating she is strongly pessimistic about the prospects for recovery.

Primary among her concerns is the lack of credit access for consumers who she said are "getting kicked out of the financial system." She said that will be the prevailing trend in 2010.

Despite being able to borrow at near-zero percent interest, banks are not taking that money and putting it back into the marketplace. The Federal Reserve said Monday that consumer lending dropped 1.7 percent on an annualized basis in October, the ninth straight monthly decline.

Here is a link to the article which includes a video clip of her appearance...  Meredith Whitney on CNBC

The Fed and free markets

Michael Shedlock (Mish) is posting an article on his blog this morning that includes an excerpt from one of his posts from April of 2008. In the earlier post, he creates an interesting question, can the usefullness of the Fed be determined using objective means? I know this is more of his campaign to end the Fed, at least as we know it today, if not completely. Some of his contentions revolve around the notion of free markets and that the Fed is the big disruptor of free markets. So what exactly is a free market? I found an answer that I think Mish will agree with, in an essay on the topic by Murray Rothbard, noted author, economist and proponent of Austrian economic theory.

The Free market is a summary term for an array of exchanges that take place in society. Each exchange is undertaken as a voluntary agreement between two people or between groups of people represented by agents. These two individuals (or agents) exchange two economic goods, either tangible commodities or nontangible services. Thus, when I buy a newspaper from a news dealer for fifty cents, the news dealer and I exchange two commodities: I give up fifty cents, and the news dealer gives up the newspaper. Or if I work for a corporation, I exchange my labor services, in a mutually agreed way, for a monetary salary; here the corporation is represented by a manager (an agent) with the authority to hire.

Both parties undertake the exchange because each expects to gain from it. Also, each will repeat the exchange next time (or refuse to) because his expectation has proved correct (or incorrect) in the recent past. Trade, or exchange, is engaged in precisely because both parties benefit; if they did not expect to gain, they would not agree to the exchange.

This definition creates a very friendly concept. Here every participant is thoughtful, honest and a responsible participant in the free market society. Where is this place? As I continue to research the information I need for this article, it is becoming more political. I apologize. That is not what I want out this blog. However, I am the primary beneficiary of the writing here and so please consider this article as a message to myself and you are free to read.

Rothbard continues in his essay to describe in more depth how he envisions a free market society.

Monday, December 7, 2009

TCW bond fund managers quit after firm ousts investment chief

L.A. money manager TCW Group is facing defections by some of its top bond fund talent after the firm on Friday fired Jeffrey Gundlach, its veteran chief investment officer.

Some of the managers who worked directly with Gundlach for the last two decades in TCW’s fixed-income group resigned on Saturday despite the firm’s efforts to keep them.

Those departing included Philip Barach and Louis Lucido, two senior managers of TCW’s mortgage-backed securities portfolios. Barach also was co-manager, with Gundlach, of TCW’s $12-billion-asset Total Return Bond fund, the firm’s top-performing mutual fund.

Friday, December 4, 2009

Mutual Funds net flows into bond funds and out of equity funds

From Strategic Insight, as of 11/19/2009:

For the third consecutive month, investors deposited a $40 billion-plus amount into bond funds, bringing year-to-date bond fund flow volumes to an enormous $330 billion. International equity fund flows rose to $14 billion in October. US equity funds, in contrast suffered net outflows (for the second straight month), reducing the aggregate equity fund net flow total for October to $7 billion.

Gold, is the luster off?

Gold is a timely topic today, as a friend so presciently pointed out yesterday. This morning the SPDR Gold Bullion Trust (GLD) is down 5%. I imagine funds that invest in the miners will see negative 10-12% results today, if the weakness continues into the close. The miner's are very volatile normally, so the result should be expected, though these results have not been observed very much this year. So the question is asked, is today's market seeing a tide change for gold? Is there continued price weakness ahead?

Recently, a detailed analysis of gold and the forces that work for and against it was posted on Financial Sense by Chris Puplava. He is very analytical in his work and uses a lot of charts to illustrate his message. Here is a link to his 11/25/2009 article for those interested in an in depth analysis.
Here is the conclusion he makes, for you bottom liners:

In short, an object in motion tends to stay in motion and that is certainly the case with gold. The bullish supports for gold are far greater than any bearish factors and even a USD rally may not stop gold as was seen in the 1st half of the 05/06 rally and the 2nd half of the 07/08 rally. Given that the IRD (interest rate differential) between the US Fed and other central banks is likely to weaken going forward, it is hard to envision a strong cyclical bull market in the USD that would derail gold. As shown from prior gold advances, gold may move close to the $1,500 an ounce mark before this advance is over, and relative to fiat currencies, the secular bull market in gold may continue until gold hits levels as high as $6,888 to $7,321 an ounce. You’ve heard many times over the past year that “the worst is yet ahead” in reference to the U.S. economy or credit markets. Well, in terms of gold it appears that “the best is yet ahead.”

Thursday, December 3, 2009

Senator Bunning takes dead aim on Bernanke & pulls the trigger

Senator Bunning says to the Fed Chairman during the Senate's confirmation hearing today, "You are the definition of a moral hazard".

I don't know of a more ardent supporter of legislation to audit the Fed than Michael Shedlock (Mish). He has also been very open about his belief that the Fed actions, especially allowing fractional reserve lending, has been a major contributor to the credit crisis. He is not suggesting the Fed intended to cause a crisis but that they failed to understand the implications of what they were creating even though many others outside of big banks and AIG did. And then the Fed was not open to listening. Today Mish has a post on his blog you will want to look at when you can. Here is a link:

Hopefully Sen. Bunning will not be alone in expressing complete dissatisfaction of Bernanke this time. Read the post and leave a comment, here or there. Scanner

Wednesday, December 2, 2009

Elitism, do we really benefit from it?

This morning I read the lead article at Baseline Scenario, Feudal Lord's of Finance, by Simon Johnson. link:

It is a brief consideration of why we have elitism in our American culture and the big banks in particular. It asks the question... is there some way we benefit from a growing class of elitists. It is a mildly intriguing article. When I got to reading a few comments, I realized this is a hot button! People are really locked on to this discussion much more than I have any clue. Read it.

Then I asked myself, what power do I have to make change occur and not feel like one of a million ants following the leaders over the cliff and into their wallet. The way we Americans can express our feelings is to leave the big banks a clear message. The message is good-bye! They will not go out of business. That is not the aim. The aim is to make it clear they are not where we place our business anymore. They had and lost it. It was their's to lose and they did. Saying good-bye is appropriate. We can sit in judgment of them. That is our privilege.

Doing business locally is beginning to look a lot more important than ever. It's now about developing local, long-term, quality jobs. So, where do you move your account? Of course I would like you to have my experience, at a credit union that is convenient for you. If you would like to consider this more, I have found a site that will help locate credit unions in your area. Here is a link: . This is not the last best idea. Please feel free to leave a comment of your own, here or on Baseline Scenario. Scanner

Tuesday, December 1, 2009

Please, Just Lie to Me. A lesson on Financial Cognitive Dissonance.

Contributed by: Anonymous, aka: Curious George
What is cognitive dissonance?

Anxiety that results from simultaneously holding contradictory or otherwise incompatible attitudes, beliefs, or the like, as when one likes a person but disapproves strongly of one of his or her habits. (

It’s not so much the definition of cognitive dissonance but rather how we respond to it that is important. If investment decisions are built on untruths, results will suffer. Every day we are presented with conflicting information and we are conflicted in what to believe. If one wants good investment results then good information really does matter. So, where is the truth?

Social psychologist Leon Festinger says “Dissonance and consonance are relations among cognitions that is, among opinions, beliefs, knowledge of the environment, and knowledge of one's own actions and feelings. Two opinions, or beliefs, or items of knowledge are dissonant with each other if they do not fit together; that is, if they are inconsistent, or if, considering only the particular two items, one does not follow from the other” (Leon Festinger 1956: 25).

His three ways of dealing with cognitive dissonance

1. One may try to change one or more of the beliefs, opinions, or behaviors involved in the dissonance;

2. One may try to acquire new information or beliefs that will increase the existing consonance and thus cause the total dissonance to be reduced; or,

3. One may try to forget or reduce the importance of those cognitions that are in a dissonant relationship (Festinger 1956: 25-26).

Let’s try a real world example

Iceland, one year later

By Chad Thomas and Omar Valdimarsson

Oct. 12 (Bloomberg) -- Arni Hallgrimsson lost his job as a public relations consultant when Iceland’s three biggest banks collapsed last year, putting him out of work for the first time since 1980. After a stint cleaning the docks at a whaling station during the summer hunt, he’s unemployed again.

“Nightmares come to an end when you wake up, but this one just goes on and on and on and on,” the 53-year-old father of three said at his home in Reykjavik, Iceland’s capital. “I’ve applied for many jobs that fit my profile. Sometimes I’ve been on the short-list, but eventually not been offered the job.”

A year after the banking crisis brought Iceland to the brink of bankruptcy, the island nation is mired in the deepest recession among advanced economies. The stock market has lost 97 percent of its value, and more than 780 companies have buckled under the weight of foreign currency loans as the krona plunged. Consumers refuse to borrow at Europe’s highest interest rates, and international banks reject requests for new financing.