Those of you who were better history students than I may remember the philosopher's stone from your study of the Middle Ages, although it was Van Morrison’s song of the same name which recently piqued my interest. The philosopher’s stone is a legendary alchemical tool, supposedly capable of turning lead into gold. In the view of some early scientists, even one as otherwise advanced as Sir Isaac Newton, it would provide its owner with enlightenment in addition to extreme wealth.
Clearly anything possessing the ability to turn lead into gold would have value literally beyond measure. But, in fact, I think a large number of us have cooperated to accomplish something quite similar over the past six months. Through our combined efforts, we have turned the lead of our investment portfolios into gold or, at least, have increased most account values considerably.
Following an up-and-down start at the first of the year, the market (as measured by the S&P 500) gained about 17.5% through the end of July. When I wrote back in November and December that we were going to remain invested on behalf of our clients, one of the reasons I did not include is that selling into a declining market requires not one but two decisions. After having chosen to sell, you have to decide when to buy back in. When I hear from people who are considering that step now, the usual reasoning is something like, “It looks as if the recovery is real.” The problem is, having absorbed whatever loss accompanied their decision to sell, they are now significantly behind the market and may feel the need to assume an overly aggressive approach in hopes of catching up.
It’s important to remember that stock markets are a leading indicator, that is, their rise predicts an improvement in the overall economy. I believe it’s too soon to say that the recession is over, thus too soon to declare that a long-term positive market trend has begun. Back in December, I quoted Warren Buffett’s comment: “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.” Greed is one of the primary drivers of people’s return to the markets. I have become concerned that those amateur investors who tend to do the wrong thing at the right time (or vice versa) are preparing to leap into a market that’s not yet ready to sustain significantly increased buying.
Peter Bernstein was an economist and historian whose writings I have followed for many years. He maintained that, regardless of the amount of information available, the future will always be unknowable. Even though some analysts claim to have forecast the market’s meltdown in response to the mortgage crisis, I don't know of any whose overall predictive successes are greater than chance. Thus I continue to believe that Bernstein is correct: it is impossible to predict the future, including market declines. Our underlying investment philosophy is to protect our clients from the worst of the market’s ravages through diversification. That has worked for us in the past and worked again during this most recent correction. One additional advantage of this approach is never having to decide when it’s the right time to get back into the markets.
That said, the further bullish sentiments spread, the more concerned I become. Although markets have made a good showing so far this year, I suspect that we’ll get at least one more pull-back so I am repositioning some of our clients’ assets in hopes of once again helping them avoid significant losses.
Unfortunately, the philosopher’s stone has eluded me just as it did the thinkers of the Middle Ages. I have achieved neither the promised enlightenment nor the ability to turn my clients’ assets into gold. However, I can safely reiterate our firm’s commitment to a strategy that tries to protect them from market-related losses while also allowing them to participate in market upswings. Unless and until I obtain the philosopher’s stone this seems the most prudent course of action.
