INVESTING: Don't follow the crowds; follow these wise men

May 5, 2008

There are many things I do not understand. I don't understand why a golf gallery must remain "pin-drop" silent while a person hits a ball that sits stationary on a tee, yet fans can scream at the top of their lungs while a batter tries to hit a ball coming toward him at 95 miles per hour.

I also don't understand how economists take massive amounts of conflicting economic data, input the statistics into a model, and, presto, out comes the "right answer." At present, many of those models predict an economic upswing in the second half of the year.

I'm also perplexed that many market prognosticators recently have predicted that the worst is behind us and that investors have many attractive places to invest. Brokerage firm chiefs-as if they have any shred of credibility left-have come out to claim the credit crisis is over. And the market has obliged with a bit of a rally over the past couple of months.

When I am trying to gain a better understanding of something, instead of listening to the daily clatter trying to outshout one another with their specious arguments, I prefer the wisdom of a few people who have demonstrated track records, and-in keeping with the theme of my last column-whose genius is in making the complex simple.

Three top-notch thinkers have weighed in with comments over the past week or so that have reinforced my thinking that difficult times still lie ahead. Mohamed El-Erian, who returned to the fixed-income investment firm PIMCO last fall after spending two years running the Harvard Endowment, wrote an op-ed piece in the Financial Times titled, "Why this crisis is still far from finished." El-Erian suggests that the problems in the financial markets have just begun to spill into the real economy, and as consumers are confronted with declining credit, declining home values, higher food and energy costs, and a declining dollar, there will be further dislocations to come.

El-Erian ended his letter with this important message: "It is still too early for investors and policymakers to unfasten their seat belts. Instead, they should prepare for renewed volatility."

Warren Buffett, fresh off his participation in the acquisition of Wrigley by Mars Inc., commented that Berkshire's holdings in areas related to housing and retail are struggling. Noting the overhang of housing inventory will take time to work off, Buffett suggested the recession is likely to be longer and deeper than most people think. That being said, he added that this was not a prediction on the stock market, which "often does not behave in sync with what's going on in business."

Writing in his quarterly letter, Jeremy Grantham of the investment firm GMO is critical of the Fed's tolerance of asset bubbles and its subsequent bailouts of the parties responsible. While admitting that the alternative to bailouts is ugly, he despises that, instead of exacting a penalty for excessive risk-taking, the Fed has shifted the pain from the rich bankers to the taxpayers.

Concerning the stock market, Grantham is incredulous that security analysts are still predicting 15-percent growth in S&P 500 earnings. He warns that "high animal spirits will not give ground easily ... but just take a deep breath, hunker down with cash, and live to fight another day." At the same time, he said, be prepared for plenty of rallies, which are quite common in long-term bear markets.

Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.
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