- Some experts are telling investors to indemnify their portfolios to a sinking economy and stock market.
- Facts and common sense reveal the global economy isn't nearly as noir a tale as widely believed.
- Protecting a portfolio from false risks can be a dangerous game for investors. Get the facts straight first.
Double Indemnity isn't just a super-cool, hard-boiled novel by James Cain, or one of the great achievements of film noir from Billy Wilder—it's today's market reality. When something is indemnified, it's being protected against hurt, loss, or damage. For instance, house insurance is an indemnification against the losses you'd incur if your house burned down.
Today's economic Armageddon true-believers are regularly espousing investment advice columns directing investors to indemnify themselves against a coming recession and bear market.
A Cushion for Uncertain Times
Anne Kates Smith, Kiplinger
In the film Double Indemnity, femme fatale Barbara Stanwyck lures an insurance salesman into a murder-for-insurance plot. If today's market analyses aren't a Stanwyck-ian scheme to get investors to fear a bear market on the back of misinterpreted data, then it's at least market noir.
Two examples from today's headlines make the case.
Weakest Holiday Season in Years
By Parija B. Kavilanz, CNNMoney.com
The article opens: "Retailers reported deep declines in their December sales Thursday, reflecting a 2007 holiday shopping season that is turning out to be the weakest in years."
But, just a few paragraphs lower, "In the overall retail sector, Thomson Financial, which also compares monthly results at 43 of the nation's largest retail chains based on analysts' estimates, said total December same-store sales rose just 0.5 percent compared to its revised estimate for a 0.7 percent gain. That's much weaker than the 3.3 percent gain for the same period in 2006."
Ok. That's not great, but it's explicitly true that holiday sales gained in 2007. Aggregate sales didn't recede, they only appeared dismal because some individual retailers posted poor results. There's more: "Even though November same-store sales rose a much better 4 percent overall, the average of the two months [including December] taken together showed a 2.3 percent rise, which Thomson said is the slowest pace of growth since 2004 when sales for the two months combined also rose 2.3 percent." Well, 2004 was a fine year for economic growth and so was the year after. Indemnity one.
Mortgage-Meltdown Upside: Lower Rates
By Brett Arends, The Wall Street Journal
We quote: "The reason mortgage rates have fallen so far isn't hard to find: Deepening fears over the economy. Nervous investors have shifted their money from riskier assets into U.S. government bonds, bidding up the price of the bonds and thereby lowering the yield. And that brings down the cost of long-term capital for other loans, including mortgages."
Mere common sense should raise a red flag on this one. It's true that Treasury bond yields are generally the base rate for a mortgage, and it's also probably true money is flowing into Treasuries as a "flight to quality." But the margin between the base rate and the actual rate can vary widely, and this is driven specifically by market conditions based on perceived risk and return. That spread hasn't widened for many kinds of debt, including mortgages. In the case of investment-grade corporations, it's actually flat or slightly less than a year ago. When market determined rates are low, it means the liquidity environment is ample and folks are willing to lend. It's perverse and wrong logic to believe housing and economic fears are driving lending rates lower. In truth, it's probably because conditions are better than most realize.
Even if fears about mortgages are driving mortgage rates lower, it's still impossible to say there's a credit crunch because folks clearly have tons of liquidity available to park their cash in those Treasuries. A true liquidity crunch is an explicit lack of cash, and it would take enormous amounts of capital to drive Treasury bonds so low in the first place.
Oh, but the plot thickens.
"But rates right now are very cheap by historic standards. The law of mean reversion would suggest they are more likely to rise from this point than to fall further."
The "law" of mean reversion is probably one of the most misunderstood concepts in finance today. It's a theory suggesting prices and returns eventually move towards the mean or average over time. There is no fundamental reason markets or economic growth must return to any sort of average. And there is no definitively right measurement period to determine what the right "average" is. Similar ideas about an "aging" bull market are just as superstitious.
These are just two examples. There are many others out there. Don't indemnify yourself against a presumed bear market based on false pretenses. That's not a noir tale worth the telling.