Forbes Guide to the Markets

What a difference a decade makes! Ten years ago, when the first edition of Forbes^® Guide to the Markets was published, the global economy was booming. “Dot com” was the watchword of the day—everybody wanted to work for one. “Dow 36000” was supposed to be just around the corner.

Today, the global economy is suffering. Bad news is everywhere. Everybody just wants to keep their job. We’re closer to Dow 3600 than Dow 36000. Some argue that economic conditions are akin to the Great Depression of the 1930s. Others see the buying opportunity of a lifetime, arguing that the prices of assets have fallen far below their true value. A third group sees some great opportunities amidst the carnage, but expects years to pass before the markets get back to normal.

How does one go about investing in times like these? Will things ever get back to normal? What is “normal,” anyway?

This question calls for some serious detective work, as practiced by a serious—if fictional—detective: Sam Spade. In The Maltese Falcon, Spade confronts the case of a man who disappeared apparently without any cause: “a man named Flitcraft.” It turns out that Flitcraft who, by all accounts had a great life, had simply disappeared: “‘He went like that,’ Spade said, ‘like a fist when you open your hand.’”

Spade first learns of the case five years after the disappearance; it turns out that Flitcraft had been walking to lunch and passed a construction site that had just the skeleton of an office building. “A beam or something fell eight or ten stories down and smacked the sidewalk alongside him . . . a piece of sidewalk was chipped off and flew up and hit his cheek . . . he still had the scar when I saw him. . . .”

Spade continues, “He was more shocked than frightened. He felt like somebody had taken the lid off life and let him look at the works.” This, it turns out, accounts for Flitcraft’s sudden disappearance. Though he “had been a good citizen and a good husband and father,” he knew now that men “lived only while blind chance spared them.”

I will come back to Spade’s story in a moment, but first we need to take a detour and talk about a close relative to “blind chance,” the concept of risk (a subject that deserves and has its own chapter). The financial crisis has brought the concept of risk to the center of investors’ collective awareness. In happier times, people focus on the expected return on their investments. Today, as Will Rogers once said, “I’m not so much concerned with the return on capital as I am with the return of capital.”

As a former chief risk officer of two multi-billion dollar hedge funds, I have thought a great deal about risk. From my perspective, it is important to recognize that risk changes over time, along with people’s perspective about it. From this standpoint, there was plenty of risk around in the late 90s, but it appeared in a different form—risk of losing ground against one’s peers, of not “keeping up with the Joneses.” Later, after the Internet bubble burst, the fear of losing what one had came to dominate the fear of not getting more.

Still later, as the housing bubble inflated in this decade, a new fear of missing out (and desire to profit) came to dominate. By early 2009, however, the collective risk profile of investors had transformed yet again, with ready cash valued as highly as “dot com” stock options were a decade earlier.

As we can see, a society’s ideas of “normal” or “expected” evolves over time. Ten years ago, at the end of a long secular bull market, most Americans were too young to remember the Great Depression of the 1930s. Many had grown up or were born after the stagflation of the 1970s. It was all too easy for the hard-earned lessons of those times to be written off as ancient history. From the standpoint of 2009, we are led to wonder: “What will the world look like in five or ten years? What existing data and theories are relevant to us as investors?”

These are excellent questions, for which there are no simple answers (which is probably the definition of an excellent question). The truth is that investors should always ask themselves which data and theories are relevant right now, and which are noise that should be ignored. In easier times, these questions tend to be given short shrift. Today, the opposite danger lurks, the danger of too much uncertainty leading to inability to make decisions—which can lead to significant regret over missed opportunities down the road.

As investors, we must strive to keep an emotional equilibrium conducive to intelligent decision making; we mustn’t yield to the twin temptations of impulsiveness and procrastination. We must “make haste slowly”!

In this spirit, I invite you to read the new edition of Forbes® Guide to the Markets. It has changed with the times, yet strives to reveal what is unchanging in markets—and in human nature.

So what became of Flitcraft? After the accident he disappears, wandering around for a few years, eventually settling down again and re-establishing a normal life like the one he’d had prior to the falling beam. As Spade tells it, “he had settled back naturally into the same groove he had jumped out of . . . that’s the part of it I always liked. He adjusted himself to beams falling, and then no more of them fell, and he adjusted himself to them not falling.”