Data or Relationships

Wow, what a harrowing swing we have seen in the stock and bond markets of late. Asset allocation, which reduces the downside risk of investing, provided no safety in the July to August market correction. All major equity indices were down at least 10% from their earlier market peaks. Why? We are seeing a realization of some of the fears that were first showing up in theory in February 2007.

These are just some of the headlines in recent pages of the financial press.

  • The pace of construction of new homes fell in July to the lowest in nearly 11 years. Housing starts reached an annual rate of 1.4 million units, down 6.1% from June and 21% below July 2006 levels and was the weakest reading for housing starts since January 1997.
  • Countrywide Financial shocked the markets by stating it would tap its entire $11.5 billion line of credit.
  • The Chicago Board Options Exchange’s volatility index, or “fear gauge,” hit levels not seen since the October 2002 bear market.
  • The Japanese yen rallied vs. the dollar by the most since 1998, according to Bloomberg News, as speculators unwound risky “carry trades” where low interest rates in Japan have allowed traders to borrow yen and use the money to buy riskier and higher-yielding assets in other countries. Fearing market turbulence, speculators undid their trades by buying yen and closing their positions thus adding more volume and volatility to the markets.

With all of that said, as of this writing, the Federal Reserve Board made a symbolic cut in the rarely used discount rate which affects banks borrowing from the Fed in overnight transactions, i.e. this action provided an increased liquidity in the markets. Will we see a cut in the more followed federal funds rate which affects short term rates such as credit card debts, adjustable rate mortgage, auto loans and the like? Maybe. The Federal Reserve has more to their job than just making the markets happy. As such, the inflation concerns which still abound would be a reason to not cut this rate. The Fed can not step in every time the investment community makes stupid decisions and bail out those who are causing them, i.e. the unregulated hedge funds using collateralized mortgage debts. If they bail them out, what concept will be the next bubble to possibly burst and be expecting a bailout. However, the odds of the Fed actually cutting the rates and “doing what is needed with all tools available,” according to Christopher Dodd of the Senate Banking Committee, has increased.

We never know what tomorrow will bring in the markets and the underlying fundamentals – lower than historically average price to earnings ratios, relatively strong corporate earnings and other economic factors point to a market that could rise. Whatever the reactions, expect volatility, up and down, to continue throughout 2007.

The volatility we are seeing is not rare. In fact, it is common. To test this, I reviewed all trading data on the S&P 500 from January, 1, 1995 – August 15, 2007. There were 3,177 trading days in that time frame and out of those 3,177 days, 508 days (almost 16%) saw intraday swings of > 2%, i.e. from the trading high to low (not open to close). While five of the worst 100 trading days have been in 2007, none have been in the top 10. As of this research, 2007 occupied only 155 trading days out of 3,177 population days or approximately 5.0%. If 5 out of the worst 100 trading days occurred in 2007, this also represents 5% which would be an expected ratio.

The worst performing day was October 27, 1997 which was down 6.87% from open to close. The biggest intraday swing was July 24, 2002 when the high to low changed 8.85%. The best performing date was July 24, 2002 which was up 5.73% (note, the intraday swing on the same day was 8.85%).

Why all the facts? Simply to transition into an excellent article I recently read from Nick Murray on why focusing on such facts may make you appear smart in your own mind, but is it all that important to your clients? In summary, his article states, “how very badly accounting, engineering and other technical disciplines prepare one for a career in personal financial advice…two questions I received from CPA types highlighted, for me, the dangers of a crippling dependence, on the part of technically-oriented people, on statistical evidence as a form of persuasion. Simply stated, the more heavily armed you are with statistical demonstrations of your essential theses, and the more reliant on those ‘proofs’ you are in your interactions with prospects and clients, the less likely I believe you are to forge lasting relationships built on trust.”

You may be thinking that the more you can demonstrate factually/statistically, the more likely you are to succeed. Murray stated, “Once the needle of dependence on numbers goes into one’s arm, it never comes out.” Don’t ask any number, or any accumulation of numbers, to win your prospects’ or clients’ trust. They can’t and they won’t. Belief is what inspires belief, and the only sure path to trust is trustworthiness. If you do not have a deep belief in your ability to provide value in the volatile markets and focus on comprehensive financial planning, then you should stay out of the field. We must have a passion for what we do or we must simply find something else to do. Our clients pay us for our statistical data but they stay with us because of the relationships. After all, statistical data is simply a manipulation of things that have already happened. Our clients are with us for so much more.

Do it well or don’t do it at all.

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