August 02, 2011 at 06:00 AM EDT
For Rational Investors, Market Uncertainty Equals Profits
There's no question that the Washington fiasco, more commonly referred to as the debt-ceiling crisis, has injected a huge amount of uncertainty to financial markets. That's bad news for the U.S. economy - which Friday's lousy second-quarter gross-domestic-product (GDP) report demonstrates was already suffering from bad fiscal policy, bad monetary policy and a gross excess of new regulations. This deal didn't really solve any long-term problems, won't head off a federal credit-rating downgrade and all in all only adds to the market uncertainty. But here's the good news. Uncertainty breeds opportunity - especially for savvy, rational investors. And with the dark clouds of uncertainty that continue to build over the U.S. economy, we can turn this situation to our advantage in a big way. Let's take a closer look so that I can show you what I mean ... When Investors Are Certain ... But Not Rational There's an irony about investing that's not lost on savvy, rational investors - even at the retail level: If a market lacks uncertainty, it's awful tough for us to analyze and then invest with confidence. Just consider the capital markets of the late 1990s. Back then, stocks seemed to be on a steady upward march, posting double-digit gains each year. The fact that the investing masses believed there was a complete lack of market uncertainty made it very difficult for "rational investors" to invest. Those "rational" players understood that the markets were getting frothy, or speculative - in fact, the warning signs were there as early as the middle of 1996 (six months before U.S. Federal Reserve Chairman Alan Greenspan denounced " irrational exuberance "). The whole tech sector really demonstrated the pervasive belief that stock prices could only go up. After its August 1995 initial public stock offering (IPO), Internet-browser pioneer Netscape Communications Corp . saw its shares double on its first day of trading. And I'm sure we all remember how tech companies in general - and particularly companies with "dot-com" in their title - saw their valuations soar well beyond any rational expectations. For rational investors, that apparent market "certainty" made it almost impossible to invest with any degree of confidence - short or long. The market was clearly too high, especially in the tech sector, so buying made no sense. It was impossible-to-gauge euphoric speculation that was driving stock prices - not easy-to-quantify fundamentals. If you bought, you were just hoping that the " Greater Fool Theory " would bail you out with a sale to someone else at a higher price. Selling the market "short" wasn't the answer, either. Expecting an irrational trend to correct itself is a sucker's bet. And a bullish trend like this one that doesn't correct for five years is an expensive misstep - one that will send stock-market bears straight to the poorhouse. There was very little un -certainty in the market - the United States was the best economy in the best of all possible worlds and the federal budget was swinging into surplus. In fact, the only uncertainty to be found was situated far away from U.S. shores. I'm talking, of course, about the Asian economies going into crisis in the summer of 1997 and Russia defaulting in August 1998. Now there was some market uncertainty that would have let you make some real money. To continue reading, please click here ...
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