Divorced from nature, human minds often make simplistic assumptions about the future. The most common one is that today's trend is tomorrow's trend. That is the kind of thinking that creates financial bubbles.
Think about the season of spring. I know that can be difficult as we enter winter in the northern hemisphere, but it is just a metaphor anyway. So think, perhaps, of last spring. It does not come on all at once, despite being driven by the steady progression of the sun to longer days. There are cycles of cold and warmth.
We may speak of winter returning, but we know as the weeks pass the snow and ice will melt and we will get more frequent warm spells. We even change our definition of warmth. In late winter a warm day may include a night time freeze. In late spring a warm day may miss freezing by 20 degrees.
Development of spring into summer is uneven across geographies. Once state may be having a late winter storm while another has a summer-like day.
So too it is with macroeconomics. We have been through a fairly severe global recession, but it is already summer in China and India. Within the American economy one sector may advance while another remains flat or even declines a bit. In particular in 2010 we saw reduced government spending, but despite that the economy did not collapse. The economy warmed up a fair amount in 2010 despite dire predictions of catastrophe in Europe and a double dip in the U.S. And despite a still-weak housing construction sector.
There are all sorts of signs that the economy is in recovery. That may not be any consolation to those frozen in an unemployed or even homeless status, but it important for investors to see the overall picture accurately. A lot of people panicked and lost a lot of their savings in 2008 when they sold stocks at the bottom of the market. If they had held on, they would be in far better shape now.
Another economic winter will come, to be sure, but we have not even hit late spring yet, much less summer. The way to prepare for winter is to lay aside your winter supplies during the summer, rather than acting as if summer will never end.
2011 should be a good year for the American economy. That does not mean it will be a good year for every single person, or for every business, or every business sector. But hopefully we have, collectively, learned something about the wise use of credit and the need to produce real goods and services in a global economy. Bidding up the prices of things that already exist, be they Beanie Babies or houses, is not a real economic advance.
Stocks can be bid up too high too, but that was not the problem during the latest bubble. Stock prices should reflect the earnings potential of the companies involved. The more profitable companies are, the higher their stock prices should be. The main danger is getting talked into investing in companies that are not profitable, or are obviously going to become unprofitable as the economy changes.
Spring is in the air. Wise investors can hear the birds singing and the wheat and corn sprouting in the fields. If you don't sow, you can't harvest. People who are 100% in bonds should be seriously thinking of rebalancing their portfolios to include stocks again. The value of low interest bonds tends to melt away during the hot days of summer. Better to own CDs at a credit union than bonds once interest rates start rising. And beware the current line of bull about investing in foreign stock funds. Many nations have even less regulation and transparency that the United States. A good rule for investing is don't do it if you don't know what you are doing. There is plenty of risk involved even when you know what you are doing.
See also: Virtuous Economic Cycle Components [September 15, 2010]