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Bob's Journal 
What's this?______________________________________________ NOTE FOR MEMBERS: An expanded and more frequent version of Bob's Journal now appears on the members' site at www.RetirementWatch.com. Check in there for more commentary and insights on all the financial aspects of retirement.
September
21, 2007 1:45 p.m. Investors and analysts have been confused by many of the market developments of the last couple of years. They are easily explained, and the explanations are in my recent book, Invest Like a Fox…Not Like a Hedgehog. Conventional economic theory misses a few critical elements of the way markets really work. I explore these in the book and use them to explain how these “strange” market activities occur. Here are some key points from the book: While investors try to be rational, they are not always right. They make mistakes, and those mistakes result in misevaluations in the markets. Investors are wrong because they cannot know the true meaning of economic events and data. Instead, they interpret the news and try to determine the value of assets based on the interpretations. Investors can collectively be wrong as many of them adopt the same view. Because beliefs tend to persist once they are widespread, it can take a while for markets to react to new information. There are lags in behavior changes, and it is hard to know how long those lags are. The lags also explain why consumers keep spending, though their home equity is stagnant or shrinking. Investments that seem to be uncorrelated can become correlated just when an investor needs the diversification in the portfolio to be effective. Most importantly, factors outside a market or even the economy can affect prices in that market. That is because investors use multiple sources of information and can make mistakes in interpreting that information. They are not the perfectly rational, all-knowing beings imagined in modern investment theory. These and other points explain how bond yield spreads could shrink to such low levels for an extended period, how problems in the mortgage market can affect credit for other borrowers, and how those events can affect prices of seemingly unrelated investments. Many followers of traditional economic theory were hurt badly by recent economic events, especially those using quantitative investment models that assume stable relationships in the markets. Those who follow our valuation cycle and invest with a margin of safety are set for steady, solid long-term returns and avoid the wildest swings of the markets. We set our Managed Portfolios in Retirement Watch to invest according to this approach. In the October issue, posted on the web site for members only, we make some portfolio adjustments to adapt to the latest changes in the markets.
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The web site and web journal of the editor of Retirement Watch, covering all the financial aspects of retirement and retirement planning, with a few odds and ends thrown in.
E-mail: BCarlson@ Bob's Journal Archives January 2007
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