Beware False Prophets

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I have shamelessly grabbed this image from The Economist and their article “The Great Fall of China” which I recommend you read.

Investors endured an indignity Monday as global markets reeled from further bad news from China. Overnight (for us, not China) the Shanghai market saw it’s single biggest day decline, now dubbed “Black Monday” which set off sellers worldwide. The TSX dropped 420 points, the Dow Jones was down over 500 points, a drop in excess of 3.5%. The FTSE had its biggest drop in two years and brought it to its lowest since February 2014. In short, it was a bad way to begin a week.

Since then China has cut interest rates, which has encouraged global investors that doom may not be close at hand and markets have bounced up from Monday’s lows, most notably in the United States. But the news from China isn’t good. A toxic mix of investor debt, a bursting market bubble, falling exports, rumored slowdowns and a depreciating Reminbi have scared global investors. China is the world’s second largest economy, and though it isn’t integrated into the global economy like the United States, it’s impossible to conceive of a Chinese slowdown that won’t be felt the world over.

Investors should be cautious. There is a lot of speculation and it is still too early to truly know the full extent of both the problems in China and the fallout for global markets. But the threat of a global recession is real and when China’s problems are added to the abundant weaknesses found in many economies there are solid reasons to be concerned.

Big events like China’s shifting economy typically bring professional talking heads out of the woodwork to speculate about what the future might be like for investors as a result of the changing economic fortunes for the Middle Kingdom. These predictions usually over reach, though the seers behind them are intelligent, well meaning, knowledgeable and very sincere. It should be remembered too that there is great demand for experts who will take the hodgepodge of various financial data and attempt to turn it into a roadmap to understanding the future. Historically these predictions, and their adherents often don’t do well over the long term.

A name many will be familiar with illustrates my point. Canada’s own Eric Sprott, the founder of Sprott Asset Management, saw his success over the years brought to heel through his conviction in gold. Convinced that the vast printing of capital to combat the 2008 financial crisis would undermine currencies and the only safe investment was gold, Sprott ended up losing vast amounts of money by not just betting on gold’s future but by choosing the riskiest way to invest in it. Why did he do that? Backed by considerable data, a lot of analysis and his own success he was sure that he was making the right call. At the last event I attended for Sprott I sat bewildered as conspiracy theories were tossed around to explain the continued decline in gold’s price rather than face facts that they were simply wrong.

The shock of this event was largely not predicted. Afterwards predictions about American's economic future also proved incorrect.
The shock of this event was largely not predicted. Afterwards predictions about American’s economic future also proved incorrect.

There is enormous comfort in predictions. They give a sense of control and suggest an ordered universe that one can make sense of. But successful investors long ago realized that winning meant dealing with risk rather than predicting the future. Any event or scenario that seems to place countries, economies or people on a set destiny that cannot be broken is only ever superficial. Regardless of the seriousness of the situation invariably people will take action to change their fate, often with unexpected consequences. Whether it is a financial catastrophe like 2008, a price war over oil, or the sudden reversal of fortunes for the next anointed economic power, these situations are all temporary and the correct response from investors should be guarded opportunism and not confident certainty about future events.

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