Why We Need Perma-Bears

Posted by: Ben Steverman on April 24, 2008

Whenever the stock market looks shaky, the “perma-bears” come out of hiding.
These are the permanently, professionally skeptical investors or market strategists who can always be relied upon for a gloomy take on the stock market and the economy.
The obvious problem with these perma-bears? They’re way too consistent. Like a stopped clock, they’re inevitably right some of the time. But, because most of the time stocks move higher, they’re mostly wrong.
I recently interviewed retired Merrill Lynch analyst Stephen McClellan and wrote an article on his new book, “Full of Bull: Do What Wall Street Does, Not What it Says, To Make Money in the Market.” The book describes many of Wall Street’s biases and blind spots, which put individual investors at a disadvantage.
One of Wall Street’s big conflicts of interest, McClellan says: It has a huge incentive to be optimistic. Investment houses only makes money when people invest, so Wall Street tries hard not to scare off paying customers with doom and gloom.
He has a point, and that makes me more grateful for the few perma-bears that are around. Maybe we need more of them.

Reader Comments

Al Jacobs

April 25, 2008 2:22 AM

I agree that "perma-bears" may be both skeptical and useful in judging the market. Speaking of being cautious, I strongly discourage using your home's equity to invest in mutual funds.
While I tuned into one of my favorite radio financial talk shows the other day, a statement from the host caused me to wince. He informed a caller that a home with little or no mortgage is a bad idea, suggesting instead that “a substantial loan be obtained so that the money can be invested in good mutual funds.” He went on declare that “a personal residence with no mortgage earns nothing,” adding that “you have all that money locked up and you get nothing for it. It’s just sitting there, virtually unemployed.”

Let me offer a second opinion. I don’t regard home equity as unproductive. My residence, delightfully free and clear of mortgage, has a potential monthly rental value of, perhaps, $10,000. I’d need to generate a pile of pre-tax income if I had to rent my own house. Who says I’m getting nothing by having it paid-off?

But economics aside, it’s the concept I reject. It’s unwise to incur a loan on your home, which must be paid, to invest in something that may or may not produce the cash flow to make the payments. Admittedly, it can be argued that if the investment is a surefire winner with a return well in excess of the borrowing cost, it might warrant the risk. I’ll give you a glimpse of one such circumstance. A close personal friend just negotiated a $50,000 personal equity loan on his condominium home at an interest rate of prime less ¾%, so that at today’s 5¼% prime he is borrowing at 4½%. I’m placing this cash into a thoroughly sound trust deed note (similar to a mortgage) at 11%. This will net him $3,250 annually. I’ve also assured my friend that he may exit the investment at any time, which guards against the risk that a rapidly rising prime rate will result in a squeeze. He’s in a somewhat unique no-lose situation. However, if your home borrowing simply goes into a fund, your fate in the hands of the gods.

A final comment concerning mutual fund investment is warranted. From management’s perspective, its sole function is continually skimming a fee from the fund’s assets. Concerning performance, funds merely rise and fall with the general fortunes of the market. The probable rewards do not justify home mortgage risk.

Posted by Al Jacobs author of Nobody’s Fool: A Skeptic’s Guide to Prosperity. www.onthemoneytrail.com.

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About

Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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