The Bank Of England has reminded us the recovery will be slow and protracted. The stock market euphoria of the past 2 months could fast become a distant memory.
What a difference a few days can make.
Last week, euphoria prevailed. The FTSE 100 was on a tear, and many beaten down companies had seen their share prices soar higher. In fact, as can be seen from the list of the top 10 bounce back stocks, some rose by more than 300% in the space of just 8 weeks.
Where previously investors were seeing nothing but storm clouds, suddenly they were seeing the green shoots of recovery. Not only that, such was the euphoria, you cold argue they were seeing past the green shoots and looking at giant oak trees.
As I said on Monday, you shouldn't kid yourself the worst is over. We have just been through the biggest financial fracture in our lifetimes. This recession is global. It's the worst recession since the Great Depression.
The Harsh Reality Of This Recession
A few weeks of stock market euphoria doesn't change the harsh reality -- this will be a long and deep recession. The end game is still unknown.
Are we in for an elongated period of deflation, with all the economic challenges that brings? Take a peek at Japan to get an idea what that may feel like? It doesn't look pretty.
Or are we in for a period of rapid inflation? Think back to the early 1990s and 18% mortgage rates to get a feel for what that may be like. It's not pretty either.
Or is it all going to end up just fine and dandy? We'll have a little bit of inflation combined with a little bit of economic growth and falling unemployment. It would be the Goldilocks economy all over again. Oh for the good old days.
Goldilocks Mauled By The Bears
I don't profess to know how it will all turn out. My only guess is we won't be seeing a Goldilocks economy in the near future. The Goldilocks economy we've just had came about when the world discovered Chinese workers were competent and incredibly cheap, so starting the greatest outsourcing operation in the history of mankind.
But that bubble has well and truly burst.
No more will companies be able to lower their costs of production by having cheap Chinese workers make all their goods. No more will consumers be able to buy ever cheaper Chinese-manufactured goods, because they are already as cheap are they are going to get.
On the back of all this, no longer will the financial services industry be able to offer cheap money to people who can't afford it so they can live in flash houses and/or be do-it-yourself landlords.
And no more may those same financiers be able to recut and repackage those debts to offload to other banks, hedge funds or local councils, for example.
The 3 Painful Home Truths
Whatever the stock market does in the short-term, we can't escape these three painful home truths about this recession…
1) A bust of this magnitude doesn't come without consequences. We've already seen some of those consequences, such as the stock market crash, the house price slump and rising unemployment. There are more consequences to come. Remember, this is the worst recession in our lifetimes.
2) The bursting of a financial bubble is more painful and more elongated than your common or garden bubble. The dot com bust was largely confined to stock market losses -- most of the 'normal' economy operated just fine. This bust is different.
3) This is a truly global recession. No country is immune. Consumption based economies like the US and UK have been hit. Manufacturing economies like Germany and Japan have been whacked. Resource-rich economies like Australia and Canada are feeling the pinch. China is trapped in the middle. We are all in this together, for better and for worse.
Avoid These Two Investing Mistakes
In recent weeks, as we've clearly seen, the stock market can one day be incredibly depressed and the next day be incredibly euphoric. During these volatile times, your challenge as an investor is to remain on strategy.
The two biggest investing mistakes you can make are…
1) To sell just because share prices are falling.
2) To buy just because you are fearful of missing out on massive profits.
85 year old billionaire Charlie Munger summed it up perfectly when commenting on what people should expect from the stock market…
"To expect a lot is irrational. You're likely to be happier and gain felicity by aiming low."
So forget 300% returns in a matter of 2 months. Forget and ignore irrational stock market behaviour. Instead, try aiming at 7%-8% returns per annum over the next ten years.
In this tough economy, if you can achieve that goal, you will indeed gain felicity along with some extra money in your bank account.
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