How to survive the crummy economy: Do nothing
(MoneyWatch) As if investors didn't have enough to worry about, the latest news on the state of the U.S.'s already weak economic recovery is that it's getting weaker. First-quarter GDP growth slowed to just 2.2 percent, and the latest projection for full-year growth from the Philadelphia Federal Reserve's survey of professional economists is only 2.3 percent.
Adding to the list of woes is that China, the world's second-largest economy and the source of much demand, also is slowing. After growing 10.4 percent in 2010, the Chinese economy grew "just" 9.2 percent in 2011. And the World Bank just announced that "China is in the midst of a gradual economic slowdown that will squeeze growth to 8.2 percent in 2012."
Then there's Europe. The debt crisis and the austerity measures that EU member states have adopted to address the problem have pushed 12 of the region's economies into recession. Even Germany, the world's fourth-largest economy, has stumbled. Although the country's strong industrial production numbers this week suggest that it may avoid recession, the German economy shrank 0.2 percent in the last three months of 2011.
What, if anything, should you being doing in the face of all this bad news? If you're a regular reader of my books and this blog, you already know the answer: nothing -- assuming you already have a well-developed plan that includes the virtual certainty that you'll experience several periods like this one (or worse) over your investment lifetime. The reason to take a "do-nothing" approach (except rebalancing and harvesting losses as appropriate) is that you need to separate the issues of expected economic outcomes and the implications they have for your portfolio.
Investors, the financial media, and far too many investment advisors commonly fail to make this vital -- and overlooked -- distinction. They make the mistake because they fail to understand that it's totally irrelevant to markets whether economic news is good or bad. All that matters is whether the news is a surprise or not, meaning better or worse than already expected. And since by definition surprises are unpredictable (random), there's nothing you should be doing.
Another mistake is failing to understand that it's not economic growth that matters. Instead, it's the price you pay for that growth. Consider the current situation. All of the bad news about the prospects for economic growth is certainly well known by the market. The important concept here is that information is useless if everyone knows it. In other words, because of the financial crisis, the slow growth has generally been expected, and thus is already built into prices.
There will always be risks for investors. The worst part is that the most damage is typically not the result of risks that we can anticipate (often referred to as the "known unknowns"), but by those that we can't (the "unknown unknowns"). Among these I would include, for example, the OPEC oil embargo of 1974, the earthquake that hit Japan in 2011, and the September 11 terrorist attack. It's this type of risk that causes investors to demand a large equity risk premium.
The bottom line is that unexpected, bad things happen fairly frequently. Thus, it's important that you build the risk of these events occurring into your plan. That -- and the knowledge that if you know something it's already built into prices and also that any new information will be rapidly reflected in prices -- will allow you to ignore the noise, or investment porn, emanating from the financial media and from so-called expert forecasters, who have no clue where the markets are going.