No equation for current volatility

by Stephen Butler

For summer reading during my vacation in Maine, I picked up a copy of David Warsh's "Knowledge and the Wealth of Nations."

What a mistake. It's hardly a book for reading at the beach, but after paying full retail at an airport bookstore, I was determined to slog through two centuries' worth of economic argument.

My immediate objective was to gain more insight into the current level of volatility in what seem to be all investment categories -- stocks, residential real estate, bonds, interest rates. It feels as if everything is up for grabs at the moment.

It didn't help matters to read about Muriel Seibert -- a female Warren Buffett of sorts -- who was quoted in the New York Times on Sunday as saying that current levels of volatility have never been witnessed before. We are peering into an abyss.

Well, what do the economic models have to say about all this? I was hoping to learn that there is a mathematical equation that can indicate where we are in some cycle, but I came away empty-handed.

What I did gain was an admiration for how hard economists struggle to either support or butt heads with each other. Depending on the times and circumstances, some get lucky.

Milton Friedman arrived on the scene when "stagflation" during President Ford's administration was not responding to the Keynesian government intervention or "pump priming" that had worked reasonably well in the past. Friedman believed in no government intervention and that the operation of free markets should be unfettered by government attempts to "fine-tune" the economy.

Others have made the case that the "invisible hand of free markets can undergo some paralysis from time to time.''

For example, after the typewriter had been invented, the earliest layout of keys was later proven to be less efficient than newer proposed combinations that gathered the most commonly used letters in a more convenient place. However, it was too late. Too many typists, by then, had learned the original system, so even today's computer keyboards are arranged in a less-than-optimal configuration.

In the mutual fund industry, Fidelity Fund came to dominate the industry by investing heavily in technology way beyond any other mutual fund company.

A Fortune article in the '80s described how the fund maintained a building full of huge diesel electrical generators designed to maintain investor information access in the event of a power failure. In 401(k) plans, they offered voice response "daily valuation" and then online access before anyone else.

Finally, after capturing a major portion of the 401(k) plans of the Fortune 500 companies, Fidelity had successfully created, in the minds of management, the decisionmaking process previously known as an "I-can't-get-fired-for-buying-IBM-computers" mentality.

In the face of this intransigence, studies today indicate that an all-Fidelity collection of their proprietary funds suffers from performance and costs compared with the common-sense approach that draws fund selections from the entire fund universe -- the latter with technology that surpasses that of Fidelity's.

Meanwhile, few clients are leaving, so the "invisible hand" that would send most companies to a more reasonable alternative remains paralyzed.

The allegory here is that economics is a little like the Bible. You can usually find an interpretation to support whatever position you choose to adopt.

Expecting this science to offer a glimpse into the future is a mistake. More dangerous, perhaps, are the market savants that many investors swear by today. Has anyone considered what will happen to the market when Bob Brinker issues a sell signal in his newsletter?

The bottom line? Stay committed to a mix of stocks. bonds and, for most people, residential real estate that coincides with your penchant for risk. Don't be shocked at fluctuations in value, and don't expect government intervention to offer much more than interesting food for thought.

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