Hey Koala, thanks for the response, what I'm saying is that a lot of people seem to think "It's always been this way so it will continue to be this way" and that is what I mean by short term, because (a) their notion of "always" really is quite short in historical terms, and (b) the conclusion doesn't follow in any case because what they're trying to predict does not have that kind of consistency.

What you listed under "stocks will only be a wealth destroyer if..." is actually not a bad list, you're thinking along the right lines, and all of those are not all *that* unlikely in my opinion.  To assume that all of those won't happen is not good risk management.

KoalaBear33:

Most of the stuff that is happening is not a surprise to some people like me. People like me have been quite bearish on a lot of things for the last few years and the same applies to many others.  .... For example, consider housing. How many people are actually shocked that housing is collapsing?

Oh, to be sure many people may have had some thoughts or suspicions in that direction, or may even have considered it likely from an intellectual perspective, but how many actually *did* short financials or homebuilders in 2006-2007?  It is easy to see something as obvious in retrospect, but much harder to see it (and see it as actionable intelligence) ahead of time.

More to the point, the people who were buying (or not selling) actual houses in 2006-2007 certainly didn't see it, and that's quite a lot of people. 

KoalaBear33:

But the valuation of stocks matter. If you buy something that is overvalued, it doesn't matter if the company has a profit or not, you can lose money.

Just so.  And valuation depends on estimating future earnings as well as the relative attractiveness of other investments, and both of those estimates (if not the actual numbers) are subject to sudden massive shifts.

If you could somehow buy and sell stocks at a "fair" price, sure you would over a very long term participate in the general growth of the economy, but "fair" price is something that pretty much doesn't exist, stocks are either massively over- or under-valued at any point in time, and that "very long term" would have to be measured in multiple decades or centuries in order to span several over/undervaluation cycles.

KoalaBear33:

Since the whole concept is based on a low probability events that may or may not happen, how are you going to turn that into investing knowledge?

You need to read the Black Swan book for more details, but, to quote the author "I only need to be right once in a century to make money".   In my somewhat shorter experience I've been seeing about one "surprise" event from the list I've been anticipating roughly every year, which is far, far more often than I would have predicted in advance, and easily enough to make money on.

Basically, I try to make sure that I have leveraged positive exposure to good surprises, and inverse exposure to bad surprises, and by surprises here I mean the once in a decade or once in a century events.   For example: banks and insurers are sometimes subject to huge negative surprises, so being long puts on these (esp when they seem to be doing well) is generally a winning strategy.  There is nothing that can increase the value of a bank 10x, but lots of things that can decrease it 10x, see BSC, and if you happen to have some far out of the money puts in such a situation you can easily get 100x returns.   Now this doesn't happen every year, or perhaps every decade, but it does happen quite a bit more often than the price of the options would seem to suggest.  Some other types of companies are subject to potential huge positive surprises (think: companies that invent things), which you can also leverage to.

How do I think of events/scenarios like that... well, think of something which is generally considered to be just flat out impossible today (perceptual bias), but from a historical perspective is not actually very unlikely.  For example, one of my current favorites is looking at long treasury rates, see http://static.seekingalpha.com/uploads/2007/9/4/rates1.jpg , historically they seem to have ranged between 2 and 14%, and well over 6% for most of the period since we have had a fiat currency.  From that perspective, a return to above 6% is likely, and over 8% possible,  but the options market prices it as being considerably less than 1 in 100 odds over the next year.   Regardless of any sensible reasons that may be given for this, those options almost *have* to be mispriced.  Thinking about that has an additional benefit, which is that you can start from an assumed scenario and think about how it would actually come to pass (foreign dumping of treasuries?), which in turn leads to other ideas for unlikely but not impossible scenarios (what would the dollar index be with treasuries at 8%? how about the S&P dividend yield, and what does that say about the S&P itself?).

This is quite enough to be a workable investment strategy; however even if you choose not to do that but to stick with a more conventional "participating in the growth of the economy" strategy, you still have to make sure you don't have significant exposure to negative surprises. 

This thread has intrigued me, I'll have read the Black Swan.

One of the arguements I've heard from the managed funds community, against emerging markets as investments is the lack of finanical accounting rules that are imposed on US markets. Without these rules, or rules that don't fit the US mind set equates to increased risk.

How did these US rules protect investors of an Enron? The current crisis in housing?  US banks?

I've been searching for retirement projection tools, indicating the amount of money one needs for retiring in comfort.  All the models use historical returns for the US economy and projections based on this base.  They don't incorporate how the global economy landscape has changed away from the dollar.  20-30 yrs ago emerging markets had problems due to inflation, currency exchange, politics.

How does one model unexpected paradyme shifts?  I'm betting on the global marketplace is shifting to a new frontier, with significant risks.  As such the only model that works is diversification. A plan to be covered, while dynamically adapting as needed. True wealth builders in the marketplace did it by using a new paradyme.  A number of people have lost trying to play it safe, and maverics (sp?) have lost a fortune.