Psychological studies confirm that we all have biases. Yet we’re generally unaware of them.

When it comes to investing, few of them do more harm than “recency bias.” This is the tendency of investors to extrapolate recent events into the future indefinitely.

The Recency Bias Creates a “New Era” of Growth

When technology and Internet stocks were hot in the late 90s, for example, investors began talking of a “New Era” of limitless technological growth. The truth, of course, is that technological innovation does steadily increase. Alas, the same cannot be said of technology stocks.

Years of sharply rising prices lulled investors into a false sense of complacency. Investors didn’t just plan to hold Lucent (NYSE: ALU) and JDS Uniphase (Nasdaq: JDSU) long term. Many began calling them “legacy stocks,” companies that were so exceptional that they would pass them on to their children and grandchildren.

Yet someone less obsessed with recent performance and more familiar with the lessons of history might have recollected that behind every bull market is a growling bear market. From the peak in March 2000 to the bottom in October 2002, the Nasdaq (.IXIC) lost more than three quarters of its value.

Most of your children and grandchildren would have been better off with a passbook savings account or the use of a trailing stop.

Of course, recency bias works the other way, too. Last year the S&P 500 (.INX) dived 38%, its worst performance since 1931.

Now the galloping herd is convinced that stocks have nowhere to go but down. Mutual fund flow figures show investors yanked tens of billions of dollars out of equity funds in the fourth quarter alone.

Much of that money is piling into bank accounts and money market funds. Yes, they’re super safe, but they pay a national average of less than 1%.

The Recency Bias: Teaching Investors That Nothing Is Better Than Something

Still, recency bias convinces them that earning next to nothing is better than losing something.

Once again, they’re rationalizing. Sure, stocks may continue down for a while, but look beyond this week’s headlines and you may see opportunity and not just risk.

Today there is more money available to buy shares than at any time in almost two decades. The $8.85 trillion held in cash, bank deposits and money market funds is equal to 74% of the market value of U.S. companies, the highest ratio since 1990 according to the Federal Reserve.

What has happened in the past when cash reached these levels?

• In September 1974, cash on hand reached $604.5 billion, representing a record 1.21 times U.S. stock market capitalization. That preceded a 31% gain in equities between October 1974 and March 1975.
• In July 1982, just as a 20-month bear market was ending, cash as a percentage of the U.S. stock market’s value rose to 95%. The S&P 500 began a six-month, 36% advance.

According to Bloomberg, the eight previous times that cash peaked compared with the market’s capitalization the S&P 500 rose an average 24% in six months.

There are no guarantees, of course, but this is a very positive near-term signal for the market.

Smart investors – even bearish ones – understand the significance of high cash levels. For example, Leuthold Group, whose Grizzly Short Fund returned 83% in 2008 thanks to bets against equities, recently put out a bulletin calling stocks “one of the great buying opportunities of your lifetime.”

The report pointed out that the ratio of cash on hand to U.S. market capitalization jumped 86% in the first 11 months of last year. That’s the biggest increase since the Fed began keeping records in 1959.

When Will Investors Wake Up From This Recency Bias?

Some day soon, millions of investors will wake up to this recency bias and the fact that their cash is earning a negative return after taxes and inflation. And when they do, money will start migrating back to the market.

One good reason? In addition to capital gains potential, stocks currently yield three times as much as cash.

However, investors suffering from recency bias will not be persuaded by facts, figures, historical parallels or rational arguments. Unbeknownst to many of them, emotions are dictating their actions, not reason.

If history is any guide, they won’t leave the safety of cash until a rising market – and a whole new round of recency bias – convinces them that it’s safe to own equities again.

And they wonder why they don’t buy low and sell high.

Source: The Recency Bias: Why Your Subconscious Is Wreaking Havoc On Your Investment Portfolio

But there won’t be much to report.

Although the Federal Reserve’s policymaking Federal Open Market Committee (FOMC) meets Wednesday, the group doesn’t have much room to maneuver: If the Fed cuts rates to stimulate growth, already troublesome inflation could escalate out of control. But if the FOMC raises rates to reign in inflation, the entire economy could drop into a deep-and-lingering recession.

To be sure, Fed policymakers are sure to engage in some spirited debate: The debates will include such topics as pricing pressures vs. slow growth and strong energy prices vs. the weak housing market. There will even be talk about extending the emergency-borrowing program, or about expanding oversight over financial-services firms.

But if Federal Reserve policymakers do much of anything more than just debate the issue – and try and take some kind of action, using interest rates as their weapon of choice – there’s almost certain to be a negative impact on the U.S. economy.

The data coming out this week will focus on the consumer as personal income/spending and consumer credit reveal just how active folks have been during these uncertain times. As the summer (of discontent) winds down, travelers may be able to get in a last minute trip or two as gas prices have declined over the past few weeks. And retailers are hoping to benefit from the “back to school” shopping crowd. And second-quarter earnings reports continue as consumer giant, The Procter & Gamble Co. (PG), and insurer American Insurance Group Inc. (AIG) headline the reporting companies.

The final question: Will there be any new surprises as the season comes to a close?

Market Matters

As earnings season plugs along, just as many questions and concerns about the strength of Corporate America remain unanswered as when Alcoa Inc. (AA) was first on the clock a few weeks back.

At mid-week last week, just over half of the Standard & Poor’s 500 Index companies had reported and the results actually looked halfway decent (relatively speaking, that is). About two-thirds of those companies announced earnings that exceeded expectations, while only 20% or so missed on analysts’ targets.

Financials dominated the “good” news companies, as four of the five leading banks bested Street estimates (though, that often meant lower losses instead of better profits). However, when the dust finally settles, the second quarter will represent the fourth-straight period of declining earnings as S&P companies are headed for a double-digit drop from last year.

Of course, the massive plunge among financials greatly contributed to the negative results. Looking forward, the eternal optimists remain confident that positive earnings will return for the second half of the year. These optimists even believe that the financials may lead the way as commercial banks and investment banks finally move beyond the period of “never-ending” write-downs. However, if such optimism does not come to fruition and annual earnings decline for the second full year in a row, Corporate America will have accomplished something not experienced in quite a while – not even during the bear market (and recession) of the early 2000s.

So, let’s review last week’s numbers. Energy companies benefited from the surge in oil and gas prices as Exxon-Mobil Corp. (XOM) posted the best quarter ever by a domestic company (though it still managed to fall short of Street expectations). Royal Dutch Shell PLC (RDS.A, RDS.B) and Chevron Corp. (CVX) reaped some strong results as well [For a related story on Exxon and Shell, please click here. For Money Morning‘s recent “Buy, Sell or Hold” feature on Chevron, please click here].

United States Steel Corp. (S) took advantage of the rise in commodity prices, while Verizon Communications Inc. (VZ) and Motorola Inc. (MOT) both recognized better-than-expected profits. On the downside, General Motors Corp. (GM) experienced its third-worst quarter ever. Tyson Foods Inc. (TSN) struggled as increased grain prices hindered chicken sales. Sony Corp. (ADR: SNE) was victimized by a decline in consumer spending. And one-time telecom-sector darling Alcatel-Lucent (ADR: ALU) reported another terrible quarter and said goodbye to both its chairman and its chief executive officers at the same time.

Shifting to the financial world (where there’s no rest for the weary), Merrill Lynch & Co. Inc. (MER) plans to write-down another $5.7 billion as it sells off much of its underwater mortgage portfolio and looks to raise another $8.5 billion through a common stock issuance. (Some analysts believe Citigroup Inc. (C) has another $8 billion in write-downs in it, as well). First National Bank of Nevada and First Heritage Bank joined IndyMac Bancorp Inc. (OTC: IDMC) as they were taken over by the Federal Deposit Insurance Corp. (FDIC).

Volatility emerged in the energy market as oil prices fell to their lowest level in two months and even declined in July by almost $16 a barrel from previous record highs. A late-week rally pushed prices higher, though the general trend may have shifted. Some untimely comments from the Organization of the Petroleum Exporting Countries (OPEC), and turmoil in Nigeria (not to mention Iran) threaten to shift that newly upbeat mood back into a negative one.

Gasoline fell below $3.90 a gallon after hitting a high of $4.11 at mid-month. Stocks experienced quite a bit of volatility as daily triple-digit price movements (up or down) seem to have become the norm. Weaker economic data (see below) helped end last week on a sour note, while bonds benefited from a flight-to-quality that sent the yield on the 10-year below 4% again. All in all, another ho-hum summer week (if +/- 200 daily price moves can be considered ho-hum).

Buy, Sell or Hold: Cisco Systems Inc.

By Horacio Marquez

During the Internet boom in the latter part of the 1990s, Cisco Systems Inc. (CSCO) was the king of the “must-have” stocks, with shares of the maker of telecommunications-networking gear soaring 400% from June 1998 to March 2000.

At Friday’s close of $23.61, Cisco’s shares are down 69% from their all-time high of $77.31 and 31% from their 52-week high of $34.24, as most investors realize this will never be the great growth stock that it was a decade ago.

But that doesn’t mean investors should write off Cisco. Quite the opposite, in fact.

When it comes to Internet-infrastructure gear, Cisco remains the proverbial “800-pound gorilla,” the market leader and dominant-industry player.

Cisco recently reported strong earnings, meeting market expectations. Company Chief Executive Officer John Chambers – who is well known for “telling it like it is” – issued some rather cautious comments in conjunction with an upcoming performance guidance that was otherwise fairly strong.

Since then, Chambers has become much more confident in Cisco’s ability to achieve his long-term annual profit growth target of 12% to 17%. As the U.S. economy reaccelerates, technology-related spending by U.S. corporations – which accounts for about half of the capital outlays in this country – should be very robust for three key reasons:

First and foremost is that Cisco’s business, which enables computer-network and telecommunications-system connectivity, is a major way companies can improve productivity.

And right now — despite the ongoing slowdown — US companies are awash with cash, which is typically deployed in the year’s second half.
Finally, the United States actually lags other countries in terms of broadband-network deployment, and needs to close the gap in order to enhance its competitive position in the world markets.

Not that Cisco is a one-trick pony in terms of focusing only on the US market. Indeed, Cisco is a global player and is enjoying very strong growth throughout the world’s emerging markets and in Asia, which includes recent major deals in China and in the left-for dead Japan. The company is even active in Europe, despite that region’s recent slowdown. Broadband is the name of the game and, as one analyst said, Cisco is the “Internet infrastructure king.”

From a financial standpoint, Cisco is virtually bulletproof. It has a $140 billion market cap and no debt. The company last year earned $7.33 billion on sales of $34.9 billion, dwarfing such rivals as Juniper Networks Inc. (JNPR), Nortel Networks Corp. (NT) and France’s Alcatel-Lucent (ADR: ALU).

This year, revenue will advance 13% and profits 10%. After that, investors expect profits to grow at a 15% annual clip — an alluringly brisk rate for a company as large as Cisco.

Investors don’t get many chances to invest in a terrific company at bargain prices. Earlier this month, while the NXTcomm 2008 global-telecom conference was under way in Las Vegas, Cisco’s shares dropped 6.5% – for no clear reason. Some analysts worry that telecom providers – the telephone and cable companies that, up to now, were the key growth drivers at Cisco and its sector compatriots – would go the way of the enterprise sector and cut back on their equipment outlays.

But those fears are overblown. Besides, rival Juniper Networks hasn’t taken market share from Cisco.

Action to Take: BUY. Cisco has once again protected its crown:

[Editor’s Note: Horacio Marquez was working as a vice president of the Merrill Lynch Emerging Markets Fixed Income Group in 1994 when he correctly predicted that both Argentina and Mexico were headed for currency crises - cementing his reputation as one of currency crises for both Argentina and Mexico. Now Marquez brings that expertise to you with the newly created “Shadow Stock Trader” specialized trading service. To find out how to subscribe, please click here.]

Source: Buy, Sell or Hold: Cisco Systems Inc.

Unicom will also pay $24 billion to take over fixed-line operator China Netcom Group Corp. Ltd. (ADR: CN) by issuing more than 10 billion new shares, Reuters reported.

These asset swaps are the first since the government announced a little over a week ago that the country would undergo a high-profile industry overhaul that will meld China’s six main wireless providers into just three – China Telecom, China Netcom and China Mobile Ltd. (ADR: CHL).

The reason: China needs to catch up with the rest of the world in adopting third-generation, or 3G, wireless services that quicken increasingly popular Internet services such as music and video downloading.

A day before the deal’s announcement, China’s state-controlled Xinhua news agency reported that China Mobile – the world’s fourth-largest company and largest mobile phone company – said it would take over China Tietong Telecommunications Corp. for an undisclosed amount.

“The government is the owner of all the players and the umpire and determines the playing field,” Duncan Clark of Beijing-based consultant group BDA told Reuters. “This is the first step toward 3G, but does it mean 3G will come sooner? That remains to be seen.”

Industry analysts expect each of the giant telecom companies to employ different versions of 3G technologies, The Wall Street Journal reported. One of those will include China’s own 3G standard, called TD-SCDMA.

But other 3G providers such as Paris-based Alcatel-Lucent (ADR: ALU), China’s Huawei Technologies Co. and Ericsson Telefon AB LM are hoping for a shot at what could be windfall profits via contracts with China’s new telecom kings.

“This restructuring is key to a 3G rollout, and there will be lots of opportunities for domestic and foreign equipment providers,” Ian McGuinn, managing director for JL McGregor & Co., a China-focused consulting company, told The Wall Street Journal.

Source: Phase One of China’s Telecom Overhaul: China Unicom, China Telecom

Not surprisingly, all are state controlled.

But now that the first two have more assets, the up-to-now dominant China Mobile faces increased competition and a more-level playing field.

The government of China announced this major shakeup in the country’s burgeoning telecommunication industry over the weekend. It’s a massive restructuring that’ll fold the country’s top six telecom companies into three, and possibly open the way to windfall profits for wireless-equipment providers.

“Everyone has been waiting for it for over three years and now it is here,” Kelvin Ho, a Hong Kong-based analyst at Nomura International PLC, told Bloomberg News of the reorganization plan. “Creating three full-service phone companies offering both fixed and mobile services will help the fixed-line phone companies.”

Under the plan, fixed-line provider China Telecom will acquire one of China United Telecommunications Corp.’s two wireless networks and also China Satellite Communications Corp., The Wall Street Journal reported. China United is the parent company of China Unicom Ltd. (ADR: CHU).

Then, China United’s remaining wireless network will merge with China Network Communications Group, parent company of China Netcom Group Corp. Ltd. (ADR: CN).

Financial terms weren’t released.

A day before the plan’s announcement, China’s state-controlled Xinhua news agency reported that China Mobile Ltd. – the world’s fourth-largest company and largest mobile phone company – will take over China Tietong Telecommunications Corp. for an undisclosed amount.

Many investors hung up on China Mobile, which saw its shares take an 8.2% shellacking on Monday, the biggest decline in two months, following the announcement of the government plan.

Three Companies Providing “3G”

Though the arrangements of this entanglement are complicated – and without a timeline for completion – the impetus is simple: China needs to catch up with the rest of the world in adopting third-generation, or 3G, wireless services that quicken increasingly popular Internet uses such as music and video downloading.

The restructuring will also combine many phone and Internet services into one bill for many households.

“This restructuring is key to a 3G rollout, and there will be lots of opportunities for domestic and foreign equipment providers,” Ian McGuinn, managing director for JL McGregor & Co., a China-focused consulting company, told The Wall Street Journal.

And 3G providers such as Paris-based Alcatel-Lucent (ADR: ALU), China’s Huawei Technologies Co. and Ericsson Telefon AB LM are lining up for contracts.

In fact, the annual salary of Alcatel-Lucent’s Chief Executive Patricia Russo may be largely determined by how well the company capitalizes on this and other opportunities, Reuters reported. Alcatel-Lucent’s New York shares gained 4.1% yesterday (Tuesday), the first day of trading in the U.S. market since the weekend announcement in China.

Industry analysts expect each of the giant telecom companies to employ different versions of 3G technologies, The Wall Street Journal reported. One of those will include China’s own 3G standard, called TD-SCDMA.

Pressure of the Mobile Phone Industry

The bruising competition in the global telecom market only adds to the companies’ eagerness to expand China’s mobile-phone market, which at more than 465 million users is larger than the combined populations of the United States, Japan…and, for good measure, the 48-person population of the Pitcairn Islands.

In China, China Mobile controls about 68% of the domestic mobile-phone market, while China Unicom has most of the rest. China Mobile has nearly 400 million customers total, a figure that combines its Internet, mobile-phone and fixed-line services.

Before this deal, China Mobile was leading the worldwide shift away from fixed-line phone service and into mobile multimedia. It had been steadily stealing subscribers away from China’s fixed-line titan China Telecom. And its penetration into new and rural markets – with its mobile newspapers service in tow – is tapping new customers that neither telecom company previously had been able to reach.

Now, customers have half the number of companies to choose from, but the three left standing are leaner. The mobile-phone market is China Mobile’s bread and butter, and these measures could likely induce potential mobile-phone customers to feel satisfied with combined Internet and fixed-line services.

Source: In Major Shakeup, China’s Govt. Melds Six Largest Telecoms into Three