Whew! You can really tell when a story hits the media at a time when nothing else important is going on. With words like “pandemic” and “crisis” being thrown around like cowboys at a rodeo, it’s hard not to panic a little bit. If there is any good news in all of this, it seems that this flu strain is responsive to treatment by existing medicine, which seems to be available in ample supply. We hope for the best for all involved.
What I really wanted to talk about today is the housing market. Remember that problem? Every once and a while, we will hear something about how many homeowners are “upside down” (have mortgages bigger than the value of their house), how many homeowners or behind on their payments or how many foreclosures there were last month, but generally the news flow about the housing market has been rather light lately. When swine flu, automaker bankruptcies and/or banking industries do not dominate the airwaves, we might reasonably expect the media to recycle the apparent bad news about the housing market.
Recall that the baseline problems which led to the current recession and bear market were housing related. Recall that many experts consider the bursting of the housing bubble a key factor in all the economy’s current struggles. Recall that the US government is trying to lower mortgage rates in an attempt to help homeowners keep their houses. Amid of all this, it’s easy to ask “When Will Housing Recover?”
Well, in the latest issue of the Financial Analysts Journal, two finance professors, Eli Beracha and Mark Hirschey, attempt to answer that very question. They point out that in the 25-year period from 1982 to 2007 the annual rate of house price appreciation in the U.S. was 1.65% per year, and that over this period nominal house price never fell. This makes the experience in 2008, where nominal prices fell, so unusual – something not seen since the Great Depression. Yet, they emphasize, that despite stunning declines in several states (California, Nevada, Arizona, Florida and Virginia), the housing market remains moderately strong (or at least not horribly weak) through most of the country. The real trouble exists in those markets which had been the strongest.
This may sound pretty obvious to many of us, but it was a bit of good news to me – that the real estate problem was not the wide-spread “pandemic” we might think it is, just listening to the nightly news. After many pages of data and commentary, the authors were able to offer this conclusion – “…if typical per capita income growth continues for only 1.49 years [note the academic penchant for precision without accuracy! – ed.] with flat housing prices and continued low interest rates… the nationwide housing ‘crisis’ will be on the road to recovery by the second quarter of 2010.” In other words, they can see the housing market recover by the middle of next year, IF incomes rise and housing prices stabilize. Perhaps those two assumptions are overly optimistic, but they are based on reasonably assumptions spelled out in detail in the essay. IF this were true, we could expect the stock market to begin discounting this good news sometime later this year.
I am sometimes accused of being too optimistic. Well, if this is a fault, then label me “guilty.” My optimism is not congenital; is has been acquired through many years of analyzing great companies and seeing how much motivated, creative and hard work goes on behind the scenes. The economy is not one thing. It is not a monolith controlled by some all-knowing entity. Rather, it is the amalgamation of millions of actions by millions of people all trying to make products, provide services and make some money along the way. The fact that this is the driver of our economy makes me optimistic. Better news about the housing market will make me even more so.
Tuesday, April 28, 2009
Tuesday, April 21, 2009
The Susan Boyle Rally
By now I suspect that most of the world’s population which is connected to the Internet knows about Susan Boyle. She is the unassuming-looking, late-40s woman from Scotland who amazed the judges (and the world) in her audition for the television talent show “Britain’s Got Talent.” Within a week of being placed on YouTube, her rendition of “I Dreamed a Dream” has been seen and heard by over 12 million people. In an industry that so highly favors looks and image, it’s inspiring to many to see Susan Boyle receive so much praise and notice. As John Rash, an advertising columnist put it, “[her video] encapsulates the power of everyday people becoming overnight sensations.” Bravo, Susan, Bravo.
I think the stock market rally we’ve been experiencing since early March has much in common with Susan Boyle. At the beginning, there was much skepticism. Economic data was clearly drab and uninspiring. Most of the “experts” were not looking at the markets favorably. I suspect many of them expected the market to disappoint or even fall on its face.
Just as Susan’s clear and melodic tones stunned the judges, the market’s rise began to sway sentiment. As the rally progressed, grumpy skeptics, who before only saw gloom and doom, began to see “glimmers” of favorable economic activity. With the market now over 20% above the March low, many more investors are seriously discussing the market’s potential? Is this the big turn? Can it be sustained? Can this market become a “big star?”
We hope the best for Susan Boyle and her budding singing career. We can’t predict whether or not she’ll be a big success, but we hope she will be. Similarly, we hope the current rally will be sustainable and even become the next bull market, but we can’t really predict this. Yet, we are encouraged by the market’s tone and responsiveness to new information (bad or good).
In our view, the fundamentals that matter to the capital markets are always a mix of positives and negatives. The direction of the market is not so much determined by the difference between these two extremes, but rather by which part of the spectrum captures investors’ attention.
Here is a partial list of positive fundamental factors as we see them now:
• High Cash Levels. We see $9 trillion in money market accounts. These funds had been in stocks and bonds and now just sit there waiting for the “all clear” signal to get back in.
• Sentiment. High bearish sentiment (we saw historically high levels in early March) often accompanies the bottom of the market.
• Interest Rates. The Federal Reserve is determined to keep short rates low (which helps a large number of borrowers) and has also begun a tactic aimed at lowering longer-term rates, especially mortgage rates. This could stabilize the housing industry and via refinancing, put more cash into households.
• Lower Energy Prices. The dramatic decline in energy prices from last summer is another stimulus to the American household budget.
• Government Action. The new administration is determined to do as much as it possibly can to jump start the economy and return confidence to the system.
Despite the above, we continue to see significant negatives which may impact the establishment of a new bull market:
• Unemployment. As layoffs continue, many may worry about the impact this has on consumer sentiment, spending and saving. The fact that employment is a lagging indicator may not matter to the average citizen watching the nightly news.
• Earnings. First quarter results have just started to trickle out and despite good news from Wells Fargo, it’s hard to imagine that all companies will report better-than-expected earnings in a quarter where GDP is expected to fall 6%.
• “Expert” Opinions. The handful of economists and academics credited with “predicting” this recession are mostly staying with their pessimistic forecasts. Unless they are particularly nimble (and different from past prophets of doom), they will miss the upside of a new bull market. Yet, the combination of their new-found fame and continued gloomy opinions may sway investor sentiment and stifle the rally.
• Bailouts. Major U.S. industries (banks, real estate, insurance, banking, etc.) may yet require a great deal of government assistance and/or dramatic changes before the “all clear” signal can be sounded. Regardless of the skill of the decision makers involved, these industries’ status is highly uncertain and fraught with risk.
• The Other Shoe. In the back of everyone’s mind seems to lurk the fear that something else, unexpected and dire, is just around the corner, and could bring us right back to the pain and losses seen last year. This fear is particularly worrisome because it’s impossible to prove the absence of something. To the extent that this fear inhibits action, it could dampen the recovery.
Over the last few weeks, the market has clearly been focused on the ““glimmers of hope” and not the “worst economy in 50 years.” Will this continue? Hard to say. I think the time to be defensive is long past. In my view, cash is the most expensive and “risky” asset, especially for those investors with longer time horizons and important financial goals yet unmet. Time will tell.
I think the stock market rally we’ve been experiencing since early March has much in common with Susan Boyle. At the beginning, there was much skepticism. Economic data was clearly drab and uninspiring. Most of the “experts” were not looking at the markets favorably. I suspect many of them expected the market to disappoint or even fall on its face.
Just as Susan’s clear and melodic tones stunned the judges, the market’s rise began to sway sentiment. As the rally progressed, grumpy skeptics, who before only saw gloom and doom, began to see “glimmers” of favorable economic activity. With the market now over 20% above the March low, many more investors are seriously discussing the market’s potential? Is this the big turn? Can it be sustained? Can this market become a “big star?”
We hope the best for Susan Boyle and her budding singing career. We can’t predict whether or not she’ll be a big success, but we hope she will be. Similarly, we hope the current rally will be sustainable and even become the next bull market, but we can’t really predict this. Yet, we are encouraged by the market’s tone and responsiveness to new information (bad or good).
In our view, the fundamentals that matter to the capital markets are always a mix of positives and negatives. The direction of the market is not so much determined by the difference between these two extremes, but rather by which part of the spectrum captures investors’ attention.
Here is a partial list of positive fundamental factors as we see them now:
• High Cash Levels. We see $9 trillion in money market accounts. These funds had been in stocks and bonds and now just sit there waiting for the “all clear” signal to get back in.
• Sentiment. High bearish sentiment (we saw historically high levels in early March) often accompanies the bottom of the market.
• Interest Rates. The Federal Reserve is determined to keep short rates low (which helps a large number of borrowers) and has also begun a tactic aimed at lowering longer-term rates, especially mortgage rates. This could stabilize the housing industry and via refinancing, put more cash into households.
• Lower Energy Prices. The dramatic decline in energy prices from last summer is another stimulus to the American household budget.
• Government Action. The new administration is determined to do as much as it possibly can to jump start the economy and return confidence to the system.
Despite the above, we continue to see significant negatives which may impact the establishment of a new bull market:
• Unemployment. As layoffs continue, many may worry about the impact this has on consumer sentiment, spending and saving. The fact that employment is a lagging indicator may not matter to the average citizen watching the nightly news.
• Earnings. First quarter results have just started to trickle out and despite good news from Wells Fargo, it’s hard to imagine that all companies will report better-than-expected earnings in a quarter where GDP is expected to fall 6%.
• “Expert” Opinions. The handful of economists and academics credited with “predicting” this recession are mostly staying with their pessimistic forecasts. Unless they are particularly nimble (and different from past prophets of doom), they will miss the upside of a new bull market. Yet, the combination of their new-found fame and continued gloomy opinions may sway investor sentiment and stifle the rally.
• Bailouts. Major U.S. industries (banks, real estate, insurance, banking, etc.) may yet require a great deal of government assistance and/or dramatic changes before the “all clear” signal can be sounded. Regardless of the skill of the decision makers involved, these industries’ status is highly uncertain and fraught with risk.
• The Other Shoe. In the back of everyone’s mind seems to lurk the fear that something else, unexpected and dire, is just around the corner, and could bring us right back to the pain and losses seen last year. This fear is particularly worrisome because it’s impossible to prove the absence of something. To the extent that this fear inhibits action, it could dampen the recovery.
Over the last few weeks, the market has clearly been focused on the ““glimmers of hope” and not the “worst economy in 50 years.” Will this continue? Hard to say. I think the time to be defensive is long past. In my view, cash is the most expensive and “risky” asset, especially for those investors with longer time horizons and important financial goals yet unmet. Time will tell.
Monday, April 13, 2009
Happy Birthday Mr. Jefferson
Thomas Jefferson was born on this day 266 years ago. The power of his words still reverberate throughout the nation.
"We, too, shall encounter follies; but if great, they will be short, if long, they will be light; and the vigor of our country will get the better of them." --Thomas Jefferson to Thomas Digges, 1806
"We, too, shall encounter follies; but if great, they will be short, if long, they will be light; and the vigor of our country will get the better of them." --Thomas Jefferson to Thomas Digges, 1806
Wednesday, April 8, 2009
Fortune Cookie Investing
After a very satisfying meal at my favorite Asian fusion restaurant, I opened up my fortune cookie with the usual mix of hope and skepticism that dominates my life. Many years on Wall Street has taught me to be skeptical about most things. Being an optimist, so they say, is the key to a long, happy life. Maybe a fortune cookie could bring good luck. Maybe being a hopeful skeptic (oxymoron?), is a good way to cope with the ups and downs of the capital markets.
Despite my penchant for the scientific method and math proofs (I didn’t say I was normal!), I will also occasionally peek at my horoscope in the local newspaper. Generally, I place more weight on things measurable and discernable, but sometimes things just don’t work out like the formulas suggest. I am not suggesting that I ever I select stocks based on fortune cookies, the phase of the moon or tea leaves, but I am willing to consider all reasonable sources for inspiration, motivation and knowledge.
So, what did my fortune cookie say? Thus spake the ancient sage, “The problems of today will be buried by the sand of time.” Is this hopeful or fatalistic? My time in Japan taught me that fatalism is not necessarily negative or hopeless. Often it’s just a broader perspective on the issues at hand.
I think this simple saying contains a grain of important truth. Investors right now are questioning everything they’ve learned over the last few decades. The Wall Street Journal today suggests that many investors are abandoning the “buy and hold” strategy. Many are suggesting that the stock market may never again offer its historical rates of return. According to many, the massive rush into cash marks the end of an era; the stock market will never again attract the average individual investor.
To all this, I say “bah.” Buy and hold never works in a bear market. But it is arguably the best strategy for a bull market. Every time we enter a recession or a bear market, it always 1) feels unique, 2) feels worse the previous one, 3) feels like it will never end and 4) is marked by “experts” telling us that the old ways will never return. I have seen this pattern over and over again in my career.
I recall a research report from the early 1990s by a professional “expert” analyst who stated that the New England commercial real estate market was so over built that no new buildings would be needed for the next 37 years! Of course the late 1990s tech boom made that prediction totally wrong. I suspect that most of the predictions we are hearing now about the U.S. economy and stock market will likely be proven wrong within a few quarters.
What I do know is that there are still many very wonderful companies out there trying to compete and thrive in this challenging environment. The stock prices of many of these wonderful companies appear to be very cheap compared to where they could be in a more normal market and economy. I cannot predict with any accuracy when these stock prices will reflect my measure of intrinsic value, but I truly believe that the potential rewards are well worth the wait. The worse place to be right now is cash. The best place to be (if you have an investment horizon longer than a year or so) is in those stocks I feel are massively undervalued.
And, I don’t think we will have to wait all that long before the sands of time will bury our current batch of problems.
Despite my penchant for the scientific method and math proofs (I didn’t say I was normal!), I will also occasionally peek at my horoscope in the local newspaper. Generally, I place more weight on things measurable and discernable, but sometimes things just don’t work out like the formulas suggest. I am not suggesting that I ever I select stocks based on fortune cookies, the phase of the moon or tea leaves, but I am willing to consider all reasonable sources for inspiration, motivation and knowledge.
So, what did my fortune cookie say? Thus spake the ancient sage, “The problems of today will be buried by the sand of time.” Is this hopeful or fatalistic? My time in Japan taught me that fatalism is not necessarily negative or hopeless. Often it’s just a broader perspective on the issues at hand.
I think this simple saying contains a grain of important truth. Investors right now are questioning everything they’ve learned over the last few decades. The Wall Street Journal today suggests that many investors are abandoning the “buy and hold” strategy. Many are suggesting that the stock market may never again offer its historical rates of return. According to many, the massive rush into cash marks the end of an era; the stock market will never again attract the average individual investor.
To all this, I say “bah.” Buy and hold never works in a bear market. But it is arguably the best strategy for a bull market. Every time we enter a recession or a bear market, it always 1) feels unique, 2) feels worse the previous one, 3) feels like it will never end and 4) is marked by “experts” telling us that the old ways will never return. I have seen this pattern over and over again in my career.
I recall a research report from the early 1990s by a professional “expert” analyst who stated that the New England commercial real estate market was so over built that no new buildings would be needed for the next 37 years! Of course the late 1990s tech boom made that prediction totally wrong. I suspect that most of the predictions we are hearing now about the U.S. economy and stock market will likely be proven wrong within a few quarters.
What I do know is that there are still many very wonderful companies out there trying to compete and thrive in this challenging environment. The stock prices of many of these wonderful companies appear to be very cheap compared to where they could be in a more normal market and economy. I cannot predict with any accuracy when these stock prices will reflect my measure of intrinsic value, but I truly believe that the potential rewards are well worth the wait. The worse place to be right now is cash. The best place to be (if you have an investment horizon longer than a year or so) is in those stocks I feel are massively undervalued.
And, I don’t think we will have to wait all that long before the sands of time will bury our current batch of problems.
Tuesday, March 31, 2009
"Have You Ever Owned a Stock?”
This is the question I enjoy the most when speaking to a young person who is looking to enter the investment business. I rarely penalize a person for not having owned a stock, but I am always more interested in those who have. In my opinion, there is no better way to prove one’s passion for something than by actually doing it. I mean if I tell you that I really enjoy fly fishing (I grew up in Montana after all), but then I tell you I’ve only enjoyed by reading about it or watching “A River Runs Through It” a couple of times, are you really going to invite me on your next jaunt to The Bitterroot or Rock Creek?
I think the same thing applies to equity investing. All the “book learning” in the world cannot compete with the education one receives by actually buying a stock. Granted, the more knowledgeable one is about the stock market, the more likely the experience of buying a stock will actually be a positive one.
I remember very clearly the first time I bought a stock as a professional portfolio manager. I had been a sell-side analyst for several years and could tell you everything about how to value a stock, how to write a research report, how to identify an attractive stock and how to convince others that my opinion was the “best” one. Then I landed a job on the buy-side managing the US equity portfolio for a Japanese bank. All of a sudden, I was the decision maker for a large portfolio containing about 50 stocks. I recall thinking to myself, “Wow, this is more complicated than I thought.” This thought came despite my years of Wall Street experience and an advanced degree in finance from a prestigious Ivy League school. Within a few weeks I got up to speed on all the holdings in the portfolio and finally felt I was prepared to take over full responsibility of the portfolio.
Even then I felt a bit anxious as I decided on my first trade as the new portfolio manager. I ended up buying a tiny, incremental position of an electric utility already in the portfolio. I think my trade had absolutely zero probability of impacting the portfolio one way or the other, but the deed was done! I remember my boss (who had no trading experience, but had some “book learning”) saying, as he signed my trade ticket, “Ah, Mike-san, you are bullish on interest rates, no?” I’m sure I nodded and gave some vague answer, but what I was really trying to do was avoid making a big mistake on my first trade.
Since that fateful day, I have made thousands of trades, some great, some not so great, but for each one, I knew 1) what I was buying or selling, 2) why I was buying or selling and 3) how long I needed to wait for the trade to be proven successful or not. Investors who trade or invest in stocks without being able to answer those three questions are more likely than not engaging in an exercise of randomness.
Ultimately, the stock market is not one thing; it’s a collection of many things. Each stock price represents: 1) an entire company and all of its resources trying to successfully compete in its market place and 2) the collective opinion of all shareholders about this company’s prospects. When we hear the media mention the “stock market” it is easy to forget that it’s not some kind of powerful monolith, but the collective and combined effort of thousands of companies, millions of workers and millions of investors, both big and small. The general public may hate Wall Street right now (please see Jeff Korzenik’s blog for more on this topic here) but eventually, we all need to understand that what is good for the stock market (strong economy, rising profits and stable interest rates) is ultimately good for all of us.
I think the same thing applies to equity investing. All the “book learning” in the world cannot compete with the education one receives by actually buying a stock. Granted, the more knowledgeable one is about the stock market, the more likely the experience of buying a stock will actually be a positive one.
I remember very clearly the first time I bought a stock as a professional portfolio manager. I had been a sell-side analyst for several years and could tell you everything about how to value a stock, how to write a research report, how to identify an attractive stock and how to convince others that my opinion was the “best” one. Then I landed a job on the buy-side managing the US equity portfolio for a Japanese bank. All of a sudden, I was the decision maker for a large portfolio containing about 50 stocks. I recall thinking to myself, “Wow, this is more complicated than I thought.” This thought came despite my years of Wall Street experience and an advanced degree in finance from a prestigious Ivy League school. Within a few weeks I got up to speed on all the holdings in the portfolio and finally felt I was prepared to take over full responsibility of the portfolio.
Even then I felt a bit anxious as I decided on my first trade as the new portfolio manager. I ended up buying a tiny, incremental position of an electric utility already in the portfolio. I think my trade had absolutely zero probability of impacting the portfolio one way or the other, but the deed was done! I remember my boss (who had no trading experience, but had some “book learning”) saying, as he signed my trade ticket, “Ah, Mike-san, you are bullish on interest rates, no?” I’m sure I nodded and gave some vague answer, but what I was really trying to do was avoid making a big mistake on my first trade.
Since that fateful day, I have made thousands of trades, some great, some not so great, but for each one, I knew 1) what I was buying or selling, 2) why I was buying or selling and 3) how long I needed to wait for the trade to be proven successful or not. Investors who trade or invest in stocks without being able to answer those three questions are more likely than not engaging in an exercise of randomness.
Ultimately, the stock market is not one thing; it’s a collection of many things. Each stock price represents: 1) an entire company and all of its resources trying to successfully compete in its market place and 2) the collective opinion of all shareholders about this company’s prospects. When we hear the media mention the “stock market” it is easy to forget that it’s not some kind of powerful monolith, but the collective and combined effort of thousands of companies, millions of workers and millions of investors, both big and small. The general public may hate Wall Street right now (please see Jeff Korzenik’s blog for more on this topic here) but eventually, we all need to understand that what is good for the stock market (strong economy, rising profits and stable interest rates) is ultimately good for all of us.
Friday, March 27, 2009
Is This the Bottom?
This question seems to be on everyone’s lips. Even though I am an investment professional with many years of experience working on Wall Street, I still sometimes find myself having to stifle a chuckle whenever I hear a question like this. The question is really a series of questions that go something like this:
1) “Should I have put my large cash stash in the market on March 9th?” With the market up over 20% from the recent low, the answer to this one is clearly “yes.” Doing this would led to a quick 20% return, which represents roughly 2 years of “average” stock market returns. As I recall, March 9th kind of felt like the end of the world, capitalism, the stock market and life as we know it. I suspect most people would have found it difficult to throw a bunch of cash into the market that day. I suspect some investors were still in “sell everything now!” mode on that day. But such is the contrary nature of investing in the stock market.
2) “Will the stock market keep going up?” My answer is clearly “yes.” It will go up and then down and then up and then down and so forth. As the equity market strategist at one of my past firms once said so famously (and with a straight face, no less), “I predict that in the future the market will exhibit… volatility.”
3) “Is it safe to get back into the stock market?” No, it’s never “safe” to invest in stocks. One of the immutable dynamics of the investment process is the interplay between risk and reward. For this dynamic to remain in force, the assets which offer the highest potential return must also contain the highest risk. The problem is most of us have a hard time measuring risk, but can easily see returns. When a stock we own goes up, we feel good about that return. When a stock we own goes down, we feel bad about that risk. Truth is that regardless of the near-term returns, every stock possesses an inherent element of risk. By creating a diversified portfolio, investors can offset much of this risk, but never eliminate it. That said, over most long time horizons (the last 10 years notwithstanding), stocks provide the best returns of all asset classes.
4) “If the economy is so bad (everyone is still saying this, no?), why did the stock market go up?” Ah, this is a tricky one. Many people seem to think that the stock market is supposed to reflect what’s going on in the economy. To the extent that economic activity affects corporate earnings, this relationship holds true. However, the stock market is much more than a simple barometer of earnings. Stock valuation is also a function of interest rates, investor sentiment, and supply and demand. Also, the market will respond to the changes in all of the above factors, and most importantly, it will respond to changes in the expectations for all these parameters. The “Economy” is like a supertanker; it does not move nor turn quickly. The stock market, in large part because it is highly affected by changes in expectations and sentiment, is more like a sports car – it can turn quickly and at times move very fast. In the early stages of a new bull market, we will continue to see mixed news about the economy and experience turbulent crosswinds in sentiment.
I suspect that no one can really answer these kinds of questions with the level of certainty the asker ultimately wants. Sure, many (especially those looking for fame in the media) will offer blithe responses with all the confidence and supporting evidence they can muster. Some of them may actually get it right. But no one gets it right all the time. And free advice is rarely worth its price.
The most truthful answer I can give to all of these questions is “I don’t know for sure.” I don’t spend any of my time making predictions. I am fully engaged each day in trying to measure value and trying to find those stocks and funds which offer the best possible return per unit of risk. I am crafting portfolios which are thoroughly diversified and well balanced. I continue to apply the battle-tested investment principles I learned as a younger person to the strange new world in which we find ourselves. In short, I am fully engaged in the investment process every day. It is not a pure science, but not exactly fine art either. It’s not a get rich quick scheme or a hobby. The fact that I love the work makes all the challenges, headaches and heartaches well worth the effort.
1) “Should I have put my large cash stash in the market on March 9th?” With the market up over 20% from the recent low, the answer to this one is clearly “yes.” Doing this would led to a quick 20% return, which represents roughly 2 years of “average” stock market returns. As I recall, March 9th kind of felt like the end of the world, capitalism, the stock market and life as we know it. I suspect most people would have found it difficult to throw a bunch of cash into the market that day. I suspect some investors were still in “sell everything now!” mode on that day. But such is the contrary nature of investing in the stock market.
2) “Will the stock market keep going up?” My answer is clearly “yes.” It will go up and then down and then up and then down and so forth. As the equity market strategist at one of my past firms once said so famously (and with a straight face, no less), “I predict that in the future the market will exhibit… volatility.”
3) “Is it safe to get back into the stock market?” No, it’s never “safe” to invest in stocks. One of the immutable dynamics of the investment process is the interplay between risk and reward. For this dynamic to remain in force, the assets which offer the highest potential return must also contain the highest risk. The problem is most of us have a hard time measuring risk, but can easily see returns. When a stock we own goes up, we feel good about that return. When a stock we own goes down, we feel bad about that risk. Truth is that regardless of the near-term returns, every stock possesses an inherent element of risk. By creating a diversified portfolio, investors can offset much of this risk, but never eliminate it. That said, over most long time horizons (the last 10 years notwithstanding), stocks provide the best returns of all asset classes.
4) “If the economy is so bad (everyone is still saying this, no?), why did the stock market go up?” Ah, this is a tricky one. Many people seem to think that the stock market is supposed to reflect what’s going on in the economy. To the extent that economic activity affects corporate earnings, this relationship holds true. However, the stock market is much more than a simple barometer of earnings. Stock valuation is also a function of interest rates, investor sentiment, and supply and demand. Also, the market will respond to the changes in all of the above factors, and most importantly, it will respond to changes in the expectations for all these parameters. The “Economy” is like a supertanker; it does not move nor turn quickly. The stock market, in large part because it is highly affected by changes in expectations and sentiment, is more like a sports car – it can turn quickly and at times move very fast. In the early stages of a new bull market, we will continue to see mixed news about the economy and experience turbulent crosswinds in sentiment.
I suspect that no one can really answer these kinds of questions with the level of certainty the asker ultimately wants. Sure, many (especially those looking for fame in the media) will offer blithe responses with all the confidence and supporting evidence they can muster. Some of them may actually get it right. But no one gets it right all the time. And free advice is rarely worth its price.
The most truthful answer I can give to all of these questions is “I don’t know for sure.” I don’t spend any of my time making predictions. I am fully engaged each day in trying to measure value and trying to find those stocks and funds which offer the best possible return per unit of risk. I am crafting portfolios which are thoroughly diversified and well balanced. I continue to apply the battle-tested investment principles I learned as a younger person to the strange new world in which we find ourselves. In short, I am fully engaged in the investment process every day. It is not a pure science, but not exactly fine art either. It’s not a get rich quick scheme or a hobby. The fact that I love the work makes all the challenges, headaches and heartaches well worth the effort.
Friday, March 13, 2009
It’s Been One Week
Over the last five trading days the S&P 500 has risen just about 10%. Recall that just last Friday, the market had to absorb the bad news of the worst employment report (651,000 jobs lost and an unemployment rate of 8.1%) since 1983. Remember how bad that felt? So what’s the reason for this mini rally?
We’ve been taught to think that the market is always up or down for some good reason. Usually, someone in the media (or the poor fellow who writes the headlines for Yahoo Finance) can link the day’s action in the market to some news story, economic data point or world event. Sometimes there’s just more buyers than sellers.
So what good news could have contributed to the market’s action over the last five trading days? The employment report? No, that was clearly bad news. How about the news that US households lost 18% of their wealth last year? No, that sounds negative too. General Electric’s credit rating was downgraded? Well, the Wall Street Journal did acknowledge this move as a positive because it wasn’t as bad as expected. Ah, there’s something to focus on – the market tends to respond to events, not whether they are positive or negative, but how they are versus expectations. This is the perverse calculus of the equity market that often befuddles the casual observer. This is why bad news (GE’s credit downgrade) can be interpreted by the market as good news (not as bad as expected).
What is clear to me is that the stock market’s recent actions have little to do with the economy. The economy is like the proverbial oil tanker that moves slowly and makes it big, broad turns even more slowly. There was no positive economic news that could account for the market’s recent movement. This is the disconnect many individual investors struggle with – “If the economy is so bad, why did the market go up?”
To be fair over the last week, we did see a sprinkling of good news – Citigroup’s statement about being profitable through January and February; the big pharma mergers are a clear sign that the stocks are cheap and informed decision makers are acting as they should; retail sales for February were not bad, and so forth. Yet, the tone of the news flow remains very negative. Mr. Roubini was featured yet again in the media circus this week, saying now that the recession could now last three (do I hear four?) years! And then they ask him for his stock picks!?
Two items that I think could be helping the market here are 1) a serious discussion at the SEC to reinstate the “uptick” rule and 2) possible changes in mark-to-market accounting. The first item could lead to less downward pressure on stocks from short sellers. The second could ease some of the pain of toxic assets held by banks and insurance companies. Both are technical (not fundamental) in nature, but many have argued that these two factors have contributed both to the credit crunch and bear market. Might be a good idea to keep a keen ear to ground listening for action on either of these issues.
Has the market made its “big turn?” No idea. But I do know that the “big turn” will be marked with just as much uncertainty as we feel right now. Historically, bear market rallies occur frequently and will often take the market up quite a bit (remember the two-week 20%+ rally that started last November?). This could be just another one of those. However, it could be the “big turn.” That’s just the nature of investing in the stock market – it is an exercise in uncertainty. I suppose we cannot know if this is the big turn until the market penetrates some important levels – perhaps 800, 900 or 1,000 on the S&P 500. When the S&P 500 reaches 1,000 level, can we say with certainty that all is well, that it’s safe to jump back into the pool? I suppose so, but I feel sorry for all those investors sitting in cash waiting for some kind of mystical “all clear” signal that will likely emerge (if it does) only after missing 30% appreciation potential (more if they’d been in better stocks). We hold these truths to be self-evident: bear markets and recessions eventually end and the fundamental principles of equity investing are not dead.
We’ve been taught to think that the market is always up or down for some good reason. Usually, someone in the media (or the poor fellow who writes the headlines for Yahoo Finance) can link the day’s action in the market to some news story, economic data point or world event. Sometimes there’s just more buyers than sellers.
So what good news could have contributed to the market’s action over the last five trading days? The employment report? No, that was clearly bad news. How about the news that US households lost 18% of their wealth last year? No, that sounds negative too. General Electric’s credit rating was downgraded? Well, the Wall Street Journal did acknowledge this move as a positive because it wasn’t as bad as expected. Ah, there’s something to focus on – the market tends to respond to events, not whether they are positive or negative, but how they are versus expectations. This is the perverse calculus of the equity market that often befuddles the casual observer. This is why bad news (GE’s credit downgrade) can be interpreted by the market as good news (not as bad as expected).
What is clear to me is that the stock market’s recent actions have little to do with the economy. The economy is like the proverbial oil tanker that moves slowly and makes it big, broad turns even more slowly. There was no positive economic news that could account for the market’s recent movement. This is the disconnect many individual investors struggle with – “If the economy is so bad, why did the market go up?”
To be fair over the last week, we did see a sprinkling of good news – Citigroup’s statement about being profitable through January and February; the big pharma mergers are a clear sign that the stocks are cheap and informed decision makers are acting as they should; retail sales for February were not bad, and so forth. Yet, the tone of the news flow remains very negative. Mr. Roubini was featured yet again in the media circus this week, saying now that the recession could now last three (do I hear four?) years! And then they ask him for his stock picks!?
Two items that I think could be helping the market here are 1) a serious discussion at the SEC to reinstate the “uptick” rule and 2) possible changes in mark-to-market accounting. The first item could lead to less downward pressure on stocks from short sellers. The second could ease some of the pain of toxic assets held by banks and insurance companies. Both are technical (not fundamental) in nature, but many have argued that these two factors have contributed both to the credit crunch and bear market. Might be a good idea to keep a keen ear to ground listening for action on either of these issues.
Has the market made its “big turn?” No idea. But I do know that the “big turn” will be marked with just as much uncertainty as we feel right now. Historically, bear market rallies occur frequently and will often take the market up quite a bit (remember the two-week 20%+ rally that started last November?). This could be just another one of those. However, it could be the “big turn.” That’s just the nature of investing in the stock market – it is an exercise in uncertainty. I suppose we cannot know if this is the big turn until the market penetrates some important levels – perhaps 800, 900 or 1,000 on the S&P 500. When the S&P 500 reaches 1,000 level, can we say with certainty that all is well, that it’s safe to jump back into the pool? I suppose so, but I feel sorry for all those investors sitting in cash waiting for some kind of mystical “all clear” signal that will likely emerge (if it does) only after missing 30% appreciation potential (more if they’d been in better stocks). We hold these truths to be self-evident: bear markets and recessions eventually end and the fundamental principles of equity investing are not dead.
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