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Making Money in the Market: Too Easy?

24 Jun

It’s impossible to predict market changes with 100% certainty.  Signs emerge at times, though, such as when making money in the market looks easy, volatility is low and investors’ confidence level is generally high.  Remember, the market won’t provide high returns just because we need/want them, and stability breeds instability.

Quote 9 Jan

Don’t ask the barber if you need a haircut.
-Warren Buffett

why have there ever been recessions?

30 Jul

“The enthusiasm of investors about central-bank interventions has reached a pitch that is already well-reflected in market prices, and a level of confidence that with little doubt, investors will ultimately regret. In the face of this enthusiasm, one almost wonders why nations across the world and throughout recorded history have ever had to deal with economic recessions or fluctuations in the financial markets. The current, widely-embraced message is that there is no such thing as an economic problem, and no such thing as risk. Bernanke, Draghi and other central bankers have finally figured it out, and now, as a result, economic recessions and market downturns never have to happen again. They just won’t allow it, printing more money will solve everything, and that’s all that any of us need to understand. And if it doesn’t solve everything, they can just keep doing more until it works, because there is no consequence to doing so, and all historical evidence to the contrary can finally, thankfully, be ignored. How could anyone ever have believed, at any point in history, that economics was any more complicated than that?” (John Hussman, Ph.D)

Investors (with)Drawing Patterns

7 Mar

I am struck this morning by the counter-productive nature in which investors continue to make investment decisions.  Human nature, they say, is unchanging.  This past year illustrated this well.

There’s a lot of information out there about how investors often are their own worst enemies, adding money when the markets are up and withdrawing money when the markets are down. Buying high and selling low. Emotions replacing logic.  Wall Street is the only place people run from when there’s a sale.

According to Morningstar, 2011 was the second-worst year for actively managed U.S. stock funds flows (money in versus money out) since they started tracking the data.  In the last half of 2011, investors pulled more more out of these funds than during the last two quarters of 2008.  This is a striking statistic given that markets were only down 5% in the first half of 2011 (and lost 29% in the last half of 2008, amid massive financial market turmoil and government intervention).

Withdrawal behavior has a predictable effect on managers of these mutual funds – they have to be a bit more defensive and raise cash to meet redemptions.  Often, they can’t be aggressive buyers when the markets are down.  For what reason?  Mostly due to emotional decision-making by the fund’s shareholders.  In the U.S. stock funds category, investments ought to be made with the long-term in mind.  Ideally, inflows would be predictable and smooth, with new cash added over time; outflows would follow roughly the same pattern.

Unfortunately, it doesn’t tend to work like this and investors seem forever locked in a pattern of withdrawing money at the wrong time.  Since the end of the third quarter of last year, the S&P 500 Index (not including dividends) is up over 16%.  Those selling prior to the rally may have the certainty of cash, but also certainly don’t have 16% more money than they would have if they’d stayed invested (at least at this point).

Considering withdrawing or adding money to ‘the market?’ Think about the reasoning for your decisions and remove as much emotion from the process as possible. Your financial well-being will likely benefit.

converging viewpoints

4 Oct

Over the past month I’ve been mostly out of the portfolio management game, and it has been titillating (to make use of an oft-unused word) from a personal standpoint to watch the capital markets from the sidelines.  There is a constant need for client management, nearly as much as actually managing money, when managing portfolios.  And when markets are volatile and the world seems more uncertain, client management can be nearly, or more, time consuming than actually trying to add value to managed assets.  I have been able to view it through another lens and it has been fascinating.

The above is not the main subject of this post.

Though I am not actively managing client assets, I am still deeply involved in thinking about the economy, capital markets, and specific investments.  In that vein, I’ve been corresponding with a friend about the situation in the world today.  Europe finds itself in crisis.  The U.S. may be in another recession and is growing anemically at the very least.  Or that’s the way the world – viewed through the media – now seems to portray it.

My friend has always been at odds with the prevailing view of the world.  He’s been a heavy investor in foreign currencies and gold, and short the market from time to time.  Not really the buy and hold type.  Today he was lamenting that he seems to have lost his footing.  That is, the investment world seems to be saying the things he’s been saying for years.  “Wait, you agree with me?  I’m not used to that!”  When a contrarian opinion becomes consensus, it often leads to these awkward feelings.  I’ve been there myself several times.

While I’m not a ‘buy gold, the world will eventually collapse’ investor, I do think we are in what would technically be a depression.  But it’s ongoing deleveraging that leads me to that conclusion, not a hatred of Western society or the President.  (Not that my friend is motivated by these, either.)  Robust economic growth the past couple decades was borrowed from the future in the form of private and public sector debt used for consumption more than long-term asset building.  This must be now paid down.  Put matter-of-fact-ly, aggregate growth will be lower no matter what fiscal and/or monetary efforts are wielded against it. I came to this conclusion around the same time others did, albeit independently, during late 2008.  History foretells what is bound to happen out of similar conditions and this is an experiment we’ve seen run before.

Back to the main point.  Anytime one has an unwavering view that doesn’t ebb and flow with the tides of investment sentiments, the collective view will occasionally converge with it.  Sometimes, it happens in a big way.

So I’ve held this worldview and when the prevailing viewpoint is congruent with mine I, too, feel strange.  The initial feeling when the world seems to agree is one of vindication but, summarily, the contrarian in me feels uncomfortable and leads me toward rigid self-examination.  Okay, I was right but will I continue to be?  If so, why?  Is the data coming out that seems to vindicate these views even accurate?  How to capitalize on the situation from here?  It is not profitable to hold one view forever in spite of the evidence so one needs to constantly question.  The philosophical part of the post is over.  [Continue reading for more stream-of-consciousness.  This is the most fun way to write a blog – get some thoughts out on paper and minimally edit them.  Who was it – ? – Pascal or some prolific writer – who didn’t edit typos because he thought it a waste of time.  I agree to a point, though MS Word sees to it that I have far fewer typos that had I been inscribing this on papyrus several hundred years ago with a feather and charcoal.]

* * * * *

With talk of the Dow headed lower, I will always remember the WSJ headline the day before (or day of) the bottom discussing how the markets could go MUCH lower than they were at the time.  World trade data was terrible.  Unemployment was rising.  One difference between then and now is that it’s a worldwide — or at least multi-country — phenomenon, and the Fed has blown most of its firepower and, more importantly, its credibility, to little effect.  The world is more at the mercy of natural forces rather than some (flawed) idea that fiscal and monetary intervention, poorly conceived, can get us out of any mess.  The can has been kicked as far as it can go and investors know there will have to be real losses…and that governments really can’t do much about it other than let it play out.  Sure, there will be efforts to do one thing or another and on some level they might be successful.  But ultimately debt has to be paid down and that means lower growth and a slower recovery period than we’ve been used to for several decades.  Bummer, I know.  Grab a drink.

A closing thought I alluded to above: typically when the collective is leaning one way, it may not be the right way to lean.  Is it time to look for opportunities in the ‘it turns out better than everyone thinks’ trade?  Late MIT economist Rudiger Dornbusch said something like, The crisis takes longer than you think, then hits faster than you would have thought.  I would not personally bet on things getting better on a macro basis, but I think individual opportunities are clearly out there.

The Great Equalizer

12 Sep

The financial crisis of the past several years has had an equalizing effect on the experience of many in the investment industry.  After what’s transpired, a person with five years of experience might rightly be considered to possess similar competencies as someone with twenty-five.  The reason?  The crisis, abrupt market declines and recovery, and ongoing economic and market difficulties have been new to the experience of most current market participants.

The newest industry entrants (the last two to three years) that have just read about in school or saw it happening while they were taking classes and not actually investing others’ money do not count here.  I speak of those that have actually lived through it.  Moreover, those who’ve lived through it and taken time to understand what’s going on in the context of history have benefited the most.  We know similar events have taken place before, just not in most folks’ memories.  And that is the key point.  The same can be said of periods like the Great Depression as well as the go-go market of the 1960s that gave us the market malaise of the 1970s.  Each of these periods was preceded by a market unhinged from value and driven largely by younger folks who had not experienced a serious downturn in their (career) lifetimes.  Until they did.

This experience and historical knowledge is not always helpful, however.  For example, an historical perspective over this period gave me the knowledge that it could get a lot worse.  Yes, the market could have rallied big time (it did) but it could also drop in half over the subsequent several year period, as happened during the Depression.  Instead of falling to 10x normal earnings, it could go well past that and hit 6 times (it didn’t).  So historical perspective could have caused one to be more conservative than was warranted with perfect 20/10 hindsight.

Still, out of this period client interactions have changed, as well as the way portfolios are allocated.  The way an investor should think about longer-term objectives has also been altered.  While modern portfolio theory had largely been discredited before the market declines, it now has less credence in the industry (though it remains in widespread use; the investment and planning industries use it because it offers some degree of concreteness in a world that otherwise lacks concreteness).  But while it’s methodology may aid in allocating portfolios from a top-down perspective, what makes the most sense is not whether a portfolio is mean-variance efficient.  Fundamentals and client goals matter.  It’s not just the frequency of the event that’s important – i.e., that stocks go up over time.  It’s the magnitude – i.e., they can go down 50% the year you need the money.

The Great Equalizer effect of which I write needs qualified.  It has been easy, given the market rally and economic recovery (until recently) that ensued after the depth of the market lows in March 2009, to adopt a ‘bad couple of weeks’ mentality.  Seth Klarman has pointed this out and I agree.  In some ways, people forgot how bad it was in late 2008 and early 2009.  (Memory is extremely short in finance, that’s why we have such frequent cycles.)  The folks still in the game who remember it and stick with their post-crisis philosophical and methodological recalibrations are the ones whom I believe will be the most successful over time.  Yes, stocks will rally from time to time but they can also go down and stay there for an extended period (they just didn’t this time).  And given prevailing valuations the broad indexes are not discounting the double-digit returns of yore, unless we have a larger selloff and start at a lower base.  Mid single-digit returns look most likely here, but so does the possibility of large drawdowns.  Overall, though a well-considered, goal-oriented investment allocation that focuses on base hits is going to be a better approach than something that is trying to catch each wave but risks going out with the tide.

market bottom: feliz cumpleanos

10 Mar

Interesting perspective on the two-year bull run we’ve had since the market bottom.

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