Yearly Archives: 2010

George Bailey vs. Mr. Potter – Who is the Better Investor?

It's A Wonderful Life

It's A Wonderful Life

One of our family’s favorite Christmas movies is Frank Capra’s 1946 classic, “It’s a Wonder Life.”  It’s a story about George Bailey (played by James Stewart), a compassionate, but despairingly frustrated businessman, who in the end learns how important his seemingly average life really has been.  The antagonist in the tale is one “Mr. Potter,” portrayed with a full measure of bile by Lionel Barrymore.  Throughout the movie, George Bailey’s best hopes and dreams always seem to be foiled by circumstances well beyond his control, and Mr. Potter is always lurking nearby to make the hard times seem even worse.

As I reflected on this movie, I realized that both Mr. Potter and George Bailey might have made quite successful investors.  Please indulge me for a moment while I flesh out this idea a bit.

Mr. Potter, as the wealthiest man in Bedford Falls, must have been an astute businessman.  As an investor, I see him as a true contrarian and opportunist.  During the bank crisis in the Great Depression, he was able to keep his cool and actually took over the town’s main bank.  He was a buyer when everyone else wanted to sell.  I suspect he would have been driven by the analytics of an investment.  The valuation metrics and profitability stats would have been more important to him than “the story.”  His focus would have been on the numbers and not the people involved in the stocks he would have bought.  His weaknesses as an investor would have been his pride and maybe his greed.  Overconfidence and the drive to make money for its own sake are common pitfalls for investors.

George Bailey, in his heart of hearts, may have been a bigger risk taker than Mr. Potter, but his circumstances would have forced him to be more conservative.  I see him as a classic long-term investor.  He was willing (maybe forced?) to forgo short-term wants for longer-term gains.  Some of his actions led to great success by others (his brother Harry and his friend Sam Wainwright, who made millions in plastics) – in this way, he almost operated like a venture capitalist.  When he made home loans to the people rejected by the bank (he was a sub-prime lender!), he realized the value of the people, not just the numbers.  I could see him being very interested in investments such as alternative energy, which require a long-time horizon, and which may never pan out as expected, but could help not only the investor but also the world at large.  His pitfalls as an investor would include liquidity risks – he always seemed to be short on cash and had to pass up some opportunities because of this.  He could have been the plastics millionaire had he been more interested in his own wealth.

In the movie, the audience is immediately shown the evil/good contrast between Mr. Potter and George Bailey.  Viewing them as investors erases this distinction to some degree.  It is not clear to me which of them would have had the better investment performance record.  Mr. Potter clearly had more money, but George Bailey may have beat him in total return and alpha generation.   Also, it’s nearly impossible to say which approach is better.  I see them both viable ways to invest.  In fact, there are many, many ways to invest and each has its strengths and weaknesses.

In my view, the real key is finding a style that works for you and sticking with it.

And also remember the immortal words of Clarence the angel from this movie, “No man is a failure who has friends.”  May you always have  an abundance of good friends.

‘Tis the Season for Predictin’

Sell Snow

One of the eternal customs of Wall Street is the year end prediction about the coming year.  At this very moment every Wall Street strategist and analyst is putting together the new forecasts and predictions for the New Year.  All will be well-researched, logical and compelling.  Many readers of these reports will undoubtedly find their views and opinions about the coming year colored by these persuasive essays.  And just as likely, most of them will turn out to be wrong.  This isn’t really a criticism of the Wall Street strategist (I used to be one); it’s just how things usually happen.  Most predictions are clustered around a mean, and the mean expectation (in other words, the thing predicted to be most likely), rarely happens.  C’est la vie…

This week I came across three separate news items which I think powerfully demonstrate the challenge of making accurate predictions.

1.)  Today in the Wall Street Journal is a story about Citibank (C).  The company just completed a $10.5 billion stock offering wherein the government sold the last of its holdings in the company.  As you may recall, Citibank was one of the banks the U.S. government “rescued” by becoming an equity shareholder.  Recall if you can the angst generated at the time this rescue occurred.  Many of the large banks were saddled with mountains of toxic assets, and at that time, many experts were predicting that either Citi would ultimately fail or that the government was simply throwing good money after bad.  Turns out, much to the chagrin of the pessimistic prognosticators, that the U.S. taxpayer will reap a $12 billion gain on their $45 billion investment – a two-year return of 26.7%.  I think this outcome could be viewed as a surprise versus the consensus prediction.

2.)  Our good friends at MFS Investment Management pointed out this week that the entire cost of the “Trouble Asset Relief Program” (TARP), the program that was put in place in late 2008 to help the U.S. banking industry and maybe save the entire world economy, was revised downward (again) to $25 billion.  At the time of its implementation, the smartest people looking at this plan estimated that it would cost $700 billion.  Again, another huge surprise that clearly befuddled the oracles.  For reference, $25 billion is roughly 3 weeks of interest service of the U.S. national debt…

3.)  Also from MFS, some interesting data about NCAA college football.  The Auburn Tigers ended the season ranked #1 and will play for the national championship.  Back in August, Auburn ranked only #23 in the coaches’ poll.  Surprise!  Conversely, the Texas Longhorns, who were ranked #4 at the beginning of the season, wound up losing 7 games this year and did not qualify for a postseason bowl game.  More surprises!

We live in a complicated world.  Yet we all crave the easy answer.  And many people will happily try to satisfy this need for the simple answer by offering their “expert” predictions.  This behavior is rampant in the investment world.  We all would love to know what’s going to happen next year.  We would all love to know which stocks will go up the most in 2011.  Actually, knowledge like this would be priceless.  Alas, it does not exist.  Thus, we are left with predictions. And you will be seeing a lot of them over the next few weeks.

Although I spend very little time making predictions, we will sometimes put together our own little internal guesses for the market, for fun.  Let me share mine with you.

Last December I “predicted” the following:

Prediction Actual (12/6/10) 12/31/09
S&P 500 1,235 1,223 1,115
U.S. Long Bond 4.58% 3.028% 3.84%
Gold ($/oz) 1,305 1,429 1,136
Oil ($/bbl) 95 91 80

This is about as accurate as I would expect (not very).  Luckily for me, I am no longer making a living by trying to predict where prices are going.  I can spend my time finding and measuring value in individual stocks.  I find this exercise much more rewarding (in every way) than making predictions.

The Futile Search for Certainty

I am not good at small talk.

Certain Uncertainty

In social gatherings I find that I compensate for this shortcoming by either talking a lot about things I like (can you spot the boor in the room?) or by wandering around the room trying to avoid eye contact.  In those rare times when I am able to have a more normal conversation with someone, the talk inevitably turns to the economy and/or the stock market.  When someone finds out what I do for a living, they feel compelled to offer me their take on the world.  For the last year or so, the conversation has gone something like this:  

Random Person:  “Financial advisor, huh?  How about that stock market?  I hear things are really dicey now in the market.” [By the way, this has been the opening line from almost any random person I’ve spoken with over the last 2 years or so]

Me:  “Actually, the S&P 500 was up nearly 25% last year and so far in 2010 is up around 6%.  Valuations seem reasonable, corporate earnings are steadily growing, balance sheets are flush with cash and sentiment, which as you know is a contra-indicator, is still quite bearish.”

Random Person:  “Oh, really?  But what about the economy?  I hear that it’s really weak.  Stocks can‘t do well when the economy is weak, right?”

Me: “Consensus estimates for GDP growth for 2010 are around +2.6% and for next year the IMF is estimating growth at around 2.3%.  Not too long ago, U.S. GDP growth around 2.5% was a very good thing.  That’s the economy’s non-inflationary growth average over the long run.  The global economy is growing at around 4.8% this year and is predicted to grow 4.2% next year.  Given that about 50% of U.S. corporate earnings come from outside the country, I suspect that U.S. corporate earnings will continue to grow under the current GDP estimates.”

Random Person:  “But what about _________ ? (This is a fill-in-the-blank statement reflecting the latest “crisis” in the news – today it could be Ireland or China. In the past, it could have been Greece, the Gulf of Mexico oil spill, etc.)  I hear that ______ could lead to another major global crisis.”

Me:  “Possibly.  But consider that the global economy has just been through the worst crisis since the great depression and has recovered.  I suspect that at this point the policy makers have learned a great deal from the events of the last three years and are better prepared to handle any little crisis thrown at them.”     

Random Person:  “But what about the housing situation and unemployment?  How can the stock market go any higher with these two huge problems left still unresolved?  The consumer is totally stressed.  No jobs.  Banks are going to take their homes.  Given that the consumer represents 70% of the economy, how can stocks do well with the consumer in such dire straits?”

Me:  “Ninety percent of people who want jobs have jobs.  Most analysts are now calling for holiday spending to be higher this year than last.  People may be saving a bit more, but consumer spending looks reasonably robust.  Housing was a major growth factor in the middle of last decade and now it has become a drag.  Yet, the economy is still growing despite this drag. At some point, house prices will bottom and may again have a positive impact on the economy.  I don’t think a housing recovery is critical to the success of the stock market.  That was so 2006.  Anyway, about 35% of the foreclosures so far in 2010 were properties owned by investors and not the primary residences of homeowners.  Although things are not rosy yet in the housing industry, the raw numbers reported may overestimate the magnitude of the problem.”

Random Person:  “Well, yeah.  But, I’m still going to wait for more certainty before investing in the stock market.”

Me:  “Please pass the chips…”

Only once in my career has this mythical sense of certainty emerged – in the late 1990s.  At that time, EVERYONE KNEW stocks were going to go up.  I remember new associates at my firm, fresh out of college, using cash advances from their credit cards to day trade stocks.  Everyone was a “genius” back then.  We all know how that period of certainty ended.

The old masters of investing always tell us that the best time to invest in the stock market is when uncertainty is high.  Think back to March 2009, the time when the market bottomed.  How was certainty then?  In the final analysis, this is why investing is not easy.  To be really successful at it one must continually overcome both the “fight or flight” instinct buried deep inside us and the highly reasonable consensus opinion presented daily in the media.

When is the “Right Time” to Sell?

Of all the questions I have tried to answer over the course of my career, this one is the most difficult.  Value investors are pretty good at measuring value and identifying cheap stocks.  A cheap stock (assuming the underlying company has a viable business model) has a tendency to appreciate toward fair value over time.  Selling that stock when it reaches fair value may be one satisfying, simple answer to the question posed by the title.

Yet, many times (and most often in bull markets) the market will award stocks large premiums to their fair values.  So the value investor must face this dilemma when a formerly-cheap stock becomes fairly valued – “Do I sell or hold?”  This is where an assessment of the macro environment may help the value investor decide.  Is the bull market firmly established?  Is the bull market still young?  Is sentiment regarding the market unanimously bullish?  Where are cash levels?  What about technical factors?  And so on.

In those times when the macro environment is positive (obviously this is a judgment call), the value investor may be able to comfortably hold stocks which may appear to be fairly valued.  Why?  If the trend for corporate earnings is supportive and the trajectory of the stock market is generally upward, it is rare for a fairly-valued stock to collapse, or in the vernacular, to become a “torpedo stock” (one that sinks the portfolio).  Thus, in my portfolio at any given moment, one may find cheap stocks as well as fairly valued stocks.  Some purist value investors may point a finger of scorn at this confession, but I have found this approach to be workable and successful.

For me, selling is much more art than science.  Often the best time to sell is when everything looks great for a company and the valuation appears to be rich.  Sometimes these stocks can go up even more after I sell them because I was underestimating the earnings growth potential.  Yet, I never feel bad taking profits.  I am usually able to find some other, cheaper stock which I find attractive.

Sometimes the fundamentals change dramatically and the investment thesis of a stock morphs into something different and unattractive.  Before I buy a stock, I like to consider a number of future scenarios and I usually create an investment thesis – I like to know why I will make money in the stock.  When this thesis is proven wrong, I need to sell – sometimes at a loss.  Still, losing money this way is not really a total loss because it affords me the chance to revisit my thought process as I analyzed the stock.  Where did I make mistakes?  What can I learn from these mistakes?  Do I make the same kind of mistakes over and over again?  This kind of self analysis can be of great value to an investor.

Last week, I was intrigued to learn that Microsoft (MSFT) CEO Steve Ballmer sold $1.3 billion worth of Microsoft shares and plans to unload nearly another billion dollars worth before year end.  Now to be clear – I do not own the shares of Microsoft and I do not have an opinion about the company or its stock price.  The old Wall Street tradition suggests that there may be many reasons for insiders to sell stock (purchasing other assets, diversifying the portfolio, tax planning, etc.), but only one reason for insiders to buy stock – they expect it to go up!  This is why insider buying is often a more reliable signal than insider selling. (Aside – these transactions are totally different than “insider trading,” which is buying or selling based on “non-public, material information.”  “Insider trading” is illegal and insiders cannot do this either.  Most companies have very strict rules governing the buying and selling by corporate officers to avoid any hint of impropriety, and, of course, to comply with the law.)

Mr. Ballmer’s comments about this sale seem consistent with most insider sellers – he said he is selling the stock to “diversify his holdings and to help with tax planning.”  The second part of that statement caught my eye.  Does Mr. Ballmer think capital gains taxes might be going up in the future?

As I understand it, without any action from Congress, the tax rate on long-term capital gains will rise from the current 15% to 20%.  What will happen is anyone’s guess, but perhaps Mr. Ballmer is making a small wager (he still owns $9 billion worth of Microsoft shares) that the rate will rise.  After all, the difference between 15% and 20% on $2 billion is $100 million, and as they say, “that ain’t chump change.”

So what about the rest of us non-billionaires?  I am not a tax expert and am not qualified to give tax advice, but there may be some merit for some investors to realize capital gains this year, just in case the rate goes up next year.  Once the rates move higher, it will be too late to do anything.

Sitting This One Out

Sitting This One Out

Sitting This One Out

One of the unwritten rules of the equity market is that individual investors tend to buy on rallies.  We have seen this rule evident in the mutual funds flow data over the years.  With the market having rallied nicely from its July lows, one would expect to find funds flowing into U.S. equity mutual funds.  Just the opposite happened this time.  Individual investors during the third quarter were net sellers of U.S. equity mutual funds to the tune of $42 billion.  This is first time in 25 years that the market has rallied this much without net inflows into stock funds and equity ETFs (exchange-traded funds), according to research from LPL Financial.

We all know that “this time is different” are the four most dangerous words on Wall Street, and yet this phenomenon is interesting.  Are individual investors putting cash to work elsewhere, or are they still sitting on the sidelines?  In the third quarter, these investors actually placed $89 billion into bond funds.  Given how low yields currently are, I find this somewhat puzzling.  Given how much talk there is out there about the specter of rising inflation, I find this doubly puzzling.  Perhaps these “wallflower” investors were so burned in the crisis to have lost faith in the equity markets.  Perhaps all the negative talk about the “economy” (which may be largely besides the point for the stock market) has scared them away from anything but “safe” investments.  Perhaps getting 2% in a bond feels better than 0.2% in a money market fund.

To my way of thinking, cash and bonds are the most expensive assets out there, and the perception of them being “safe” will likely be tested in the coming months and years.  True, one cannot lose money in cash, but its paltry returns are unlikely to help fund any long-term financial dreams.  Believe it or not, investors can lose money in the bond market.  This may sound strange to most people, due to the fact that we have experienced a forty-year bull market in bonds.  But consider this:  $10,000 worth of a 10-year bond purchased today at 2.5% would be worth only $8,000 if the yield rose quickly to 4.0%.  If held to maturity, the investor would get back all the principle plus the interest payments, but, I wonder how prepared these investors who plowed $89 billion into bonds recently to see 10% or 20% losses in their bond holdings?  I’m not predicting this will happen, but it seems that many are investing as if it cannot happen…

Meanwhile, fundamentals for the stock market appear solid.  Valuations remain reasonable.  Cash flow is strong, and cash levels on corporate balance sheets are high (almost $1 trillion now).  Sentiment is still mixed.  Earnings growth continues to surprise on the upside.  It still feels to me that we are in the early stages of a new bull market.  Dance, dance…

Poison Ivy

Last week I helped clean up and paint the wall around the family cemetery of Jeremiah Moore, a 16th century evangelist from Virginia.  This was the Eagle Scout project for one of the young men in my neighborhood, and I was happy to help out.  I spent the bulk of my time cleaning the walls and removing ivy from them.  The paint used was an authentic lye-based whitewash that may have been very similar to the original paint on the wall.  I was assured by the organizers that none of the ivy in the area was of the poisonous variety.

Years ago, I had a bad case of poison ivy, and since then I’ve been very sensitive to this plant’s stinging sap.  As I merrily pulled ivy from the wall, I never even imagined that any of the leaves I touched might be dangerous to me.

Within the week, I was looking at a fresh field of blisters and rash on both of my forearms.  Surprise!  In the past when thus tormented, I would simply go to the doctor and get some kind of prescription cream.  But, being the new millennium man that I am, I did what I always do when faced with a question – I searched the Internet.

I found that steroid shots, which some of my friends recommended, were “bad” in that they might weaken my immune system.  Ditto with any steroid creams, OTC or prescription.  I found a vast array of “home remedies” and I tried a few:  really hot water, soaking my arms in baking soda-saturated water and calamine lotion.  None of these efforts seemed to make any difference.   I asked some friends what they had tried with success.  One friend told me of a sure-fire cure, an OTC cream.  I could not find it at the few drug stores I visited.  Another friend suggested using bleach.  I even cautiously tried this crazy-sounding idea.  Again, no luck.

Someone who heard of my plight and had also attended the service project suggested that maybe it was not poison ivy after all; that poison sumac may be the culprit!

So what?

First of all, never listen to any medical advice I may offer…

Secondly, I found many investment implications as I pondered my recent experience.  I think that many people approach their investments just as I treated my poison ivy.  They may talk to friends seeking advice.  No matter how crazy their friend’s ideas may sound (Bleach? Really?), they may try it.  They may seek “solutions” on the Internet or in the media.  There is an abundance of free investment advice everywhere you look.  But many of these approaches may be as ineffective as soda water.  They may even sooth one’s concerns for a while (like the calamine lotion), but they may not adequately address the core issues facing the investor.  They may also ignore sound advice (like going to the doctor), and seek something that sounds easier or satisfies a need to “try something different.”  Sometimes one may find that the “solutions” offered are totally wrong for one’s specific needs – such as trading currency futures when one is really seeking long-term capital appreciation or preservation of capital.

Eventually my poison ivy (or sumac!) rash will dry up and go away.  For many people, however, their need for long-term financial planning will not.  Their haphazard attempts to bring order and clarity to these important life decisions will leave them confused, frustrated and apathetic.  They may push financial planning to the bottom of their priority list.  They may simply rely on the hope that everything will eventually work out all right.  This “que sera” approach seems to be widespread, and it may be one of the big long-term challenges for the United States.  As cliché as it may sound, “Failure to plan is a plan for failure” seems to fit this circumstance.

Mark Twain Urges Caution

“OCTOBER: This is one of the peculiarly dangerous months to speculate in stocks in. The others are July, January, September, April, November, May, March, June, December, August, and February.”  — Mark Twain.

This week I was reading some commentaries from the pundits about the market’s action in August (recall that the S&P 500 fell 4.7% that month).  They went on and on about how the global economic growth looked like it was decelerating and there were troubling signs out of China and Ireland; that the housing market was still weak and sentiment was flagging, etc.  It was as if they were searching hard to find solid reasons for the market’s action.

Well, as September comes to a close, we find out that September 2010 represents the best monthly return (+8.76% for the S&P 500) in SEVEN DECADES!  I wait with bated breath (filled, as always, with a good measure of irony) to hear what these same pessimistic pundits, these grumpy gurus, these cranky commentators will have to say about September’s performance.  No doubt they will have reasonable reasons as to why the market did so well.

Therefore what?

It’s a hard thing trying to make sense of the stock market in the short run.  The forces driving the markets are complex, inter-connected and very dynamic.  For this very reason I like to focus on things which I can better understand – individual company fundamentals.  Some stocks are still cheap.  Some stocks which I own and considered very cheap performed extraordinarily well in September.  Some I have sold and some I still hold.  I note the passing commentary about the economy, the world and other big picture stuff with an adequate amount of attention, but the bulk of my energy and focus is centered on the individual companies.  I think this is where the real action is, and the greatest potential to create wealth.

And in a nod to Mark Twain, I think stock speculation is always a risky proposition.  That’s why I prefer to invest.

Why I Like Stocks

Why I Like StocksSometimes people ask me if I’m always bullish on stocks.  My first reaction is to ask them why they are asking the question.  After a moment of silence (checking my first reaction), I often answer “no,” but then I qualify it with a “but I usually am.”

It’s easy to label someone who is always bullish as naïve, Pollyanna, or perhaps selling something.  I would submit that I am none of these (unless you count this blog as my selling something – and if you do, please send me the money you owe me for reading it!).

I started working on Wall Street in early the 1980s.  My first job was in sales.  I did my fair share of “smiling and dialing” trying to convince my clients to listen to my smart ideas.  Shortly I was attracted to the more analytical side of the business and became a sell-side analyst. After a few more years, I was hired to actually invest money in the U.S. equity market for a large foreign bank.  Sometime in the mid-1980s, I realized that I was a value investor.  Of all the investment approaches and styles out there, this one, and only this one, spoke to me.  I read all I could about John Neff, Warren Buffett and Chris Brown and considered them role models and superheroes.

The 1980s was a good decade for the stock market, with the S&P 500 providing total annual returns of 12.6%.  This is despite two recessions early in the decade.  In 1987 we had “The Crash” (which is now called a market “break”).  At the time, most “experts” concluded that Wall Street would never be the same after this experience, and that the equity market could never really recover from the shock.  Once again, these experts were wrong.

The 1990s were even better than the 1980s.  Total annual returns for the S&P 500 were over 15%.  This decade also started with an early recession and real estate woes that many thought would be difficult to overcome.  Few could have imagined early in the decade the tremendous impact the Internet could have on the stock market.  Late in the decade was the first time I ever became cautious on the market.  At that time it was very hard for me to understand the valuations being awarded to tech companies with no earnings and a business model that made little sense to me.  For the first time in my career, I actually held cash in my personal investment portfolio.

Of course, we all know what happened.  The “experts” who had predicted a permanent “paradigm shift” were looking at big losses like everyone else.  I found some measure of comfort in my cheap stocks and cash position.  As the market fell, I began to become more bullish.  I selectively increased my exposure to the market and by early 2003, I was fully invested again.  The decade of the 2000s has been widely labeled as the “Lost Decade” for equity investors, given the poor returns of the market.  I really don’t feel that way.  I can’t disclose the actual numbers, but I know my personal returns for this decade were much better than “the market” and probably close to bond returns.  Why is this possible?  Well, I don’t buy the stock market.  I buy stocks.  I actively research them, looking for value and then I actively manage them, selling them when they become expensive and buying them when they look cheap.

Why do I like stocks?  I continue to see many great values out there.  Stocks look cheap to me now, especially when compared to U.S. Treasury bonds.  I suspect that the next 10 years will surprise us (as every decade has since the 1960s).  Given the still-high level of pessimism and worry about stocks, I suspect that this surprise will be on the upside.  I am confident that a portfolio of actively managed (which doesn’t necessarily mean actively traded) cheap stocks will beat not only “the market” but bond returns (and probably gold returns as well) over the next ten years.

The Recession is Over!

And now something that is assured to make everyone feel a little better…

The organization (National Bureau of Economic Research) responsible for marking the beginning and ending of every recession in the U.S. reports today on its website that the recession which began in December of 2007, ended in June of 2009.  I am so relieved!  All of our worries and debates about the economy over the last 15 months were apparently for naught.

All irony aside, this “news” probably seems to most people as either old or maybe just wrong.  I heard Liz Ann Sonders, the investment strategist for Charles Schwab, publically announce at a conference in March of this year that she thought that the recession ended last June (nice call, Liz!).  Much of the media continues to “talk down” the economy, as if somehow economic weakness is more newsworthy than economic recovery.  To the person who is still without work, this announcement offers little solace.

To me, this announcement underscores my opinion that so much of what people seem to worry about (in connection with the capital markets) is totally beside the point.  Very few people “knew” that the recession began in December 2007 (remember that the NBER did not mark the beginning of the recession until well after the credit crisis in 2008 began).  Receiving the news about the recession’s end now also seems to offer little insight into the capital markets’ future prospects.  Even knowing that the recession was ending in June of 2009 (had the NBER been able to make the announcement then), probably would not have encouraged people to buy stocks or bonds (good things to have done, in hindsight).

In fact, when one looks at the now-defined boundaries of the recession, it conforms very nicely to the “usual” pattern of nearly all recessions since 1929 – the stock market begins the recession at a high level, then bottoms out near the end of it and by the end has recovered nicely from the bottom.  For all the talk about this recession being so spectacular and unusual, the stock market reacted in somewhat of a predictable pattern after all.  Of course, this opinion can only be offered now with the wisdom gained with hindsight.  Near the end of the bear market in March of 2009, almost no one felt confident that good times were just around the corner.

Therefore, what?

First, I guess I want to stress the point that words have specific meanings.  The word “recession” was used and overused to such a degree that it began to have no meaning.  It was as if “recession” was the catch phrase for all that was wrong with the world and the capital markets.  The “recession” is the reason we are unhappy.  The “recession” is the reason people are out of work.  Because of the “recession” we must all learn to live with less (the new normal?).  And so on.  Understanding what a recession really is (see the NBER’s website for more details about this) can help one rise above the melodrama that often follows economic trauma.

Secondly, I wish to stress that even as important as the macro stuff (economy, etc.) may be, there is always a bull market somewhere.  Good investors know how to search for and uncover value.  Sometimes it may seem that they are insensitive to the predictions about the economy and other big picture issues.  In reality, they are simply keeping focus on the things they think matter the most – individual company fundamentals.

The Death of Stock Picking (Again)

The Death of Stock Picking

The Death of Stock Picking

Every now and then, something crosses my desk that makes me smile.  This week it was another hard-biting (?!) piece by our friends at Yahoo Finance.  In it, they asked the question, “Are stock pickers a dying breed?”  The idea here is that given that the majority of stock trades are now made by machines (algorithmic trading) and or index products (ETFs), how can the “old-fashion” stock pickers compete?

Hearing this question took me back to the late 1990s when making money in the stock market was, well, easy money.  Back then, I recall having feelings of inadequacies because “value investing” (my bread and butter) was way out of style. In fact, many of my younger colleagues at the time used the moniker “value stock” as a euphemism for a “bad stock.”  Tech and Telecom stocks went up; “value stocks” just sat there, or even — *gasp* — went down!  Valuation was simply not that important to the performance of a stock back then.  Everyone considered the era as a “paradigm shift” in the stock market, and suggested that those who were hung up on out-of-date notions such as valuation were really out of touch with reality.

Within a few short years, these colleagues were once again at my door seeking my perspective on valuation and fundamentals.  Back then, “the death of stock pickers” was a ubiquitous, although short-lived, theme.  Seeing this theme re-emerge now makes me smile.  Why?  As Bob Olstein (a veteran stock picker) says in the article, “…fundamentals always trump volatility.”  I agree.  In the short run, the market can be impacted by the newest “latest thing”, but in the end, stocks do trade on something beside sentiment and hot air.

Why do I believe this?  The ultimate answer has to do with investor choices and long-term cash flow models comparing stocks, bonds and anything else that may have an earnings stream.  But instead of this note becoming a dry academic study, let it suffice to say that investors, of all kinds, have choices.  Even the choices made by computers and the ETF guys are somehow controlled or programmed by people making choices.  In theory, all of these investors are intelligent enough to make reasonable, if not always rational, decisions.  Sometimes, herd mentality takes over and moves the market in dramatic ways.  Eventually, reason returns and stocks begin to trade again based on dividend yields, earnings growth and valuation.

It has always been this way and I suspect it always will.

Every time someone comes up with a new way to make money in the market, it works until it stops working.  When it stops working, confusion and volatility usually follow because all of the comfortable models and modes have become unreliable.  But then, fundamentals become, once again, the main consideration for investors.  I think this will happen again.

You might be tempted to say, “But hasn’t the world changed?”

I’ll let Mr. Olstein answer that one for me.

“This is my 15th world change- Okay?”

Touché and amen.