Monthly Archives: September 2010

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.

Data=>Spin=>Prescription: A New Way to Look at the World Around Us

One of the hallmarks of the capital markets professional is an addiction to data flow.  The premise here is that all data might be important to the investment decision making process and thus needs to be absorbed, monitored and analyzed.  For most people (normal ones, that is, not investment professionals), the need for data is less critical.  The regular flow of information provided by the nightly news, radio talk shows or even a newspaper may be sufficient for the average person.

Maybe it’s just me, but it seems that most data I see these days carries a lot of baggage with it.  That is to say, almost no one reports on the data in a neutral, non-biased way.  Nearly everything I see these days fits my “Data=>Spin=>Prescription” model.

Let me try to explain with an example.

“An oil well springs a leak in the Gulf of Mexico” (this is the data).  “There must be some malfeasance; someone must be to blame” (this is the spin).  “Let’s ban all oil drilling in the Gulf of Mexico” (this is the prescription).  I am not offering any opinions of my own regarding this progression; I simply want to show how it works.  Let me offer another example.

“During the decade of the 2000s, the S&P 500 fell 9.1%” (the data).  “The stock market is obviously a lousy investment” (the spin).  “Sell your stocks and buy bonds” (the prescription).

Whenever I hear any kind of simple data=>spin=>prescription statement, my highly-tuned contrarian senses begin working overtime.  Are there other ways to look at these data other than the “spin” presented?  Are there less-obvious factors at work?  Could the prescription actually be the worst possible conclusion? These kinds of questions immediately fill my mind when faced with this kind of “analysis.”  [Quick aside:  Although much of this stuff is presented as analysis or interpretation of data, I fear that much of it is simply someone trying to foist his or her agenda on the rest of us.  Or maybe that’s too cynical…]

In practical terms, most of us cannot become expert enough in the fields that really matter to simply consume data and interpret them ourselves.  For example, I’m glad that I don’t have to sort through raw meteorological data to figure out whether I should wash my car today or not.  Yet, I feel in many areas, particularly in the capital markets arena, that we are being fed opinions dressed up as facts.  Given that human behavior can significantly impact the markets, I think that this is a dangerous trend.

Maybe a glimpse into how some of the smartest investors operate may be of some value here.  When I was a sell-side analyst, I spent a great deal of effort to understand the companies in my industry.  My job was to know these companies inside and out, to understand all of the factors impacting their businesses, and to predict what would happen to their stocks.  I had to place a rating (buy, sell or hold) on each of my stocks.  Needless to say, this was a huge undertaking.

Once I had sufficient knowledge of the companies and my ratings were firmly attached, my next task was to market my opinions to the professional investors on the buy-side.  I was certain that I would be able to influence their actions by sharing my opinions with them.  Imagine my surprise when I met with some of the more senior analysts and portfolio managers and found out that they cared almost NOTHING about my opinions!  They wanted data; they wanted facts.  Opinions, they concluded, were low value commodities, but facts that they did not know, were of great value.  So, each meeting with these clients became facts fests, where I would share what I knew, but not necessarily what I thought.

Therefore, what?

I suppose that I wish to caution all who care to read this to be wary of silver-tongued experts who disguise their opinions as facts and offer prescriptions that may seem logical (given their spin), but may be exactly the wrong thing to do.

Forewarned is forearmed.