Monthly Archives: October 2010

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.