Monthly Archives: November 2013

Another Excellent Prediction!

Anyone who has read my blog over the years knows that I don’t make predictions.  Trying to guess where the market might be in a few quarters is about as useful as forecasting the weather out a few months.  I read lots of commentary about the market, and always have to chuckle when I see a truly outrageous forecast.  By the way, if you want to appear on television as a “market guru” be sure to bring a few outrageous forecasts with you.  They are the most “newsworthy” ones.  No one wants to hear your middle of pack predictions…

Anyway, I chuckle at these wild forecasts mostly because the people spouting them usually are not professional investors.  And even if they are, no one is likely to remember their incorrect forecast (most are incorrect, no?), and if by some small chance they are correct, the upside might be huge (I have known people on Wall Street who made a career out of being right once…)

So, let’s go back in time to February 2012.  We had just finished a very volatile year (2011) and people were debating which way the U.S. stock might be headed.  I always think a better question than “Where do you think the market is going?” is “How is your portfolio invested right now?”  To my surprise, Barron’s cover for its February 13, 2012 edition (see above) made the bold prediction that the Dow Jones Industrial Average would reach the 15,000 level by the end of 2013.  At the time, it did seem like a very brash forecast.  The DJIA was about 12,500 at the time.

I had a number of issues with this cover.  First of all, almost no professional investor measures performance against the DJIA.  It’s only 30 stocks, it’s price weighted (that is stock with higher prices have more influence on the index than lower-priced ones) and it’s comprised of only big-cap, blue-chip stocks.  Second, any strategist worth his or her salt does not give both level and time frame for a forecast.  Hence, “The DJIA will reach 15,000” is a “good” forecast.  Equally fine would be “The DJIA will trend higher by next summer.”  To say “The DJIA will be at 15,000 by the end of 2013” is way too specific to be credible.   The third and final issue I had was that the forecast, despite what I thought at first glance, was not really that bold.  It represented only a 20% increase in a period of almost two years. That averages out to be about the long-term average for stocks.  Not exactly swinging for the fence on this one…

Nonetheless, I was somewhat impressed at Barron’s moxie to print such a lead story.  We discussed this idea a bit at our Investment Policy Committee meetings, reaching as we usually do, no meaningful consensus about “the market.”  We spend more time figuring out which undervalued stocks to buy.  For some reason, I cut out the center panel of the cover, and with a black sharpie crossed out the 5 in “15,000” and with a red pen wrote a “6” next to it.  Thus was born a rare forecast from yours truly.  I pinned the modified cover on the big map that adorns my office wall. See photo below.

In the name of full disclosure, this forecast was never mentioned outside our firm.  No bets were made; no consideration ever offered or given.  In true Wall Street fashion, I did not specify the time frame for my “forecast.”  I simply stated that the DJIA will reach 16,000.  Well, miracle of miracles, wonder of wonders, the DJIA hit the 16,000 market last week – near the end of the year.  One could argue that because I used the Barron’s cover, the implied time frame for my forecast was the end of 2013.  One could possibly conclude that I made one of the best calls of the last two years, predicting the level and time frame for the most popular and widely quoted stock index!

 

That said, my “success” with this forecast underscores how useless most predictions are.  No one made any money based on this forecast.  I did not buy more stocks because of this forecast (I was fully invested in stocks at the time anyway).  I was not quoted in the media.  My level of fame has not changed since I nailed this forecast (my Q Score has hovered around zero for about 30 years now…).  None of my IPC colleagues talked about it to anyone else.  They did not adjust their portfolio based on it.  Almost no one knew about it (those who did probably forgot about it a week later…).  Most importantly, had it been wrong, nobody (including myself) would bother even mentioning it. Herein lies the biggest risk of listening and acting on forecasts – the forecasters tend to remember and highlight the correct ones and ignore, rationalize or blithely dismiss the wrong ones.

 

So, where do I think the DJIA is going from here?  I predict that it will display volatility, both now and into the future.   And that is one prediction I can stand behind with confidence…  =)

 

Bullish in Orlando

Last weekend I enjoyed the company of 1,100 retail investors at the biennial conference of the American Association of Individual Investors (AAII) held (this year) in Orlando, Florida.  The non-profit AAII has been around since 1978, and does a great job, in my view, educating individual investors regarding stock market portfolios, financial planning and retirement accounts.  The conference featured some high-profile keynote speakers (Nobel Prize winning economist Robert Shiller, for example), useful advice from professional investors, lots of nuts and bolts presentations, and the latest tools (software, etc.) to help investors get their portfolios and financial houses in order.

The range of expertise of the attendees is incredibly wide – from true neophytes taking their first baby steps into the capital markets to grizzled veterans who clearly knew what they were doing.  As is common with most distributions, the majority of the folks there were somewhere in the middle.  A lot of the people I met seemed to like passive investments (index ETFs, etc.), but most seemed fond of some sort of active management.  The mood was quite positive, and more people were bullish than bearish, but I still sensed a quiet tension about the future in many.  I met a few dizzy day-traders (yes, they’re still out there!), one of whom mentioned that she had lost a ton of money in the late 1990s, a bunch more in 2008, and told me that she’d “better get her act together sometime…”

As colorful and friendly as the attendees were, the presenters were actually quite helpful and user-friendly.  It is beyond the scope of this note to mention all the highlights, but a few quotes and anecdotes may help the reader get a feel for the conference.

One oft-repeated theme was that investors need to find a style that fits them and stick with it.  One person suggested that investors write down how they want to invest during a time when they feel calm and rational.  They then should refer to this document (and follow it) in those times when they are stressed, and especially when they feel “this time is different.”  Do-it-yourself investors are notorious for being bad market timers and prone to “sell low” and “buy high” (I’ve seen tons of data supporting this notion).  Listening to the advice of the AAII presenters could help avoid this tendency.

One person observed that many investors feel a great need to “do something” with their portfolios, especially in times of stress.  One person had some great quotes that I really agreed with:  – “The short-term is absolutely meaningless.” “It is human nature to look at the short term.”  “Focus on the facts.” “A great company is not always a great stock.” “A disciplined, unemotional approach is better than anything else.”

I heard a funny story about how many people pick stocks based on image, brand name or a vague feeling about the company (without doing any real analytical work concerning valuation, earnings, cash flow, etc.).  Imagine that you walk into a doctor’s office. The doctor looks at you and without doing any tests or asking you how you feel, says “I think I will prescribe for you the yellow pill.”  You protest, saying that how in the world does he know the yellow pill will be right for you or how does he even know what’s wrong with you.  He counters with something that we’ve all heard people say about a stock they like:  “I have a good feeling about the yellow pill…”  Classic.

One presenter spoke at great length about Benjamin Graham, arguably the best investor of the 20th century – he was Warren Buffett’s mentor!  Graham suggests that the “intelligent investor” (which is the title of his perhaps most famous book) is one not with a high IQ, perfect SAT scores, or fancy degrees from Ivy League schools, but one who possessed patience, independent thinking, discipline, an eagerness to learn and self-control.  These traits of character were, in his view, more important than smarts.

Overall, it was a very enjoyable experience for me. It’s encouraging that someone is trying to help people be smarter about their money and finances amid all the commercial voices simply trying to sell them something. Bravo, AAII!

Mixed Signals

Sometimes I really am confused about the macro picture.  In these times, I am grateful to be a “bottom up” investor, focused on individual company fundamentals and valuation, and not on what the Fed might do, what the economy looks like or other such big imponderables.

I read a lot of the commentary about the markets, the economy, and investment strategies (aka “sales pitches”), but rarely do I find truth in them.  These days I see a large divergence of opinions among stock market strategists.  One group sees the stock market as a fragile bubble, inflated to dangerous levels by the hyper-aggressive easy money policies of the U.S. Federal Reserve, abetted by nearly every other Central Bank that matters.  The other camp has begun to speak of the rarest of market phenomenon – the “melt-up.”

We all know what a “melt down” is – that’s what happened in 2008.  A “melt-up” (don’t you just love all of the clever jargon Wall Street dreams up?) is when the market moves suddenly and surprisingly upward.  This “melt-up” (if it were to happen) would be fueled by rising investor confidence, strong funds flows into the equity market, and perhaps stronger economy data.  One could argue that much of the economic data from the market’s low point in 2009 has been mixed.

The pace of the current economic recovery has been tepid in comparison to the past ones.  The unemployment rate remains much higher than it was at similar points in past recoveries.  Also, policy actions (tax increases, sequestrations, government shut down, etc.) may have dampened economic growth or at least disguised the true underlying strength of the economy.  I was a bit surprised that few people commented on the strong U.S. third quarter (+2.8%) as something important.  This figure was the best showing for the economy since Q1 2012.  It was also the fourth quarter of consecutive growth.  Granted, I am a firm believer that the stock market and U.S. economic growth are not highly correlated, but a stronger economy is rarely a bad thing for share prices.  Sentiment is improving, the U.S. economy is growing at a faster pace and money is flowing into the stock market – what’s not to like?

So, which is it going to be – a correction or a melt up?  Again, I’m thankful that I don’t have to answer this question in any meaningful way for myself or my clients.  One of these two camps may prove to be “right” in the short run.  To me, more important than being “right” about macro forecasts is investing in securities that will make money for my clients and me.

I do believe that we are still in a bull market (I am fully invested in equities in my own retirement accounts).  I don’t think we are on the eve of a recession.  I suspect that the current economic cycle has further room to run and may actually surprise us with its duration and eventual strength.  From where I sit, cash seems like the worst “investment” out there (cash holdings for “rainy days” are not considered “investments” in my opinion).  Most importantly, I can still find good quality stocks trading at a considerable discount to my estimate of fair value.  All of this points to a continuation of the bull market which began in March of 2009.