After last week’s –5% drop in the S&P 500, many were already calling an end to this rally. But I don’t think it’s over yet: far from it. This move up is likely to continue—with inevitable pauses such as the one last week—for many more months and even years. I suspect that before the new bull market is finally over, and stocks again suffer a –20% or greater decline, we’ll not only have reclaimed the highs of October 2007, but should be well beyond them. With very rare exceptions, bull markets are much bigger than the bears that precede them. The main risk to I see now isn’t losing money, but missing out on big profits.
Of course, I could be wrong. But I’m not seeing any economic or financial signs that disturb me. Most of the latter are hugely positive; for example, 3-month LIBOR (the rate at which many banks lend to each other) is now 0.78%. This is the lowest level ever, and it has fallen from 1.10% only one month ago. If LIBOR were to drop to about 0.50%, that would mean the inter-bank lending market was back to normal. It’s possible we could see this in just a couple of months.
Investor sentiment, while way better than it was in early March, remains tepid. And last week’s market drop was enough to convince many that the bear market is not yet over. As recently as last night, few expected a rally today. Tokyo was down –2.4%, as were several other Asian markets. But India changed all that when it rocketed +17% shortly after the open, apparently giving strong approval to the winning party in the just-completed election. Almost immediately, other Asian markets that were still open (Tokyo was closed) turned strongly positive, and the bull was reinvigorated. All this shows that markets can shift suddenly for little apparent reason.
Some of you are still waiting to see your re-allocated portfolios; most who have received them so far have had no comment (either you think they’re terrific or I’ve totally confused you). To all of you: don’t worry about missing the bull, we’ve got plenty of upside ahead of us. Just returning to the old highs on the S&P 500 would give us a +73% rise from here, and that’s without dividends. Allocating wisely among countries, industries and individual securities could provide even better results: non-US developed markets need to rise +87% (without dividends) to reclaim their 2007 highs, for example, and many individual stocks (such as GE) need to triple (that’s +200%) just to reach their old highs.
What’s driving the rally? There’s just too much cash out there, and cash isn’t earning squat. After inflation and taxes, nearly all so-called “risk free” investments are earning negative returns. If investors want to make a reasonable return in this environment, they simply have to take some risk. And in a nearly perfect reversal of the bear market, since their recent lows, riskier investments have provided higher returns than less risky ones. The risk-return relationship is again positive, as it has typically been over the long term.
Here’s a note from STIR Research on how institutional investors are dealing with their mounds of cash (written just before today’s big jump):
“According to this week’s Barron’s, growth stock managers have been left behind the last two months. Only 33% beat the benchmarks in March and only 25% in April. They want to catch up, and with high levels of cash, they are looking to buy on any dip.
“But the market has not been very accommodative. Last week we had 4 down days for the S&P 500, NASDAQ, the Russell 2000 and others. But on three of those down days volume was below normal. Even with Friday’s option expiration, which normally leads to a spike in volume, it was below average.
“We are interpreting that to mean, that even when the buyers pull back, sellers are not panicking and dumping stocks. Instead the selling has been drying up. Therefore, institutional investors wanting to deploy some of their excess cash, have to bid stocks higher to find willing sellers: a formula for a market moving higher.
“In a bullish report sent out Friday by Goldman Sachs, they noted that following the 18 largest bear markets in history, the initial rally lifts stocks 43% and lasts 180 days. And that is just the average.”
The last point is interesting. Given that the recent bear market was at least 50% worse than average, one could expect the initial rally to be roughly 50% stronger than average. This would imply that 6 months after its low, the S&P 500 would rise +65%, which translates into a level of 1,100 (compared to 910 today, or another +21% gain over the next 3 1/2 months). I’m not saying that this is what will happen, but it wouldn’t be out of line historically. Of course, if the global economy and credit markets are in decent shape by September, stocks should continue to move upward.
Remember that stocks are not the only “risky” asset. Corporate and municipal bonds, commodities, and real estate all fall into the risky asset category, and should also do well as the financial markets improve. They, too, deserve a place in most portfolios (and my model portfolios do include them). The only assets I would avoid right now are US Treasuries, CD’s and other “risk-free” assets. They should lag severely, and could even provide negative returns going forward.
Wednesday, May 20, 2009
Friday, May 15, 2009
Don't moor yourself to the wrong anchor
For a while there, it looked liked the market would continue to go straight up without pause. Last week, stocks—especially the beleaguered financials—were on a tear. This week, they’ve dropped back significantly (although they did rise +1% today). The market never goes straight up, and I’m actually pleased that we’re taking a breather, because investors were getting ahead of themselves. Think about it: in only 2 months, the S&P 500 had risen nearly +40%. It was time for a rest. As of today, the S&P 500 is “merely” up +34% from its March 9 low.
Whether this is a bear market rally or a nascent bull is beside the point; predicting short-term market moves is impossible anyway. The bears say the recovery will be too weak to justify a continued rise in stock prices. The bulls say that the market had priced in a depression, and we’re ending up with “just” a severe recession, meaning prices got too low and need to rise. Who knows and who really cares? Prices of nearly everything—not just stocks—dropped to depression-like levels. But now the global credit markets are clearly in recovery, and the economy will eventually follow. Already, it’s clear the economic cliff-dive that began last September has abated, the rate of decline has slowed dramatically, and some areas are already in an early uptrend. The world hasn’t come to an end (sorry, Dr. Doom).
It’s about now in the market cycle that investors again start making irrational decisions. Panic is just a memory, and despair is fading. Indecision is the order of the day. “Do I buy or do I sell? Do I take my money and run or do I put more to work now that the coast seems clear?” In trying to make these difficult decisions, many investors look to “anchors”: prices of individual assets and market indices that seem to have special significance. Problem is, these anchors are almost always meaningless and thus misleading.
For example, in early March the S&P 500 was at a bear market low of 666. Today it is at 893, a +34% gain in only 2 months. Many people say: “Too far, too fast. Must be a bear market rally.” These people have “anchored” that 666 value, giving it special meaning and significance. The unspoken assumption is that 666 was an accurate measure of the stock market’s value, and that the current level of 893 is thus too high because stocks shouldn’t rise so fast. But what real significance does 666 have, other than the level of the S&P on a particular day? Maybe 893 is closer to the market’s intrinsic value, or maybe the correct number is 1,000. We just don’t know, and of course, both current prices and intrinsic value change continuously.
The key point is that the market low of 666 is just an arbitrary, and basically meaningless, number. But people will be anchored to it and reference it for months and years to come. This “anchoring bias” is compounded by another cognitive error that investors typically make, called “recency bias.” This is the natural tendency to remember recent events more clearly and to weight them more heavily than more distant events. Remember when all the market pundits were referencing current prices to the bull market high of 1576 from October 2007? But today you don’t routinely hear that “stocks are cheap because they’re 43% below their highs.” Rather, they’re expensive “because stocks are 34% above their lows.” We anchor to the more recent number and tend to forget the older one. But in reality, both the high and low values are just arbitrary numbers of no significance except to statisticians and market historians.
We do the same thing with individual stocks, anchoring their highs and lows (emphasizing whichever of these is more recent). Take, for example, BHP Billiton, the world’s largest mining company. Many investors think it is becoming expensive because at a recent $50 per share, it’s doubled from a low of $25 in only 6 months. You don’t hear anyone saying it’s cheap because the stock is down 48% from a high of $96; that anchor is too far in the past. Again, these numbers should have no significance to the methodical investor, because there are only 2 prices of any importance: today’s, and what you think the stock will be worth in several years. Everything else is noise.
Another common anchor, perhaps the most often used (and abused), is the most meaningless of all: the price you paid for a stock. How often have you heard (or said), “I’ll sell the stock when it recovers to my purchase price” or “I’ll sell it after it doubles” or “I’ll sell it if it falls 20% below my purchase price.” If Mr. Market doesn’t care about high and low prices, how indifferent must he be to the price you paid? Basing a sell decision for a stock in relation to your purchase price makes no more sense than selling your house solely because it’s now worth twice what you paid. You should sell your house when you need to move, no matter what its current value. Similarly, the only reason to sell a particular stock is because you believe that the money would be better deployed elsewhere: in a different stock, in a different type of asset, or in consumption. The current price of the stock, whether in comparison to its recent high or low, or to your purchase price, is completely irrelevant. (It is relevant, however, in comparison to your assessment of the stock’s intrinsic value).
So don’t get too anchored; go with the flow, because prices and values are fluid. And don’t make the mistake of assuming that recent price movements have any impact on future prices. If a stock has recently doubled, it’s not necessarily expensive, but could potentially double again. Similarly, if it’s just fallen in half, it’s not necessarily cheap and worthy of purchase. It might halve again. In other words, random prices are just that: random. And “past performance does not predict future results” is totally true with individual stocks and the market as a whole. The future cares not a whit about the past, nor does Mr. Market, and neither should you.
Whether this is a bear market rally or a nascent bull is beside the point; predicting short-term market moves is impossible anyway. The bears say the recovery will be too weak to justify a continued rise in stock prices. The bulls say that the market had priced in a depression, and we’re ending up with “just” a severe recession, meaning prices got too low and need to rise. Who knows and who really cares? Prices of nearly everything—not just stocks—dropped to depression-like levels. But now the global credit markets are clearly in recovery, and the economy will eventually follow. Already, it’s clear the economic cliff-dive that began last September has abated, the rate of decline has slowed dramatically, and some areas are already in an early uptrend. The world hasn’t come to an end (sorry, Dr. Doom).
It’s about now in the market cycle that investors again start making irrational decisions. Panic is just a memory, and despair is fading. Indecision is the order of the day. “Do I buy or do I sell? Do I take my money and run or do I put more to work now that the coast seems clear?” In trying to make these difficult decisions, many investors look to “anchors”: prices of individual assets and market indices that seem to have special significance. Problem is, these anchors are almost always meaningless and thus misleading.
For example, in early March the S&P 500 was at a bear market low of 666. Today it is at 893, a +34% gain in only 2 months. Many people say: “Too far, too fast. Must be a bear market rally.” These people have “anchored” that 666 value, giving it special meaning and significance. The unspoken assumption is that 666 was an accurate measure of the stock market’s value, and that the current level of 893 is thus too high because stocks shouldn’t rise so fast. But what real significance does 666 have, other than the level of the S&P on a particular day? Maybe 893 is closer to the market’s intrinsic value, or maybe the correct number is 1,000. We just don’t know, and of course, both current prices and intrinsic value change continuously.
The key point is that the market low of 666 is just an arbitrary, and basically meaningless, number. But people will be anchored to it and reference it for months and years to come. This “anchoring bias” is compounded by another cognitive error that investors typically make, called “recency bias.” This is the natural tendency to remember recent events more clearly and to weight them more heavily than more distant events. Remember when all the market pundits were referencing current prices to the bull market high of 1576 from October 2007? But today you don’t routinely hear that “stocks are cheap because they’re 43% below their highs.” Rather, they’re expensive “because stocks are 34% above their lows.” We anchor to the more recent number and tend to forget the older one. But in reality, both the high and low values are just arbitrary numbers of no significance except to statisticians and market historians.
We do the same thing with individual stocks, anchoring their highs and lows (emphasizing whichever of these is more recent). Take, for example, BHP Billiton, the world’s largest mining company. Many investors think it is becoming expensive because at a recent $50 per share, it’s doubled from a low of $25 in only 6 months. You don’t hear anyone saying it’s cheap because the stock is down 48% from a high of $96; that anchor is too far in the past. Again, these numbers should have no significance to the methodical investor, because there are only 2 prices of any importance: today’s, and what you think the stock will be worth in several years. Everything else is noise.
Another common anchor, perhaps the most often used (and abused), is the most meaningless of all: the price you paid for a stock. How often have you heard (or said), “I’ll sell the stock when it recovers to my purchase price” or “I’ll sell it after it doubles” or “I’ll sell it if it falls 20% below my purchase price.” If Mr. Market doesn’t care about high and low prices, how indifferent must he be to the price you paid? Basing a sell decision for a stock in relation to your purchase price makes no more sense than selling your house solely because it’s now worth twice what you paid. You should sell your house when you need to move, no matter what its current value. Similarly, the only reason to sell a particular stock is because you believe that the money would be better deployed elsewhere: in a different stock, in a different type of asset, or in consumption. The current price of the stock, whether in comparison to its recent high or low, or to your purchase price, is completely irrelevant. (It is relevant, however, in comparison to your assessment of the stock’s intrinsic value).
So don’t get too anchored; go with the flow, because prices and values are fluid. And don’t make the mistake of assuming that recent price movements have any impact on future prices. If a stock has recently doubled, it’s not necessarily expensive, but could potentially double again. Similarly, if it’s just fallen in half, it’s not necessarily cheap and worthy of purchase. It might halve again. In other words, random prices are just that: random. And “past performance does not predict future results” is totally true with individual stocks and the market as a whole. The future cares not a whit about the past, nor does Mr. Market, and neither should you.
Friday, May 1, 2009
March was nice, but April was nicer
I wanted to quickly recap April’s market performance. For the month, the MSCI ACWI (All-Country World Index) rose +11.8%, one of the best monthly performances in history. Tacking on March’s +8.2% rise, we now have a 2-month rally that’s totaled +21.0%. And since its March 9 low, the MSCI ACWI has soared +31.1%.
Despite this stellar performance (or perhaps because of it), many investors are worried. Are stocks moving up too fast? Could this just be another of those bear market “head fake” rallies that will give up the ghost as did several prior ones? These fears are not unfounded, as there’s been a lot of bad news recently, and much more still to come. Add to that the recent outbreak of Mexican swine flu, and there’s plenty to worry about.
But as I’ve said so many times before, bear markets climb a wall of worry. The time for successful investors to be brave is when most others are scared. And the data continue to suggest that the majority remain bearish and afraid:
“In this week’s latest survey of Investment Advisors, according to Investors Intelligence, more advisors are bearish than bullish. In fact, for the past 4 weeks the number of bullish advisors has been falling as the market has moved forward. Basically the market continues to climb a wall of worry. While earnings have been poor as everyone was expecting, the surprise has been that in many key places, they haven’t been as bad as expected....
“With the majority of advisors not believing in the rally, probably means it still has more room to move on the upside over the coming weeks.”
(The above is from STIR Research, whom I’ve quoted before.)
If my recent conversations are any indication, most of you feel the same way, much more afraid of another drop than of missing the new bull market. All this pessimism is good, and adds to my confidence that the lows are finally behind us. Much data, moreover, are suggesting an end to this recession sooner than most had thought. It looks like we won’t have to wait until the end of 2009 for the economy to start growing again; that could happen as soon as next quarter. No, the stock market isn’t crazy, it’s just doing its job, which is to discount the future.
A note on swine flu: Even if we do see a global pandemic, the social and economic toll are likely to be significantly less than in prior ones, and certainly nothing like what we saw with Spanish flu in 1918. And even during that horrific period, when over 20 million people died worldwide, the Dow Jones Industrial Average gained +26.4% in the year following the month during which the pandemic first started to mushroom. Strange as it may seem, pandemics are not necessarily bad for stocks.
But today’s situation is far different from 1918, and even from the other, smaller, flu pandemics of the 20th century. First, the new virus was identified early, and public health measures have been quickly put in place worldwide. Second, the current swine flu virus doesn’t appear to be any more virulent than normal flu, in sharp contrast to the 1918 Spanish flu or the recent avian flu. Third, we have the ability to make vaccines today, though it will be several months before one is available. Fourth, we have 2 antiviral drugs in ample supply that are highly effective in reducing symptoms of the virus. Fifth, new research indicates that the majority of deaths from Spanish flu were from bacterial pneumonia superimposed on the original virus, for which we have safe and effective antibiotic treatment today.
Most of the people who die or become seriously ill from flu virus are the elderly and the infirm; most children who succumb have ongoing medical problems. Healthy children and adults typically come through the illness unscathed, even without antiviral drug treatment. And the bulk of the economic effects of a pandemic come not from the illness itself, but from attempts to reduce the spread of the virus. Quarantines (both voluntary and imposed), work absences, reduced travel and shopping, can all contribute to an economic slowdown. The key is to protect yourself without becoming a drag on the economy.
Despite this stellar performance (or perhaps because of it), many investors are worried. Are stocks moving up too fast? Could this just be another of those bear market “head fake” rallies that will give up the ghost as did several prior ones? These fears are not unfounded, as there’s been a lot of bad news recently, and much more still to come. Add to that the recent outbreak of Mexican swine flu, and there’s plenty to worry about.
But as I’ve said so many times before, bear markets climb a wall of worry. The time for successful investors to be brave is when most others are scared. And the data continue to suggest that the majority remain bearish and afraid:
“In this week’s latest survey of Investment Advisors, according to Investors Intelligence, more advisors are bearish than bullish. In fact, for the past 4 weeks the number of bullish advisors has been falling as the market has moved forward. Basically the market continues to climb a wall of worry. While earnings have been poor as everyone was expecting, the surprise has been that in many key places, they haven’t been as bad as expected....
“With the majority of advisors not believing in the rally, probably means it still has more room to move on the upside over the coming weeks.”
(The above is from STIR Research, whom I’ve quoted before.)
If my recent conversations are any indication, most of you feel the same way, much more afraid of another drop than of missing the new bull market. All this pessimism is good, and adds to my confidence that the lows are finally behind us. Much data, moreover, are suggesting an end to this recession sooner than most had thought. It looks like we won’t have to wait until the end of 2009 for the economy to start growing again; that could happen as soon as next quarter. No, the stock market isn’t crazy, it’s just doing its job, which is to discount the future.
A note on swine flu: Even if we do see a global pandemic, the social and economic toll are likely to be significantly less than in prior ones, and certainly nothing like what we saw with Spanish flu in 1918. And even during that horrific period, when over 20 million people died worldwide, the Dow Jones Industrial Average gained +26.4% in the year following the month during which the pandemic first started to mushroom. Strange as it may seem, pandemics are not necessarily bad for stocks.
But today’s situation is far different from 1918, and even from the other, smaller, flu pandemics of the 20th century. First, the new virus was identified early, and public health measures have been quickly put in place worldwide. Second, the current swine flu virus doesn’t appear to be any more virulent than normal flu, in sharp contrast to the 1918 Spanish flu or the recent avian flu. Third, we have the ability to make vaccines today, though it will be several months before one is available. Fourth, we have 2 antiviral drugs in ample supply that are highly effective in reducing symptoms of the virus. Fifth, new research indicates that the majority of deaths from Spanish flu were from bacterial pneumonia superimposed on the original virus, for which we have safe and effective antibiotic treatment today.
Most of the people who die or become seriously ill from flu virus are the elderly and the infirm; most children who succumb have ongoing medical problems. Healthy children and adults typically come through the illness unscathed, even without antiviral drug treatment. And the bulk of the economic effects of a pandemic come not from the illness itself, but from attempts to reduce the spread of the virus. Quarantines (both voluntary and imposed), work absences, reduced travel and shopping, can all contribute to an economic slowdown. The key is to protect yourself without becoming a drag on the economy.
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