December 18, 2012
How Wild is the Stock Market?
The Investment View from Prescott, Arizona
A fascinating part of stock market analysis is that the market is driven largely by career risk of institutional money managers – mutual funds, pension funds, hedge funds, that sort of thing. Those managers control the vast majority of stocks that change hands every day. They can make or break the stock market with their collective actions.
Their prime objective, as 20th century economist John Maynard Keynes put it so well, is to keep their job. To do this, he explained that one must never, ever be wrong on their own. To keep this from happening, institutional investors pay ruthless attention to what other investors in general are doing. The great majority go with the flow, either completely or partially.
I sometimes refer to this as “closet indexing”. Although the fund they run is not described as an index fund, one that mirrors a stock index such as the S&P 500**, their holdings and performance will always bear a striking resemblance to the index. In fact if the prospectus on one of your investments has wording like “keeps 80% of its holdings” in a certain category of stocks, then your performance is going to look an awful lot like that index.
With most of the managers doing the same things at about the same times, this creates herding, or momentum, which drives prices far above or far below fair price. There are other inefficiencies in market pricing, of course, but this is by far the largest.
This explains the wide disparity between a remarkably volatile stock market and a remarkably stable economic growth rate (GDP), together with an equally stable growth in “fair value” for the stock market.
This difference is huge – two-thirds of the time annual GDP growth and annual change in the fair value of the market is within 1% (plus or minus) of their long-term trends. The stock market’s actual price is within 19% (plus or minus) of its long term trend two-thirds of the time.
Thus, the market moves 19 times more than justified by the underlying engines of growth. No wonder the stock market can cause so much angst.
To reduce this wild volatility is one of the main reasons that Hepburn Capital strives to use different decision making criteria. Even in times when we are out of sync with the stock market, our returns are usually less volatile.
Slice of Life
Winter finally arrived last week, a little late, but as a golfer I’m not complaining about all the nice weather we had the last few months. It was a great time to live in Prescott. And now I can just hear all the plants and animals going “Ahhhhh” with all the moisture that we received last week.
Life is good.
Scottsdale Office Date
Please call (928) 778-4000 for an appointment if you would like to meet Will in the Scottsdale office.
How’s the Market Doing?
All the major markets, those for stocks, bonds and gold are in trading ranges. This means that they are below earlier highs but are not in a downtrend that creates a series of new lows, either. Sometimes I refer to this as going sideways.
The S&P 500** index of stocks stalled out three times in September and October at about 1460 before retreating to November lows. So, as of this writing, the stock market is down for the 4th quarter.
From a technical analysis perspective, this is called a “Triple Top”, and provides a negative outlook for stocks. For some reason buyers stopped thinking the market is a good deal at that level and sellers start thinking they won’t get a higher price in large enough numbers to turn the market around.
We may never know why, but when it happens 3 times, something is up and wise investors pay attention.
After topping out at $1,900 an ounce in August of 2011, gold’s attempts to rally have failed three times at the $1,800 an ounce resistance level over the last 13 months. This presents another triple top for us to consider.
Despite the textbook case for inflation to take off and gold to soar, the facts are that neither is happening right now.
The bond market is also locked in a very tight range caused by the Federal Reserve’s purchase of bonds. The recent announcement that the Fed would increase their buying of bonds to almost $1 trillion per year makes me think that this trading range would continue.
The technical meaning of the bond’s trading range is probably not as significant as the gold or stock markets because the Treasury market is being artificially propped up by Fed action.
Free Services for Non-Profits
For over 25 years now, Prescott has been very good to me and to Hepburn Capital Management. Thank you.
One way I express my gratitude and give back to our town is to manage money for local non-profit organizations for free. I already do this for several churches and charities, and would be happy to do the same for yours.
If you know of a local board that is not happy with the earnings rate on their savings, I would be happy to speak with them to see if my low-risk strategies might provide better results. Just call the office to schedule an in-office meeting or to have me address a board meeting. 778-4000
What’s Going On In Your Portfolio?
The Flexible Income* model portfolios now sport two real estate investment trusts that both pay over 6% in dividends each year. They replaced the government bond fund we had held.
Municipal bond funds make up about 1/3 of the portfolio, and have weakened a little since our last newsletter. Considering that they are still the strongest performers in the portfolio this year and the increasing tax issues driving municipals continue to persist, I will be patient with them.
Other Flexible Income* holdings include floating rate bond funds and diversified bond funds.
Our growth model* has new holdings in homebuilding and supplier stocks, although volatile, are doing OK for us, plus two real estate investment trusts, a Korean fund, a pharmaceutical stock and diversified bond funds. We have a small gain for December as of this writing on December 16th.
What We Were Saying Back Then
It is a big mistake to try to predict what the market will do next, because that affects how we interpret factual data.
It is easy to make shoot-from-the-lip predictions but that only tends to make one’s ego focus on how that prediction just has to be right and make investment decisions based upon it, sometimes long after the data has clearly shown otherwise.
There is a fine line between using historical precedents to anticipate market action, and to make predictions using those anticipations. The line is crossed where your own opinions and predictions cloud your objectivity and you lose the ability to effectively weigh the facts of market action.
This is always a factor in the markets – personal biases shape everything. However, to succeed, facts must ultimately determine every course of action.
Prediction season at the year end is always entertaining, but keep in mind how amateurish all those talking heads and columnists really are when they shoot their mouths off.
Take those predictions with a grain of salt, because no one really knows, and those making predictions make it harder for themselves to manage money well.
Overhaul your linen cupboard, store bed linen sets inside one of their own pillowcases and there will be no more hunting through piles for a match.
Our Spotlight Strategy
With our Adaptive Growth strategy we strive to provide high total return from a combination of investments from both the equity and income markets with the emphasis on equities.
If you would like a current copy of our SEC Form ADV, Part 2, it is on our website at hepburncapital.com/form-adv.html
* The model accounts mentioned in this article are hypothetical examples of how the strategy may work as designed. Activity in client accounts may be different from that in the model in amount of each investment, specific timing of trades, and actual security used, which may vary from account to account. Not all trades are profitable. It should not be assumed that current or future holdings will be profitable. A list of all trades in these accounts for the past 12 months will be provided upon written request.
** The S&P 500 and Nasdaq Indexes are unmanaged lists of stocks considered representative of the broad stock market. Investors cannot invest directly in the S&P 500 Index.
This newsletter may contain forward-looking statements, including, but not limited to, statements as to future events that involve various risks and uncertainties. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause actual events or results to differ materially from those that were forecasted. Information in this newsletter may be derived from sources deemed to be reliable, however we cannot guarantee its accuracy. Please discuss any legal or tax matters with your advisors in those areas. Neither the information presented nor any opinions expressed herein constitute a solicitation for the purchase or sale of any security.