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Tuesday, January 29, 2013

Investors Regain Enthusiasm for Stocks...Just as They Hit All Time Highs....Not A Recipe for Long Term Investment Success

50 year SP 500 chart 

You can call it herding, momentum or investors just investing with their eyes firmly fixed on the rearview mirror. Whatever the label, it is no surprise that as the S+P 500 hit near an all time high, investors suddenly have a renewed appetite for stocks.  Reports in the NYT and WSJ wrote of renewed interest in stocks among individual investors.
From the NYT:
As Worries Ebb, Small Investors Propel Markets
Americans seem to be falling in love with stocks again.
Millions of people all but abandoned the market after the 2008 financial crisis, but now individual investors are pouring more money than they have in years into stock mutual funds. The flood, prompted by fading economic threats and better news on housing and jobs, has helped propel the broad market to within striking distance of its highest nominal level ever.
“You’ve got a real sea change in investor outlook,” said Andrew Wilkinson, the chief economic strategist at Miller Tabak Associates.

Not surprisingly the near record high for stocks has triggered….record money flows into stock funds, domestic and intermational. From Barrons. A widely watched survey of individual investors (AAII) shows a big increase in bullishness. Not surpisingly this survey is regarded by professionals as a contrary indicator.

Equity Funds Set For Record $55B Monthly Inflow: TrimTabs

By Brendan Conway
Investors are feeding money to stock funds at a record-breaking pace this month, according to TrimTabs Investment Research.
$55.0 billion has bee invested in all equity mutual funds and exchange-traded funds in January, by the firm’s count.  The previous record: $53.7 billion in February 2000, “which was just before the technology bubble popped.”….
When it comes to ETFs, investors have shown a heavy preference for emerging markets and global stock funds. The top asset gathering ETF this month is iShares MSCI Emerging Markets(EEM), whose net inflows stand at $3.4 billion. The tech-heavy PowerShares QQQ (QQQ) is next in line, gaining $1.5 billion. Vanguard FTSE Emerging Markets (VWO) is third at $1.4 billion.iShares MSCI EAFE (EFA) and WisdomTree Japan Hedged Equity (DXJ) round out the top five with $1.1 and $1 billion, respectively.

This seems like a  clear example of investors chasing returns. It’s hard to find anything that has fundamentally changed in the economic picture in the last few months. America may not have fallen off the “dreaded fiscal cliff”  but neither has there been any real movement in the budget issues and ongoing debate over tax increases vs spending cuts. And whatever improvement has been present in the economy has been going on in fits and starts for at least a year. There  was no recent economic data that showed a strong acceleration in growth or reduction in unemployement. In fact today's release of consumer confidence survey  showed a decline.

It seems like the only reason for the change  in sentiment and renewed  buying of stocks is….stocks have been going up. Investors feel that stocks are somewhat “less risky” now that they have  risen significantly. This is almost never the case, the higher the price of the asset the riskier it is.

 A stock market at relatively high valuations is more likely to turn in poor performance going forward than a beaten down asset . Price can deviate from value in the short term . Stocks that have had a big run up are close to full value if not overvalued while the reverse would be clear for an asset after a big decline in price. 

A widely used measure of stock market valuation based on long term data is the schiller pe ratio. 

As can be seen below

... while certainly not in bubble territory the stock market measured by the schiller p/e is certainly not chearp. Based on shorter term data based on current earnings the p/e of the sp 500 is now at 17.49 around 13% above its long term mean average of 15.49. While I wont make a market prediction it's safe to say that those who are piling into stocks now are not buying into a cheap market.

The real path to long term investment success is to stick to an asset allocation that meets the investors personal financial circumstances and risk tolerance. For investors who do that, a share increase in the price of an asset offers the opportunity to rebalance. Such investors will be returning their portfolios to align with their long term allocation: selling assets that have appreciated sharply and buying those that have underperformed.  Such investors are “selling high and buying low” when rebalancing. Looked at another way they are effectively  selling highly valued riskier assets to the performance chancing herd that has a refound “appetitie for stocks.

Research has shown pretty clearly who will perform better. Individual investors (as evidenced by money flow data) inevitably buy high late into market rallies and of course often liquidate on the selloff. On the other hand research shows that holding a balanced allocation and rebalancing to keep the allocation in place s gains higher risk adjusted returns….and doubtless affs far more to those investors that buy and sell at the times indicated by large money flows in and out of stocks.

..In other words buy and hold ...or more precisely buy a balanced portfolio and rebalance is not "dead"...and in my view market timing was never viable.

Thursday, January 24, 2013

Actually I May Have Already Found an Article I Agree With More

FT again Same Authors Again and a similar title

Investors must rediscover their patience

I wish I could convince all my clients to look at their investing this way
I'll respect FT policy and provide just the link here.

For those who dont want to read the whole thing. Here's the takeaway:

  • Momentum is seductive but in the long run creates high turnover and poor long termresults. ....But paradoxically since it provides the best potential for managers to satisfy the short term performance preoccupation of investors..both investors and their managers follow short term strategies...which are sure to produce poor long term results:

The saddest aspect of this is that long-term investors have been drawn into the momentum game. Symptoms of this include the emphasis on relative performance, leading to risk being equated with tracking error – a recipe for herding. Asset owners cannot duck responsibility for this. To keep their agents on a short leash, performance is invariably compared with a market value-based (in effectively herd-weighted) benchmark and funds are switched from recent poor performers to better ones, amplifying momentum.

  • Price can deviate from value in the short term...investors focus too much on price and short term returns.

  • Long term investors can benefit from price returning to value but only if they have a long term approach.

The authors have this advice for investors and their managers:

  • Limit portfolio turnover to 30% of a portfolio (I would put the number much lower)
  • Switch away from benchmarking to market capitalization weight indices which ae subject to distortions due to momentum ("bubble risk)
  • Lengthen the time frame for evaluating portfolio performance.

I don't think I Have Read an Article I Agree With More than This One....

From the FT...always a far more useful read than the NYT or WSJ

Here summarizing an academic paper by Paul Wooley and Dmitri Vayanos of London School of Economics

I respect FT policy and just provide the takeaway from the article entitled

Tackling the two-headed monster of efficient markets theory and the principal-agent problem

  • Traditional investors are destined to be frustrated they give money to a money manager that fails to outperform the relevant inded. "Being a traditional investor sucks, doesn’t it?"

  • Being a traditional manager "sucks too". Investors expect alpha but dont want a policy that differs "too much from the benchmark indices"
What should investors do:

  • Focus on Long Term Results
  • Limit turnover in the portfolo
  • Invest for the long term focus on the long term not short term price movements
  • Dont benchmark to cap weighted indices which have higher weightings to assets that are highly valued and subject to poor long term results
  • Avoid or limit performance based conpensation or tied them only to long term performance
  • Avoid "sophistate "new" strategies and "alternative investments" even if they may offer some advantages those are likely to be offset by high fees and lack of liquidity
  • Insist on transparency of the portfolios
sounds good to me...and it's what I do with my clients...and hope my clients will do for me.

Unfortunately for me this is hard to do for investors...which means I either suffer "career risk" with clients withdrawing assets based on short term performance.