Last week we had the referendum heard round the world. Voters in the United Kingdom turned their backs on the Continent after 43 years.
Investors worldwide were fearful and fled equities in droves. In two days the Dow Jones Industrial Average fell 871 points.
And then a strange thing happened. Investors decided that perhaps the sky was not falling after all. Counting a one day run up before the vote, in just four trading days, the Dow had nearly returned to its level of the week before. By the fifth day, it was actually 100 points higher.
This is yet another lesson that investors should not react rashly to emotional events. In the short run, markets are highly unpredictable. Study after study going back a century has shown that investors are likely to hurt themselves by quickly reacting to events and trading emotionally.
The research firm Dalbar has shown that current investors receive about one-third of the return of the mutual funds they invest in because they make ill-timed moves in and out.
It feels uncomfortable to sit there and do nothing while the world is falling apart. But do it anyway. Your wallet will thank you.
The Three Dangerous Times
The three particularly dangerous times for investors: when markets go up, when they go down and when they are flat.
For the last two years, U.S. markets have been in a narrow trading range. Some days the market is up a lot, some days it’s down big. But overall, for two years the broad market is close to flat — up 3 percent a year — a third of the long-term average.
During a long flat period, investors get bored and are often up to mischief, searching for alternatives that promise much and mask danger.
In bear markets — the market often plunges quickly –and investors are prone to panic and do things that imperil their finances for many years.
When the market is doing well — bull markets — people get exuberant and overconfident and may take on greater risks and obligations than they intend. This sets them up for failure in the next cycle.
Given this bleak picture, what should investors do to improve their odds of success? Investors need to be patient, avoid emotional decisions and think long-term.
None of this is easy but it’s important for a successful investment experience.
The U.S. stock market is off to its worst start ever — down nearly 12 percent in just three weeks. Standard & Poors searched records back to 1897 and couldn’t find anything worse.
While the market has been drifting lower since summer — including a brief but scary decline in late August — this drop has seemingly come out of nowhere and is unremitting in its furor.
Yesterday, the Dow dropped 550 points by midday before rallying sharply. While there are always things to worry about, this seems to be the bear market about nothing.
The Chinese economy, the second largest in the world, may be getting unhinged. And the oil market has gone from boom to busted in 18 months but hey, nobody’s perfect.
If it weren’t for these minor issues, the outlook might seem bright. Job growth has been strong in the U.S. and corporate balance sheets are in the best shape in years.
Worldwide, corporations and investors are awash in cash and looking desperately for places to stash it (no place more frantic than Colorado where legal marijuana growers can’t access the banking system).
So what’s an investor to do? It’s usually best to hunker down and not panic. And if you feel like panicking, turn off the TV and the Internet and take a walk. You’ll feel better and in the long run, your portfolio will thank you.
For years I’ve felt like a lonely optimist in a dark and dangerous world.
In 2007, the U.S. economy was booming. House prices soared, unemployment was rare and anything seemed possible.
Then came the Great Recession, stock market collapse and the world financial system’s near failure. No one knew what to do.
Since that scary winter of 2009, the U.S. economy has rebounded. Car sales have doubled and housing starts quadrupled. The unemployment rate is half the recession peak.
Anecdotally, the pickup is dramatic. Help wanted signs have sprouted in store windows, trucks clog highways and realtors occasionally smile. The stock market has nearly tripled. For the first time in years, U.S. energy independence is possible.
Yet most Americans believe the country is on the wrong path. Only a month ago, the stock market plunged amid a weakening economy and troubles in China.
While problems never disappear, perspective is in order. U.S. GDP is up $3 trillion from the recession low to $17.4 trillion. The number of people with jobs in the U.S. is up by 10 million from 2009 to 148 million now.
Is everything perfect? No. But gloom and doom are overstated. After a scary drop in late August and September, the stock market rebounded and is flat for the year.
An investor must be an optimist and it’s possible they are at least partly right.
Index Funds have attained a near untouchable status among the financial press and investors. And for good reason. The funds — at least the highly diversified ones — are regularly among the top long-term investments. Recently, a Bloomberg article took an opposite tack, bashing index funds for being mindless machines that let nimble investors exploit their announced intentions. The article is harsh but accurate. Index funds are predictable and not perfect investments but they do serve many investors well. There are approaches that take the index funds as a useful starting point, attempt to preserve what’s good and enhance returns by avoiding some of the index fund flaws. Trading is one significant area. Index funds buy and sell holding whenever an index changes essentially letting the marketplace know what you are going to trade before you do it. A more patient approach to trading can lead to significant gains. For the rest of the gory details, here’s the link to “Can you really game index funds?” http://www.bloombergview.com/articles/2015-07-07/can-you-really-game-index-funds-
Like Mining Low Grade Ore
Most investors look for a big strike, a huge vein of ore. It’s always possible that they will find it but the odds are heavily against them.
Successful investing is more like mining for low grade ore. It’s a less exciting, methodical process that takes a long time. But with careful attention to strategy and execution, the probability of success is much higher.
Working with low grade ore isn’t as exciting and you’ll never have one of those “Eureka” moments. But neither do you have the frustration of one barren mine after another.
Investors look for the magic stock or the magic fund, a lottery ticket, that will bring them quick riches. In practice what works is a long-term, diversified portfolio with careful attention to minimizing taxes, watching costs and removing emotion from the process.
Those who react to the latest news or are constantly on the lookout for a winner fly in the face of decades of market history. While there is a logic and temptation to that approach, nearly all academic literature belies this notion.
Once in a blue moon, investment lightning strikes. Do you want to put your future on the line with those odds?
Apple Goes Into Dow
This week Apple Computer becomes part of the prestigious Dow Jones Industrial Average. The Dow is made up of 30 stocks and since its creation in 1896 has become the single most widely cited indicator of stock market performance. And yet its quirky structure shows the dangers of relying on any one indicator to mark investment performance. The Dow Jones average is based on just price, not the total value of the companies. Once a stock splits, its weight in the Dow goes down even though the value stays the same. After some moves in the Dow this week Goldman Sachs will have the heaviest weight in the average because it has the highest price. Moves in the price of Goldman stock will have a disproportionate affect on the average. Often the Dow moves in sync with other major averages such as the S&P 500 but many times they have widely divergent moves. While the Dow is a good shorthand way of following the stock market, keep in mind that its only a snapshot of a small number of stocks and there are thousands of other great companies.
The Dog That Didn’t Bark
This summer the Washington Post had an article titled,” So Whatever Happened to the deficit?”
Not quite a year ago, House Republicans threatened to shut the Federal government as part of their effort to lower the deficit. Meanwhile, while no one was looking, the deficit shrunk dramatically on its own.
The deficit has shrunk from an unsustainably high $1.6 trillion in 2009 to an estimated $500 billion for the fiscal year that ends in a few weeks.
The deficit will keep dropping as long as Congressional gridlock prevents new spending.
Most economists consider the current level sustainable.
Meanwhile, the economy has continued a five-year expansion. While the economy isn’t back to where it was before the Great Recession, this is a huge improvement from those dark days of late 2008 and early 2009 when the world economy threatened to collapse completely.
As a result, the stock and bond markets have staged dramatic, if unheralded rallies. The stock market has nearly tripled from the bottom in March 2009 and the broad bond market is up more than 30 percent, according to Bloomberg.
While none of this feels like a boom because it isn’t, the trends are good and investors shouldn’t be overly pessimistic.