Monday, October 13, 2014

How do you see the world? And how might that impact your investment results?

In that the stock market is a market because it's where buyers and sellers meet---and that the player on one side of a transaction essentially disagrees with the player on the other side---there are forever two opposing cases to be made about a given security, and, of course, about the market as a whole.

Having begun my career in 1984, at the tender age of 12 (oops! transposed those numbers)---and being that I make my living helping investors live comfortably (financially and, therefore, emotionally)---I've come to learn that the stuff individuals bring to the market can have a major impact on their degree of long-term success. By "stuff" I mean their personalities; their glass-half-full versus half-empty proclivity, their---to put it crudely---baggage.

How do you see the world? Do you see opportunity? Do you see the amazing technologies that have literally transformed your daily life? Do you acknowledge the productivity, and the freeing up of human capital, resulting from the miracles of those technologies? Do you see the ever-growing connectivity between yourself and the rest of the world? Do you see how international commerce moves products and services around the globe and how it's just now beginning to penetrate the lives of folks who've been mired in underdevelopment and poverty for eons. Do you see the financial markets as gateways to growth for budding global enterprises---as well as sources of opportunity for you to invest and grow your estate? Or do you see a world of conflict? Instead of a world of growing connectivity and, therefore, peace, do you see only the violent exchanges between Russia and Ukraine, etc.? The evil of ISIS? The threat of Ebola? Do you see technology and globalization as little more than job killers? Do you see the financial markets as scary places that can destroy your wealth without a moment's notice?

In the following I'll lay out for you today's short-list bullish and bearish near-term cases for the stock market. I'll do this in complete straight forward fashion. There'll be no attempt to steer you to either side of the debate. Consider this a personal exercise. Observe which story you cling to. Then try to identify why one story makes more sense to you than the other. Consider how you view other aspects of your life. Is there a pattern? Ask yourself if your politics, and/or your chosen media outlet, might be influencing your vision. Does your optimism truly reflect reality? Or are you just a perpetually optimistic sole? Are you pessimistic (I know, "realistic") because your objective assessment of the world tells you there'll be no overcoming present obstacles? Or has that forever been your assessment of the world?

Here's the near-term short-list bullish case for stocks:

Bad news from Europe is now, or very close---given recent declines---to being completely priced into the market.

No U.S. recession in sight. The classic indicators---yield curve, TIPS spread, employment trend, financial stress index, business activity, to name a few---all presently point away from recession in the foreseeable future. Bear markets (but not corrections) are generally recession-born.

Inflation is barely a blip and, therefore, the Fed will remain accommodative (keeping interest rates low) far into 2015, if not beyond.

The dollar is strong and will attract capital from around the world.

Gasoline prices are plummeting. Creating tens of billions of dollars of discretionary income for consumers.

Weekly jobless claims have been dropping steadily. There's historically been a negative correlation between weekly claims and the stock market (they tend to move in opposite directions).

October---the historically most volatile month of the year---has been very rough thus far. Setting the stage perfectly for November and December: the historically best months for stocks.

Fund managers, by and large, have underperformed the market this year. The recent dip is offering them one last chance to catch up by year-end. The moment they believe the bottom's in, they'll buy ferociously.

With the exceptions of consumer staples, health care and utilities, the major sectors are firmly in oversold territory. That's a technical indicator that says there'll be some serious buying in the not-too-distant future.

Short interest (traders aggressively [as in riskily] betting on a decline) is relatively high. As those oversold stocks get grabbed, shorts will panic and cover (buying to close out their positions), pushing stocks even higher. The put/call ratio is also extremely high at the moment---another huge contrarian indicator.

Sufficient worry. There's plenty of angst toward the market these days. And bull markets virtually never end amid pessimism. It's euphoria that kills bull markets. And these days, euphoric we ain't.

Corporate Earnings continue to grow, and won't peak until the economy peaks.

Corporate Balance sheets are flush with cash, and capital expenditures (investing in expansion) are just beginning to ramp up.

The retail investor has yet to join the party. Bull markets tend not to end until after the little guy dives in with both feet.

Warren Buffett---considered by many to be the greatest stock market investor of all time---sees the recent pullback as a great buying opportunity.


Here's the near-term short-list bearish case for stocks:

The Euro Zone is an utter mess. Which puts huge upward pressure on the dollar which will surely hit the revenues and, thus, the stock prices of U.S. multinational companies.

China simply isn't delivering on its 7.5% growth forecast for this year. Meaning commodities and global equities are surely to fall further as the world's second largest economy will not provide the fuel markets were previously discounting.

Corporate earnings per share have been more the result of financial engineering (share buybacks) than they have an increase in business. Companies can only do so much propping up before reality hits and earnings growth wanes.

The Cyclically Adjusted Price to Earnings Ratio (CAPE), which factors in historical earnings results (as opposed to merely this or next year's earnings), sits at a scary high 26.

Small cap stocks have taken a real beating of late. Which is one harbinger of a complete market breakdown.

Declining energy prices foretell of a coming weakening of the U.S. economy.

The present bull market is among the longest running in history. It simply can't hold up much longer amid such global weakness and stretched valuations.

The housing market is simply not showing sustainable improvement and, therefore, not going to fuel the recovery going forward.

Traders are betting big on a drop, as evidenced by short interest and the put/call ratio.

Wage growth has been virtually non-existent and, therefore, we won't see a meaningful contribution to growth from consumer spending (two-thirds of the economy).

Record low interest rates tell of an ugly forward outlook for the U.S. economy.


While I could effectively rebut every single point in both arguments, all of them are---at least to some degree---legit.

So which story would be yours? If you're more impacted by the latter, read them again in reverse order to make sure you haven't fallen prey to recency bias. Now, per paragraph 4, consider to what extent, if any, your opinion might be influenced by your politics and/or other outside forces. I know folks who completely abandoned their long-term strategies based solely on who occupied the White House at the time. In the cases I've observed---without exception---those moves proved to be extremely costly.

So how---other than what I just described with regard to our politics---might our "stuff" impact our investment results? It's quite simple actually:

The eternal optimist can throw all caution to the wind. She's apt to over-invest relative to her personal circumstances (age and obligations). She likes to rush in and buy every single market dip with her reserves. She might refuse to rebalance (sell back to a target allocation) when the market's on an upswing. Essentially, she's prone to taking more risk than her personal circumstances justify, which could find her having to unload positions at the worst possible time (during a bear market) to satisfy her personal obligations.

As for the pessimist: He has a penchant for selling at precisely the wrong times---when the market dips that is. He tends to under-invest relative to his personal circumstances. He often refuses to rebalance (buy back to a target allocation) when the market's on a downswing. Essentially, he allows for less volatility than his personal circumstances justify, which might ultimately compromise---due to subpar long-term results---his retirement lifestyle.

All that said, if you're our client---and you're pessimistic---you know I'll never criticize your carefulness: Performance shmerformance! I'll take peace of mind over performance any day of the week. If, on the other hand, you're an optimist, you've experienced my occasional efforts to tame your enthusiasm.

My aim here is not to suggest that you should attempt to change who you are, but to have you consider to what extent your excitement or despair may be influenced by factors other than the legitimate evidence before you---and how your instincts might not serve you all that well when it comes to your portfolio.

Oh, and as for compiling a list of bullish and bearish indicators: I promise you, unequivocally!, I could have created such a list at any time during my thirty-year career. Like I said in paragraph 1, there are forever two opposing cases to be made about a given security, and, of course, about the market as a whole.

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