Keep Your Eye on the Prize

09/28/2011 7:30 am EST

Focus: MARKETS

John Reese

Founder and CEO, Validea.com And Validea Capital Management

Because the market is more about traders than investors at this point, it’s important that investors don’t get caught up in the frenzy, writes John Reese of the Validea Hot List.

Lately—for the past few years, in fact—it seems like macroeconomic factors have had a far greater impact on the market than have individual stock fundamentals.

Some have termed it the "risk-on, risk-off" trade: Negative news about the global economy sends equity investors rushing herd-style for the door, fearing another 2008-like crisis and market crash. When economic news is good (or "less bad"), they breathe a sigh of relief and pile back into equities.

Often, this occurs indiscriminately. It doesn’t matter much what the individual stock or company does—if the broader economic news is bad, sell it; if the news is okay, buy it.

Correlation levels bear out this trend. The Chicago Board of Options Exchange runs a "correlation index" that measures how closely the movements of the S&P 500 components track each other. The index had been in the 40 to 50 range in the months leading up to the Lehman Brothers collapse; after, it rose sharply, topping 100 in November 2008.

It fell quite a bit, but hasn’t gotten back to pre-Lehman levels, staying well above 50 for most of the nearly three years since. It’s been rising since late July as the Europe fears have heated up, and for the past couple days has been in the low 80s.

This can be maddening for a value investor. After all, value investors depend on certain stocks becoming overvalued and others becoming undervalued. When everything moves more or less together, a wrench is thrown into that whole process.

Stocks move less on their earnings power and share prices, and more on vague premonitions and hunches. One day, a resignation by a top European Central Bank official sends the market plunging downward, as investors fear it’s a sign that Europe won’t be able to pull together to fix its problems. Another day, the German Chancellor makes some positive comments about Greece, and the market jumps—all is well again.

Some say this has brought in a new age of investing, one in which you have to play the risk-on, risk-off game, and somehow do it better than the masses. To those who try, I say good luck. Because, most likely, luck is the only thing that will work if that’s the game you’re playing.

Think you can predict what top European officials will do or say from day to day? Or that you can jump in early—ahead of the high-frequency traders—when the market starts to assert an upward or downward trend on a given day?

I certainly can’t do either of those things. And frankly, I don’t know anyone who can. I think even great investors like Warren Buffett, Benjamin Graham, Joel Greenblatt, and Peter Lynch would readily admit that they can’t either.

What to do then? Well, in a recent Wall Street Journal article, Jason Zweig offered some insights. One big thing you can do is keep perspective, he says, and I couldn’t agree more. The first step in doing that is realizing that, while it may seem like today’s market is more at risk from macro factors than markets of the past were, it’s really not.

|pagebreak|

The notion of "normal" times is a misguided one. While today, macro events like the European banking crisis, US debt, and terrorist threats play on investors’ minds, a myriad of other macro events—many with far wider-reaching impacts—played on investors’ minds in the past.

World War II threatened to end our country as we know it. The opening of China to the outside world created tremendous opportunity, and uncertainty, in the global economy. So too did the fall of the Soviet Union—which, at the time, was the largest nation in the world.

In his article, Zweig interviews investment advisor William Bernstein, who, in addressing the issue of terrorism and the supposed "unprecedented" impact it has on the economy, put things in crystal-clear perspective.

"Two generations ago, the US endured a global conflict that cost 50 million lives," Bernstein said. "The next generation faced down the Soviet Union and its 20,000 nuclear warheads. If you had told Americans then that the US should someday be even more afraid of a handful of jihadis from countries that couldn’t even make their own bicycles, they’d have keeled over laughing."

I don’t mean to make light of the problems facing us today. They are very serious indeed, and there is no guarantee they will be fixed efficiently or in totality. But I believe we’ve lost some perspective. And a big reason, as Zweig astutely notes, is the tremendous advances in information sharing.

"The average person lives today in a virtually mediated reality," Sheldon Solomon, a psychology professor at Skidmore College, told Zweig. "Thanks to the unfiltered spread of news over services like Facebook and Twitter, we all get a wide variety of instantaneous images that are likely to have more-inflammatory effects."

You also have instantaneous access to your portfolio. Every time the market drops, you see it right there on the screen, and it can hit you right in the gut. That’s led many investors to shorten their time horizons, Zweig notes, when they should in fact be lengthening them.

I agree. If you think you can time all of the macro news and move in and out of the market in short intervals, you’re most likely fooling yourself.

Equity investors have over the past 20 years (through 2010) averaged annualized returns of 3.83%, according to the research firm Dalbar. In the same period, the S&P 500 has gained 9.14%. By jumping in and out of the market at the wrong times, investors have cost themselves more than 5 percentage points per year.

From 2008 to 2010—as this brave new "macro" world took hold—investors fared slightly better, but still lagged the S&P by about 1.4 percentage points per year. Their hunch-playing, on average, still detracted from their returns.

Instead of trying to time the market’s day-to-day or week-to-week swings, I’d rather stay the course and stick to a good strategy for the long term. Let the traders take each others’ money—and then give it right back—as they try to outguess the market in the short term. Focus on the fact that plenty of good values exist right now in the market.

History has shown that when fears are high, those who buy equities with a long-term perspective make out well. They buy low—maybe not at the absolute low, but low enough—and good things happen when you buy low.

Remember, when Lehman Brothers collapsed exactly three years ago yesterday, on September 15, 2008, many said those who kept buying stocks—particularly US stocks—were headed for ruin. Well, it’s three years later, and the S&P 500 and the Nasdaq Composite are both in the black.

And those are indices. Many good stock-picking strategies have fared far better.

Subscribe to the Validea Hot List here…

Related Reading:

Related Articles on MARKETS

Keyword Image
The Best Buys in Cybersecurity
12/08/2017 5:00 am EST

After weeks of sifting through hundreds of cybersecurity stocks on the market, I finally narrowed my...