Ken Fisher: Market Myths
11/07/2003 12:00 am EST
Money manager Kenneth Fisher focuses on behavioral finance theory - the application of psychology to investment analysis. He is controversial, as his theories are often critical of the very nature of financial insitutions and the investment process. I personally view his commentary as among the very finest in the advisory field.
"Our brains were not set up to invest in the stock market. We got our brains from far-distant ancestors and our brains were set up to process information long before the development of financial markets. Most of the dilemmas that behavioral finance have discovered over the last 30 years get their roots out of the fact that we come from this evolutionary psychological background where we see things in ways that aren’t really correct formats for seeing finance. Because of this we often see things blindly, and that leads us to old mythologies that we hold dear and long – but are simply wrong.
"For example, this audience is obviously interested in investing. It is likely you read a lot about investing and you know that at the beginning of the year it was assumed that the economy wasn’t going to do well this year, that the consumer was tapped out, and that the market would not do well for the year. Yet, the economy has been stronger than anyone thought and the market’s been great, so somehow that analysis had to be wrong.
"When everybody knows something, it’s either wrong or already priced into the market. There are no exceptions to that – it’s core finance theory. The market - in theory and reality - is a discounter of all known information. Among other things, what that means is that you can’t make excess returns relative to the market by making decisions from commonly available information. With no disrespect to journalists and the media, if you make decisions based on the things you can read in newspapers and magazines and see on TV, finance theory says that you will be lucky sometimes, but that more likely you will be wrong. Some people think they are smarter, so that they can make decisions off commonly known information. Those who think they can make decisions off commonly know information because they are smarter, are really stupid.
"If you think you can make decisions off of common available information because you are wiser and/or have more experience and training, you are also wrong. Curriculum is a subset of known information. If you could do that by experience and training then all you would have to do is get an MBA and a CFA and work in the industry for 20 years and then beat the market. But since you know that very few of the people who do that beat the market, you see evidence that curriculum alone is inadequate. Thus, those who think you succeed with commonly available information because they are wiser, are what behavioral finance theory defines as a fool.
"You can pick up a coin and flip it and have a 50-50 chance of getting ahead. For example, you can do that at the end of each year, and use that method to determine whether or not to overweight technology. You would have a one-half likelihood of being right for the following year. But that’s just being lucky. Again, it is pointless to try and make decisions based on commonly available information. Finance theory says that if you are going to make excess returns you must somehow know something that is not commonly known. Surprises are those things that are not commonly available information.
"Meanwhile, think about another myth. Do you remember at the beginning of the year hearing about how investors weren’t pessimistic enough for the market to go up? One indicator that is commonly used is a survey of newsletter writers, known as Investors Intelligence. These indexes won't help you with the market, as has been demonstrated, at some statistical length. There is simply no predictive value from this data. Statistically, it just doesn’t hold up. But again, people don’t go back and check this, the myth lasts, and people pay attention to it. The fact that folks think these surveys are predictive and bearish is useful if you know they really aren't. When they create fear, these sentiment indicators can be bullish. Here's another myth: Remember the saying, ‘Sell in May and go away.’ People also said that the markets are always weakest in September and October. But as of late October, the S&P is at a new high for the year.
"I would also note that at the beginning of the year, everyone said the market’s P/E was too high for the market to go up a lot. Everyone has heard that. People generally believe that today’s high p/e ratios are appalling. They are actually a bit appealing. When everyone thinks something is appalling - when it is appealing - that’s actually bullish. For every period where high-p/e markets fizzled, there are comparable ones where they did well. The market's average P/E ratio is a bad market forecaster. There is just no statistical significance. Take advantage of the popular fear of P/E ratios. Bet against it. Few feared 2000's P/E's. Now that people think P/E's are too high, buy into the market."
Incidentally, in his latest featured column in Forbes magazine, Kenneth Fisher also notes several of his current favorite stocks: "Bearingpoint (BE NYSE) is the old KPMG consulting business. Corporate consulting will have high demand in coming years. At six times cash flow (in the sense of net income plus depreciation), BE is dirt-cheap growth. For great brand names in a well-run, growing firm that isn't too expensive at a market P/E, buy Church & Dwight (CHD NYSE) which, among other things, owns the names Arm & Hammer, Brillo and Sno Bol. For fun, try Leapfrog Enterprises (LF NYSE), the world's most innovative toymaker. I've known founder Michael C. Wood for a decade and have confidence he will keep leapfrogging one jump ahead of peers. Or, take a spin with International Speedway (ISCA NASDAQ), which combines the best sports radio network not owned by a media giant with the best racetracks."
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