Last Monday, the U.S. markets dropped roughly 1% of their value, and Europe and Asia were down by similar amounts the following day. The market (the S&P 500) then fell 2.1% on Friday in a sickening lurch. This combination was enough to cause pundits and investors to ask whether we are now in the early stages of a bear market or, indeed, if the past almost-five years should be considered an interim market rally inside of a longer-term bear market.
The answer, of course, is that nobody knows--not the brainiac Fed economists, not the fund managers and certainly not the pundits. A Wall Street Journal article noted that most of the sellers on Friday were short-term investors who were involved in program trading, selling baskets of stocks to protect themselves from short-term losses. Roughly translated, that means that a bunch of professional traders panicked when they learned that Chinese economic growth is slowing down on top of worries that the Fed is buying bonds at a somewhat less furious rate ($75 billion a month vs. $85 billion) than it was last year.
What we DO know is that it is often a mistake to sell into market downturns, which happen more frequently than most of us realize. A lot of people might be surprised to know that in the Summer of 2011, the markets had pulled back by almost 20%--twice the traditional definition of a market correction--only to come roaring back and reward patient investors. There were corrections in the Spring of 2010 (16%) and the Spring of 2012 (10%), but almost nobody remembers these sizable bumps on the way to new market highs. Indeed, most of us look back fondly at the time since March of 2009 as one long largely-uninterrupted bull market.
Bigger picture, since 1945, the market has experienced 27 corrections of 10% or more, and 12 bear markets where U.S. equities lost at least 20% of their value. The average decline was 13.3% over the course of 71 trading days. Perhaps the only statistic that really matters is that after every one of these pullbacks, the markets returned to record new highs. The turnarounds were always an unexpected surprise to most investors.
We may get a full 10% correction or even a full bearish period out of these negative trading days, and we may not. But the history lesson suggests an important lesson: if we DO get a correction or a bear market, we may not remember it a few years later if the markets recover as they always have in the past. The people who lose money in the long term are not those who endure a painful market downturn, but the people who panic and sell when the market turns down.
Sources:
http://finance.yahoo.com/blogs/the-exchange/stocks-plunge-in-u-s---dow-sinks-more-than-280-points-205935575.html
http://www.bloomberg.com/news/2014-01-16/crashes-corrections-and-monday-s-bear-market-.html
http://www.bloomberg.com/news/2014-01-23/the-bull-market-ends-or-is-it-just-a-correction-.html
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.
Monday, January 27, 2014
Monday, January 20, 2014
BOGUS EFFECT
This time of year, we often find ourselves reading about the "January Effect," which is sometimes described as a predictable way to forecast returns, and sometimes as a way to know whether this is, or is not, a good year to invest and make some money.
Unfortunately, most of this reporting is nonsense.
Let's start with the predictable part. Wouldn't it be nice if, even for just one month of the year, we could know whether the market is going to go up or down? That's what market pundits are implying in their January Effect reporting: that markets have a strong tendency to rise in January. Why? The explanation, first offered in 1942, is twofold:
1) Stock investors tend to harvest their tax losses at the very end of the year, selling any stocks that happen to be below the price they paid for them, and, of course, claiming the loss on their tax returns. This selling activity depresses the prices of stocks generally in late December (Why do we not hear about a negative "December Effect?"), but when those investors buy back into the market in January, the additional buying demand pushes up prices.
2) Mutual funds, who are the biggest stock investors, have to report their holdings as of the end of the year. If they made an embarrassing mistake and purchased a stock which subsequently dropped like a stone, the portfolio manager engages in an exercise known as "window dressing:" she conveniently sells that stock right before December 31, and then reports a portfolio that doesn't include the losing investment. This is a great way to prevent reporters from asking pointed questions about what they might have seen in that dog stock when they purchased it in the first place. And it makes it look like, despite what might have been poor performance throughout the year, the fund is strangely only invested in stocks that went up.
Of course, the cash position is only temporary; the fund will put the money to use in January. Just like the tax harvesting activity, these sales in December and purchases in January, we are told, have a wind-at-the-back impact on share prices in the first month of the year.
So why is this nonsense? Back in 1942, and for some years afterwards, it might have made sense to do all your tax loss harvesting once a year as the holiday decorations were being taken down at the malls. Today, with modern software tools, professional investors can check daily to see if there are portfolio losses they can harvest, so the buying and selling is spread out through the year. Also, today's mutual funds report the contents of their portfolios quarterly, rather than annually, so the window dressing activity (which still goes on), happens each fiscal quarter, rather than all at once at the end of the year.
Moreover, a quick glance at history suggests that returns in the month of January have been pretty random for this century's investors. The S&P 500, in the calendar month of January since January 2000, has delivered returns of -4.18%, +6.45%, -2.12%, -5.87%, +2.04%, -1.73%, +0.89%, +1.53%, -4.74%, -11.37%, -5.22%, +1.12%, +2.77%, +2.44% and -0.77% last January. If you can see a pattern there worth betting on, chances are you're also a genius at the racetrack.
The other January Effect says that if stocks rise in January, they will be up for the year, and if they fall in January, then the market will deliver losses through December. Of course, any time you give the market a head start in either direction, there will be a slight tendency for the rest of the year to follow suit--similar to if you saw an Olympic sprinter break out of the blocks ahead or behind the pack, you would notice a tendency to finish ahead or behind. Not a guarantee, you understand, but a tendency.
Looking at the historical record, when stocks finish the first month down, they finish the year down 58% of the time--almost exactly what you would expect within the statistical probabilities of randomness. Researchers have actually determined that--probably also due to random factors--the returns in September have historically been the best predictor of returns for the year as a whole.
The truth is, none of us have a way to predict even a week, much less a month, much less a year of market returns. Whenever we read about the Super Bowl winner predicting the market, or the month of January or September or the winning party in the Presidential election, we should recognize that the article is being written purely for entertainment, giving us a chance to fantasize that, somehow, we can, for a moment, know the unknowable future and maybe even profit from it.
Sources:
http://moneymorning.com/2013/12/26/january-effect-exist/
http://blogs.wsj.com/moneybeat/2014/01/15/so-much-for-the-january-effect-sp-500-back-in-record-territory/
http://blogs.barrons.com/stockstowatchtoday/2014/01/14/after-the-drop-as-january-goes-so-goes-the-year/
http://www.businessweek.com/articles/2014-01-07/investors-looking-for-a-january-effect-should-wait-a-few-months
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.
Unfortunately, most of this reporting is nonsense.
Let's start with the predictable part. Wouldn't it be nice if, even for just one month of the year, we could know whether the market is going to go up or down? That's what market pundits are implying in their January Effect reporting: that markets have a strong tendency to rise in January. Why? The explanation, first offered in 1942, is twofold:
1) Stock investors tend to harvest their tax losses at the very end of the year, selling any stocks that happen to be below the price they paid for them, and, of course, claiming the loss on their tax returns. This selling activity depresses the prices of stocks generally in late December (Why do we not hear about a negative "December Effect?"), but when those investors buy back into the market in January, the additional buying demand pushes up prices.
2) Mutual funds, who are the biggest stock investors, have to report their holdings as of the end of the year. If they made an embarrassing mistake and purchased a stock which subsequently dropped like a stone, the portfolio manager engages in an exercise known as "window dressing:" she conveniently sells that stock right before December 31, and then reports a portfolio that doesn't include the losing investment. This is a great way to prevent reporters from asking pointed questions about what they might have seen in that dog stock when they purchased it in the first place. And it makes it look like, despite what might have been poor performance throughout the year, the fund is strangely only invested in stocks that went up.
Of course, the cash position is only temporary; the fund will put the money to use in January. Just like the tax harvesting activity, these sales in December and purchases in January, we are told, have a wind-at-the-back impact on share prices in the first month of the year.
So why is this nonsense? Back in 1942, and for some years afterwards, it might have made sense to do all your tax loss harvesting once a year as the holiday decorations were being taken down at the malls. Today, with modern software tools, professional investors can check daily to see if there are portfolio losses they can harvest, so the buying and selling is spread out through the year. Also, today's mutual funds report the contents of their portfolios quarterly, rather than annually, so the window dressing activity (which still goes on), happens each fiscal quarter, rather than all at once at the end of the year.
Moreover, a quick glance at history suggests that returns in the month of January have been pretty random for this century's investors. The S&P 500, in the calendar month of January since January 2000, has delivered returns of -4.18%, +6.45%, -2.12%, -5.87%, +2.04%, -1.73%, +0.89%, +1.53%, -4.74%, -11.37%, -5.22%, +1.12%, +2.77%, +2.44% and -0.77% last January. If you can see a pattern there worth betting on, chances are you're also a genius at the racetrack.
The other January Effect says that if stocks rise in January, they will be up for the year, and if they fall in January, then the market will deliver losses through December. Of course, any time you give the market a head start in either direction, there will be a slight tendency for the rest of the year to follow suit--similar to if you saw an Olympic sprinter break out of the blocks ahead or behind the pack, you would notice a tendency to finish ahead or behind. Not a guarantee, you understand, but a tendency.
Looking at the historical record, when stocks finish the first month down, they finish the year down 58% of the time--almost exactly what you would expect within the statistical probabilities of randomness. Researchers have actually determined that--probably also due to random factors--the returns in September have historically been the best predictor of returns for the year as a whole.
The truth is, none of us have a way to predict even a week, much less a month, much less a year of market returns. Whenever we read about the Super Bowl winner predicting the market, or the month of January or September or the winning party in the Presidential election, we should recognize that the article is being written purely for entertainment, giving us a chance to fantasize that, somehow, we can, for a moment, know the unknowable future and maybe even profit from it.
Sources:
http://moneymorning.com/2013/12/26/january-effect-exist/
http://blogs.wsj.com/moneybeat/2014/01/15/so-much-for-the-january-effect-sp-500-back-in-record-territory/
http://blogs.barrons.com/stockstowatchtoday/2014/01/14/after-the-drop-as-january-goes-so-goes-the-year/
http://www.businessweek.com/articles/2014-01-07/investors-looking-for-a-january-effect-should-wait-a-few-months
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.
Monday, January 13, 2014
BEHAVIORAL FINANCE AND "NANNY" PROVISIONS
One of the most interesting areas of financial research these past ten years has come, oddly, not from economists or investment researchers, but psychologists, who are pioneering a branch of study known as "behavioral finance." This has led to one of the strangest sights in the history of Nobel prizes: the 2002 prize in economics handed out to psychologist Daniel Kahneman for (according to the Nobelprize.org website) "having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty."
The behavioral finance research tells us that most people take mental shortcuts to arrive at decisions, and some of them lead to odd conclusions. Around the time you make your New Year's resolution to lose weight, do you buy a $500 annual membership to a gym or opt for a $10 per visit pay-as-you-go fee? Most people who choose the former end up actually going to the gym less than once a month; the flat fee is only a bargain when you assume that the bold post-resolution intention will actually happen, but it's often a terrible deal when a person's actual behavior is taken into account.
How do you decide whether to be an organ donor when you face the option on your driver's license application? In countries where the default option is yes (you consent to be an organ donor), 90% of individuals happen to be registered organ donors. In countries where the default option is no, the percentage ranges from 10% to 30%.
This research is now finding its way into the hands of policy makers, who are pioneering a new governmental role of protecting you against the dangers of your own mental shortcuts. One recent example is automatic enrollment in a company retirement plan. Research shows that if people are required to affirmatively opt-into having a portion of their paycheck sent to their 401(k) retirement plan, they will do so at a lower rate (67%) than if they are enrolled by default and have to affirmatively opt-out (77%). The U.S. government has been encouraging auto-enrollment policies at American corporations, on the theory that workers will be better off if more of them are making regular 401(k) plan contributions.
Another example in Britain came when the government offered tax incentives for people to insulate their attics, reducing energy consumption and the associated pollution from energy production. But so few people showed an interest in the incentives that the UK government finally had to switch tactics. It offered the same tax break, but added a loft clearance service that would help people clean out their attic and give them assistance in disposing of (sell or throw away) unwanted items. The new service tripled insulation participation rates.
When the city of Copenhagen painted green footprints on the sidewalks leading to litter bins, littering decreased by 46%.
The idea of applying behavioral economics to political and social initiatives sounds a lot like manipulation to its critics, who worry that we are moving toward a "nanny state" where the government feels compelled to protect us from our own behavioral biases. Reducing litter on the streets of Copenhagen is relatively noncontroversial, but what about initiatives that try to influence buyers to select more energy-efficient cars? Or government policies that discourage the consumption of certain foods or beverages? The New York City ordinance against large soda containers was based on the assumption that people were unable to recognize, on their own, the health risks of soda consumption.
Interestingly, at least one of these behavioral initiatives is now showing evidence of backfiring. The Center for Retirement Research at Boston College found that companies that have switched to automatic enrollment in their 401(k) plans have been paying for the additional cost by giving their employees smaller employer matches--3.2%, compared with an average 3.5% for plans without automatic enrollment. At the same time, the Boston College researchers and the Vanguard organization have found that for some workers, the automatic savings rate offered in the default is lower than what many workers would have chosen if they had made an affirmative decision to participate. Worse, the automated mix of investments (typically target date funds) that is the default option has underperformed the investment mixes that workers have tended to select on their own. For some workers, at least, the government's behavioral finance nudge will cost them real money.
Sources: http://www.politico.com/magazine/story/2013/12/obamas-nanny-state-100848.html
http://swampland.time.com/2013/08/09/nudge-back-in-fashion-at-white-house/
http://money.usnews.com/money/retirement/articles/2013/11/18/the-downside-of-401k-automatic-enrollment
http://www.401khelpcenter.com/cw/cw_auto_enroll.html#.UqYzl2RDuAc
http://www.inudgeyou.com/green-nudge-nudging-litter-into-the-bin/
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.
The behavioral finance research tells us that most people take mental shortcuts to arrive at decisions, and some of them lead to odd conclusions. Around the time you make your New Year's resolution to lose weight, do you buy a $500 annual membership to a gym or opt for a $10 per visit pay-as-you-go fee? Most people who choose the former end up actually going to the gym less than once a month; the flat fee is only a bargain when you assume that the bold post-resolution intention will actually happen, but it's often a terrible deal when a person's actual behavior is taken into account.
How do you decide whether to be an organ donor when you face the option on your driver's license application? In countries where the default option is yes (you consent to be an organ donor), 90% of individuals happen to be registered organ donors. In countries where the default option is no, the percentage ranges from 10% to 30%.
This research is now finding its way into the hands of policy makers, who are pioneering a new governmental role of protecting you against the dangers of your own mental shortcuts. One recent example is automatic enrollment in a company retirement plan. Research shows that if people are required to affirmatively opt-into having a portion of their paycheck sent to their 401(k) retirement plan, they will do so at a lower rate (67%) than if they are enrolled by default and have to affirmatively opt-out (77%). The U.S. government has been encouraging auto-enrollment policies at American corporations, on the theory that workers will be better off if more of them are making regular 401(k) plan contributions.
Another example in Britain came when the government offered tax incentives for people to insulate their attics, reducing energy consumption and the associated pollution from energy production. But so few people showed an interest in the incentives that the UK government finally had to switch tactics. It offered the same tax break, but added a loft clearance service that would help people clean out their attic and give them assistance in disposing of (sell or throw away) unwanted items. The new service tripled insulation participation rates.
When the city of Copenhagen painted green footprints on the sidewalks leading to litter bins, littering decreased by 46%.
The idea of applying behavioral economics to political and social initiatives sounds a lot like manipulation to its critics, who worry that we are moving toward a "nanny state" where the government feels compelled to protect us from our own behavioral biases. Reducing litter on the streets of Copenhagen is relatively noncontroversial, but what about initiatives that try to influence buyers to select more energy-efficient cars? Or government policies that discourage the consumption of certain foods or beverages? The New York City ordinance against large soda containers was based on the assumption that people were unable to recognize, on their own, the health risks of soda consumption.
Interestingly, at least one of these behavioral initiatives is now showing evidence of backfiring. The Center for Retirement Research at Boston College found that companies that have switched to automatic enrollment in their 401(k) plans have been paying for the additional cost by giving their employees smaller employer matches--3.2%, compared with an average 3.5% for plans without automatic enrollment. At the same time, the Boston College researchers and the Vanguard organization have found that for some workers, the automatic savings rate offered in the default is lower than what many workers would have chosen if they had made an affirmative decision to participate. Worse, the automated mix of investments (typically target date funds) that is the default option has underperformed the investment mixes that workers have tended to select on their own. For some workers, at least, the government's behavioral finance nudge will cost them real money.
Sources: http://www.politico.com/magazine/story/2013/12/obamas-nanny-state-100848.html
http://swampland.time.com/2013/08/09/nudge-back-in-fashion-at-white-house/
http://money.usnews.com/money/retirement/articles/2013/11/18/the-downside-of-401k-automatic-enrollment
http://www.401khelpcenter.com/cw/cw_auto_enroll.html#.UqYzl2RDuAc
http://www.inudgeyou.com/green-nudge-nudging-litter-into-the-bin/
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.
Monday, January 6, 2014
HOW TO BEAT THE MARKET
Chances are, you've read articles saying that it is impossible to beat the market--that is, to consistently earn higher returns than the stock market averages. At a recent conference for industry professionals in Dallas, the distinguished economist Dr. Horace Brock offered a deep dive into economic theory, and told the audience that there are actually multiple ways to beat the market.
The first and most obvious way is cheating. If you have inside knowledge about a stock that nobody else possesses, then you can make more astute trades than everyone else. The Securities and Exchange Commission has managed to catch a number of these criminals. You may have heard of Ivan Boesky, or Martha Stewart's famous phone call to her friend the founder of ImClone. Quest Communications chief Joseph Nacchio dumped more than $50 million of company stock in 2005 before his company went into decline. More recently, police are pursuing a massive insider trading case against a French doctor and FrontPoint Partners, who are accused of netting $30 million while trading on nonpublic knowledge.
Until they were caught, these "investors" (and Galleon Group hedge fund manager Raj Rajaratnam, Charles and Sam Wyly and certain Bear Stearns hedge funds) were making a lot more money in the markets than you and I ever will.
If you're not especially good at cheating, then you can rely on the second way to beat the market: luck. Don't laugh; there's evidence that most of the mutual funds that outperform the overall market in any given year just happen to be lucky. Their luck tends to lead to bad luck for investors, however. Investors have a tendency to assume that the fund managers who had great performance this year are brilliantly astute, move their money out of less-lucky funds, and then lose money when the managers' luck runs out and their funds underperform by roughly what they were outperforming before. Net-net, these managers had exactly as much bad luck as good luck, but many more investors were exposed to the bad luck period than the good luck period. Ouch!
You can also win the lottery, and some people are lucky enough to do so. Their "investment" return on that lottery ticket is astronomical; nobody can deny that.
Brock offered three other ways to beat the market, all of which rest on sounder footing. By way of background, he cited very complicated research by Mordecai Kurtz at Stanford which showed that almost 95% of the short-term market movements can be explained by two things: news and expectations. The news is pretty simple; suppose Intel beats the consensus estimate of its earnings next quarter by two cents a share. This can either send the stock price soaring or tumbling, depending on whether most investors expected the stock to miss its earnings estimate (therefore, the news is better-than-expected and the stock rises), or to beat its earnings estimate by more than two cents (bad news, the stock plunges). Bigger picture, the news might be that Greece has tumbled into default, causing a short-term plunge in stocks around the world.
But longer-term price movements depend on how the world changes more gradually, based on trends that are not obvious and seldom in the news. To take some of the more obvious examples: China abandons communism and gradually becomes the second-largest economy in the world. The Internet is born, and creates entirely new market dynamics. Europe adopts a new common currency, which sets in motion a lot of other changes for good or ill.
So how do you beat the market? If you are slightly more astute about understanding the business implications of these trends than the average person, Brock told his audience, then it is possible, over the long-term, to position your assets more advantageously. Your secret sauce is thinking and reading--or investing with very thoughtful money managers who take a long-term view of gaining returns.
You can also beat the market by not following the herd. Brock said that new mathematical models of market bubbles and busts allow for what he called "the uneven distribution of mistakes," a world where most investors can be wrong about their expectations or evaluations, all in the same direction. Remember how people were flipping houses in 2007 and Wall Street firms were betting the world that housing prices would never go down? Remember the technology mania leading up to the 2000 Tech Wreck?
You can beat the market by holding a diversified portfolio (which will keep pace with the market) and systematically rebalance your investments regardless of what fearful or euphoric cries other investors are screaming outside your window. That way, when the distribution of mistakes is nearly 100% on the side of euphoria, you will be holding fewer stocks than the average investor and participating less in the inevitable bust. And when the distribution of mistakes is on the side of fear and nobody wants to own stocks, you're participating in the market and benefiting from the inevitable recovery.
These last two methods of beating the market are not nearly as exciting as cheating or winning the lottery. So if you want excitement, you can turn to the last way that Brock said markets can be beaten. Every Wall Street firm has active traders who stare at six or eight computer screens all day long, with their finger hovered over a buy or sell button. They house their trading servers in the same building as the mainframe servers that process orders for the New York Stock Exchange and Nasdaq, so their buy and sell commands will arrive milliseconds ahead of the competition. They study expectations, and then, as soon as news arrives, that instant, they make a trade that will be thousandths of a second ahead of other quick-twitch traders--and, probably, a few days ahead of the trade that you and I would eventually be tempted to make.
This quick-twitch trading arrangement doesn't always work out exactly as planned, however, which greatly adds to the excitement. Bruno Iskil, otherwise dubbed "The London Whale," managed to trade away more than $6.2 billion (with a "b") of the assets of JPMorgan in 2012, while Brian Hunter's quick reflexes on the keyboard ultimately cost hedge fund investors in Amaranth Advisors a total of $6.4 billion in 2006. Baring Brothers Bank collapsed in 1995 thanks to the fast and furious futures and options trading activities of Nick Leeson. Yasuo Hamanaka at Sumitomo Bank ($2.6 billion in losses), Jerome Kerviel at Societe Generale Bank ($6 billion), Toshihide Iguchi at Daiwa Bank ($1.1 billion) and Kweku Adoboli at UBS ($2 billion) all generated their share of excitement for the institutions that employed them.
The good news here is that it appears, based on sound theoretical evidence, that people CAN beat the market in a variety of ways. Some of them are legal, but only a few are safe. The safest methods also happen to be pretty boring--and, alas, they don't come with guarantees.
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.
The first and most obvious way is cheating. If you have inside knowledge about a stock that nobody else possesses, then you can make more astute trades than everyone else. The Securities and Exchange Commission has managed to catch a number of these criminals. You may have heard of Ivan Boesky, or Martha Stewart's famous phone call to her friend the founder of ImClone. Quest Communications chief Joseph Nacchio dumped more than $50 million of company stock in 2005 before his company went into decline. More recently, police are pursuing a massive insider trading case against a French doctor and FrontPoint Partners, who are accused of netting $30 million while trading on nonpublic knowledge.
Until they were caught, these "investors" (and Galleon Group hedge fund manager Raj Rajaratnam, Charles and Sam Wyly and certain Bear Stearns hedge funds) were making a lot more money in the markets than you and I ever will.
If you're not especially good at cheating, then you can rely on the second way to beat the market: luck. Don't laugh; there's evidence that most of the mutual funds that outperform the overall market in any given year just happen to be lucky. Their luck tends to lead to bad luck for investors, however. Investors have a tendency to assume that the fund managers who had great performance this year are brilliantly astute, move their money out of less-lucky funds, and then lose money when the managers' luck runs out and their funds underperform by roughly what they were outperforming before. Net-net, these managers had exactly as much bad luck as good luck, but many more investors were exposed to the bad luck period than the good luck period. Ouch!
You can also win the lottery, and some people are lucky enough to do so. Their "investment" return on that lottery ticket is astronomical; nobody can deny that.
Brock offered three other ways to beat the market, all of which rest on sounder footing. By way of background, he cited very complicated research by Mordecai Kurtz at Stanford which showed that almost 95% of the short-term market movements can be explained by two things: news and expectations. The news is pretty simple; suppose Intel beats the consensus estimate of its earnings next quarter by two cents a share. This can either send the stock price soaring or tumbling, depending on whether most investors expected the stock to miss its earnings estimate (therefore, the news is better-than-expected and the stock rises), or to beat its earnings estimate by more than two cents (bad news, the stock plunges). Bigger picture, the news might be that Greece has tumbled into default, causing a short-term plunge in stocks around the world.
But longer-term price movements depend on how the world changes more gradually, based on trends that are not obvious and seldom in the news. To take some of the more obvious examples: China abandons communism and gradually becomes the second-largest economy in the world. The Internet is born, and creates entirely new market dynamics. Europe adopts a new common currency, which sets in motion a lot of other changes for good or ill.
So how do you beat the market? If you are slightly more astute about understanding the business implications of these trends than the average person, Brock told his audience, then it is possible, over the long-term, to position your assets more advantageously. Your secret sauce is thinking and reading--or investing with very thoughtful money managers who take a long-term view of gaining returns.
You can also beat the market by not following the herd. Brock said that new mathematical models of market bubbles and busts allow for what he called "the uneven distribution of mistakes," a world where most investors can be wrong about their expectations or evaluations, all in the same direction. Remember how people were flipping houses in 2007 and Wall Street firms were betting the world that housing prices would never go down? Remember the technology mania leading up to the 2000 Tech Wreck?
You can beat the market by holding a diversified portfolio (which will keep pace with the market) and systematically rebalance your investments regardless of what fearful or euphoric cries other investors are screaming outside your window. That way, when the distribution of mistakes is nearly 100% on the side of euphoria, you will be holding fewer stocks than the average investor and participating less in the inevitable bust. And when the distribution of mistakes is on the side of fear and nobody wants to own stocks, you're participating in the market and benefiting from the inevitable recovery.
These last two methods of beating the market are not nearly as exciting as cheating or winning the lottery. So if you want excitement, you can turn to the last way that Brock said markets can be beaten. Every Wall Street firm has active traders who stare at six or eight computer screens all day long, with their finger hovered over a buy or sell button. They house their trading servers in the same building as the mainframe servers that process orders for the New York Stock Exchange and Nasdaq, so their buy and sell commands will arrive milliseconds ahead of the competition. They study expectations, and then, as soon as news arrives, that instant, they make a trade that will be thousandths of a second ahead of other quick-twitch traders--and, probably, a few days ahead of the trade that you and I would eventually be tempted to make.
This quick-twitch trading arrangement doesn't always work out exactly as planned, however, which greatly adds to the excitement. Bruno Iskil, otherwise dubbed "The London Whale," managed to trade away more than $6.2 billion (with a "b") of the assets of JPMorgan in 2012, while Brian Hunter's quick reflexes on the keyboard ultimately cost hedge fund investors in Amaranth Advisors a total of $6.4 billion in 2006. Baring Brothers Bank collapsed in 1995 thanks to the fast and furious futures and options trading activities of Nick Leeson. Yasuo Hamanaka at Sumitomo Bank ($2.6 billion in losses), Jerome Kerviel at Societe Generale Bank ($6 billion), Toshihide Iguchi at Daiwa Bank ($1.1 billion) and Kweku Adoboli at UBS ($2 billion) all generated their share of excitement for the institutions that employed them.
The good news here is that it appears, based on sound theoretical evidence, that people CAN beat the market in a variety of ways. Some of them are legal, but only a few are safe. The safest methods also happen to be pretty boring--and, alas, they don't come with guarantees.
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.
HAPPY NEW YEAR 2014
We just want to take a moment and wish you a Happy New Year - a year of success and happiness, peace and prosperity, and fresh hope and confidence. May 2014 see many dreams come true for you and those you love.
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO PETER MONTOYA.
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO PETER MONTOYA.
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