Financial Advisor IQ, a division of the Financial Times, speaks with Jeff Vollmer on technical analysis, and how it can support fundamental efforts and undergird a firm’s investment process.
Jesse Livermore was an early twentieth-century investor who made and lost several fortunes.
As speculators go, and realize that speculation and investing are distinctly different pursuits, Livermore was one of the best. He made fortunes short selling stocks when everyone else was long during the crashes of 1907 and 1929.
Livermore was the consummate market historian. Much of his success was attributed to his dedication to studying the human condition.
Livermore once wrote, “All through time, people have basically acted and reacted the same way in the market as a result of: greed, fear, ignorance and hope. That is why the numerical formations and patterns recur on a constant basis.”
In other words, history repeats itself. Primarily because human beings never change. Our emotions, and the means by which they drive behavior in various situations, remain as much a part of us as they were thousands of years ago.
Last week, as equities continued their four-week slide and gave back the nice gains gleaned through April’s end, investors reacted as Livermore might have anticipated. Fearfully.
Is the EU breaking apart? Will China’s slowdown affect portfolios? Is this the sequel to 2008?
Anecdotally, investors are shooting first and asking questions later. ICI reported that mutual fund outflows increased dramatically last month. Nervous investors are going to cash.
So, is the euro zone’s demise immanent? Should we be raising cash?
Let’s begin by looking at valuations.
One of the better sources for earnings estimates (2012 and 2013) comes courtesy of Standard & Poors. S&P’s analysis indicates that the S&P 500 index is currently undervalued, with a P/E of 13.1 versus a fair value of 15. This would represent the cheapest PE level for the index since 1994.
One might rightly argue this valuation, pointing to the speculative nature of earnings estimates. Yet, American companies have proven themselves to be extremely capable these last 13 quarters of getting the most from their income statements. Cost cutting and technological advancements have seen companies enhance margins. Even amidst a secular slowdown, we’ve reason to believe that they will do more of the same.
Investors, practicing the herd mentality, tend to do precisely the wrong things are the worst of times. In this case, as the ICI fund-flows data shows, investors are getting out of the markets even as they’ve already corrected sharply.
Typically, even as stocks become cheaper, investors become more pessimistic. Equities fall in price, dividend yields become more attractive, yet the public piles out of stocks and into bonds, even as the 10-year Treasury yield hits record lows.
Think about it. I can buy McDonald’s stock, which recently hit an all-time high, and get paid a 3.20% yield for doing so. And possible incur some appreciation when the stock bounces. Or, I can buy ten-year Treasury bonds and make 1.46%.
Warren Buffet recently said that “Bonds today should come with a warning label.” They yield nothing. And when interest rates inevitably rise, investors will be trapped as the value of their funds drops like an Aroldis Chapman fastball.
Trust me, you should always defer to ownership, as opposed to creditorship. Participate in the growth of great enterprises will always be preferable to lending to them.
But aren’t risk-free Treasury bonds a safe bet during unsafe times?
Last time I looked, McDonald’s was turning record profits. The U.S. government was running a $15 trillion deficit. Hardly a flight to safety.
So, will markets decline further from here, or will valuations hold and opportunistic buyers step in?
Short term, who knows? The markets are a pricing mechanism, constantly reconfiguring to adjust to the current fiscal and economic realities. It is certainly capable of drifting lower. Markedly so if the EU breaks up. But, we don’t think the EU will break apart. The Northern European industrial overlords have too much to lose. They will coddle, cajole and fight to keep their grand experiment alive.
Europe will likely look much more Federalist, with common banking and fiscal representation, at some point next year. Every headline leading to those developments will see global markets reacting positively.
Yet investors, losing sight of that fact, will continue to suffer from data disconnect. The public, confronted by headline risk, will sell stocks every time CNBC reports the day’s economic headlines. Leaving investors pondering, months down the road, as to when they put their retirement funds back to work. After markets recover by 5%? 10%? 15 to 20%?
While the world is, at the moment, economically challenged, investors believe that every data point will send them headlong back to Q4 2008.
These cycles of panic and euphoria get us nowhere. In order to create wealth and maintain our fiscal independence, cooler heads must prevail.
Do yourself a favor. Utilize the fear and paranoia to your advantage. Take the ICI fund flow data, and when the public is piling out of equities, buy. When the public is pouring into equities, sell (or hedge).
Run opposite the herd. Because the public is much like every horror movie heroine you’ve ever known. Forever doing the wrong thing at the worst time. Doomed from the start.
The best financial advisors are those who can bolster the courage of clients during the most difficult times. Who can convince clients to do that which they should be doing, as opposed to that which they want to do. Who can steer clients’ thoughts away from the media frenzy, and back towards their mid- and long-term objectives.
Even in the darkest of times, opportunities arise. In 2008, Treasury bonds. Managed futures. Cash. These asset classes prevailed amidst the carnage.
As did McDonald’s (+5%), Wal-Mart (+15%), Dollar Tree (+57%), Ross Stores (+15%), EZCorp (+31%), DeVry (+10%), Amgen (+24%) Genentectch (+23%), among others. Among others.
As Jesse Livermore said, the human condition will not change. Investors will continue to vacillate between despair and euphoria. Markets will rise and fall. Only the means by which you respond to these movements will determine your fate.
Lemmings never die alone. They follow each other, one by one, off of the cliff. Yet, for those forward thinkers among us, opportunity awaits. Chances to step away from the herd. To back away from the cliff. To take advantage of the opportunities that tomorrow will bring.