Posts tagged ‘Mr. Market’

Mr. Market Bullying Investors

Source: Photobucket

There’s been a bully pushing investor’s around and his name is “Mr. Market.” Volatility is Mr. Market’s partner in crime, and over the last 10 trading days Mr. M has used volatility to school equity investors to the tune of 1,600+ point swings, which has contributed to equity investors’ failing grade over the last few months. Who is Mr. Market? Charles Ellis, author of Winning the Loser’s Game (1998) described him best:

“Mr. Market is a mischievous but captivating fellow who persistently teases investors with gimmicks and tricks such as surprising earnings reports, startling dividend announcements, sudden surges of inflation, inspiring presidential announcements, grim reports of commodities prices, announcements of amazing new technologies, ugly bankruptcies, and even threats of war.”

 

How has Mr. Market been stealing investors’ lunch money? The process really hasn’t been that difficult for him, once you consider how many times investors have been heaved into the garbage can over the last decade, forced to deal with these messy events:

• 2001 technology bubble beating
• 2006 real estate collapse
• 2008 – 2009 financial crisis and recession
• 2010 “flash crash” and soft patch
• 2011 debt ceiling debate and credit rating downgrade

With this backdrop, investors are dropping like flies due to extreme bully fatigue. Over the last four months alone, approximately $75 billion in equities been liquidated, according to data from the Investment Company Institute – this is even more money withdrawn than the outflows occurring during the peak panic months after the Lehman Brothers collapse.

The Atomic Wedgie

Exhibit I (Source: Photobucket)

Mr. Market understands the severity of these prior economic scars, which have been even more painful than atomic wedgies (reference Exhibit I above), so he opportunistically is taking advantage of fragile nerves. Introducing the following scary scenarios makes collecting lunch money from panicked investors much easier for Mr. Market. What is he using to frighten investors?

  • A potential Greek sovereign debt default that will trigger a collapse of the Euro.
  • Slowing growth in China due to slowing developed market economic activity.
  • Possible double-dip recession in the U.S. coupled with an austerity driven downturn in Europe.
  • Lack of political policy response to short and long-term economic problems in Washington and abroad.
  • Impending deflation caused by decelerating global growth or likely inflation brought about by central banks’ easy monetary policies (i.e., printing money).
  • End of the world.

Bully Victim Protection

Of course, not all of these events are likely to occur. As a matter of fact, there are some positive forming trends, besides just improving valuations, that provide protection to bully victims:

  • Not only is the earnings yield (E/P – 12-month trailing EPS/share price) trouncing the yield on the 10-year Treasury note (~8% vs. ~2%, respectively), but the dividend yield on the S&P 500 index is also higher than the 10-year Treasury note yield (source: MarketWatch). Historically, this has been an excellent time to invest in equities with the S&P 500 index up an average of 20% in the ensuing 12 months.
  • Jobs data may be poor, but it is improving relative to a few years ago as depicted here:

    Source: Calafia Beach Pundit

Source: Calafia Beach Pundit

  • Record low interest rates and mortgage rates provide a stimulative backdrop for businesses and consumers. Appetite for risk taking remains low, but as history teaches us, the pendulum of fear will eventually swing back towards greed.

Source: Calafia Beach Pundit

As I say in my James Carville peace from earlier this year, It’s the Earnings Stupid, long term prices of stocks follow the path of earnings. Recent equity price market declines have factored in slowing in corporate profits. How severely the European debt crisis, and austerity have (and will) spread to the U.S. and emerging markets will become apparent in the coming weeks as companies give us a fresh look at the profit outlook. So far, we have gotten a mixed bag of data. Alpha Natural Resources (ANR) acknowledged slowing coal demand in Asia and FedEx Corp. (FDX) shave its fiscal year outlook by less than 2% due to international deceleration. Other bellwethers like Oracle Corp. (ORCL) and Nike Inc. (NKE) reported strong growth and outlooks. In the short-run Mr. Market is doing everything in his power to bully investors from their money, and lack of international policy response to mitigate the European financial crisis and contagion will only sap confidence and drag 2011-2012 earnings lower.

Punching Mr. Market

The warmth of negative real returns in cash, bonds, and CDs may feel pleasant and prudent, but for many investors the lasting effects of inflation erosion will inflict more pain than the alternatives. For retirees with adequate savings, these issues are less important and focus on equities should be deemphasized. For the majority of others, long-term investors need to reject the overwhelming sense of fear.

As I frequently remind others, I have no clue about the short-term direction of the market, and Greece could be the domino that causes the end of the world. But what I do know is that history teaches us the probabilities of higher long-term equity returns are only improving. Mr. Market is currently using some pretty effective scare tactics to bully investors. For those investors with a multi-year time horizon, who are willing to punch Mr. Market in the nose, the benefits are significant. The reward of better long-term returns is preferable to an atomic wedgie or a head-flush in the toilet received from Mr. Market.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, and FDX, but at the time of publishing SCM had no direct position in ANR, ORCL, NKE, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

September 24, 2011 at 2:18 pm 1 comment

Ellis on Battling Demons and Mr. Market

A lot of ground was covered in the first cut of my review on Charles Ellis’s book, Winning the Loser’s Game (“WTLG”). His book covers a broad spectrum of issues and reasons that help explain why so many amateurs and professional investors dramatically underperform broad market indexes and other forms of passive investing (such as index funds).

A major component of investor underperformance is tied to the internal or emotional aspects to investing. As I have written in the past, successful investing requires as much emotional art as it does mathematical science. Investing solely based on numbers is like a tennis player only able to compete with a backhand – you may hit a few good shots, but will end up losing in the long-run to the well-rounded players.

Ellis recognizes these core internal shortcomings and makes insightful observations throughout his book on how emotions can lead investors to lose. As George J.W. Goodman noted, “If you don’t know who you are, the stock market is an expensive place to find out.” Hopefully by examining more of Ellis’s investment nuggets, we can all become better investors, so let’s take a deeper dive.

Mischievous Mr. Market

Why is winning in the financial markets so difficult? Ellis devotes a considerable amount of time in WTLG talking about the crafty guy called “Mr. Market.” Here’s how Ellis describes the unique individual:

“Mr. Market is a mischievous but captivating fellow who persistently teases investors with gimmicks and tricks such as surprising earnings reports, startling dividend announcements, sudden surges of inflation, inspiring presidential announcements, grim reports of commodities prices, announcements of amazing new technologies, ugly bankruptcies, and even threats of war.”

           

Investors can easily get distracted by Mr. Market, and Ellis makes the point of why we are simple targets:

“Our internal demons and enemies are pride, fear, greed, exuberance, and anxiety. These are the buttons that Mr. Market most likes to push. If you have them, that rascal will find them. No wonder we are such easy prey for Mr. Market with all his attention-getting tricks.”

 

The market also has a way of lulling investors into complacency. Somehow, bull markets manage to make geniuses not only out of professionals and amateur investors, but also cab drivers and hair-dressers. Here is Ellis’s observation of how we tend to look at ourselves:

“We also think we are ‘above average’ as car drivers, as dancers, at telling jokes, at evaluating other people, as friends, as parents, and as investors. On average, we also believe our children are above average.”

 

This overconfidence and elevated self-assessment generally leads to excessive risk-taking and eventually hits arrogant investors over the head like a sledgehammer. Michael Mauboussin, Legg Mason Chief Investment Strategist and author of Think Twice, is a current thought leader in the field of behavioral finance that tackles many of these behavioral finance issues (read my earlier piece).

The Collateral Damage

As mentioned by Ellis in the previous WTLG article I wrote, “Eighty-five percent of investment managers have and will continue over the long term to underperform the overall market.” When emotions take over our actions, Mr. Market has a way of making investors make the worst decisions at the worst times. Ellis describes this phenomenon in more detail:   

“The great risk to individual investors is not that the market can plummet, but that the investor may be frightened into liquidating his or her investments at or near the bottom and miss all the recovery, making the loss permanent. This happens to all too many investors in every terrible market drop.”

 

With the market about doubling from the early 2009 equity market lows, this devastating problem has become more evident. With volatility rearing its ugly head throughout 2008 and early 2009, investors bailed into low-yielding cash and Treasuries at the nastiest time. Now the stock market has catapulted upwards and those same investors now face significant interest rate risk and still are experiencing meager yields.

The Winning Formula

Ellis acknowledges the difficulty of winning at the investing game, but experience has shown him ways to combat the emotional demons. Number one…know thyself.

“’Know thyself’ is the cardinal rule in investing. The hardest work in investing is not intellectual; it’s emotional.”

 

Knowing thyself is easier said than done, but experience and mistakes are tremendous aids in becoming a better investor – especially if you are an investor who spends time studying the missteps and learns from them.

From a practical portfolio construction standpoint, how can investors combat their pesky emotions? Probably the best idea is to follow Ellis’s sage advice, which is to “sell down to the sleeping point. Don’t go outside your zone of competence because outside that zone you may get emotional, and being emotional is never good for your investing.”

Finding good investment ideas is just half the battle – fending off the demons and Mr. Market can be just as, if not more, challenging. Fortunately, Mr. Ellis has been kind enough to share his insights, allowing investors of all types to take this valuable investment advice to help win at a losing game.

Wade W. Slome, CFA, CFP® 

Plan. Invest. Prosper. 

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

January 10, 2011 at 1:51 am Leave a comment


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