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May 11, 2009

THE MARKETS

Would you agree that the stock market has been volatile in the last six months?

As you may have guessed, that’s a bit of a trick question. Most people would say that, yes, the stock market has been very volatile since early November 2008. For example, just from November 7, 2008 to November 20, 2008, the S&P 500 index dropped 19%. It then rallied 24% by January 6, 2009. But, that was just a tease. Between January 6 and March 9, the S&P 500 index dropped a frightful 28%. And, just when people thought the financial system was coming to an end, the index turned around and proceeded to rise a whopping 37% from the March 9 low to last Friday, according to Yahoo! Finance.

It’s enough to make your head spin.

But, let’s assume for a moment that you went into hibernation for the past six months and slept right through this volatility. Would you wake up happy or sad about your portfolio? Well, if your portfolio performed similar to the S&P 500 index, then you’d wake up essentially the same as you went to bed, meaning, there was no net change in your portfolio. Surprisingly, from November 7, 2008 to May 8, 2009, the S&P 500 index moved less than 1%. That’s right, after netting the 19% drop, the 24% gain, the 28% drop, and the 37% gain, the index is essentially flat.

One of the keys to being a successful investor is to get neither too depressed when the market is down nor too euphoric when the market is up. Checking your portfolio on a daily basis can lead to a daily dizzy spell while checking it on a less frequent basis may help keep you on an even keel.

Our job is to monitor your portfolio on a regular basis and do the worrying for you so you can “hibernate” from the market and take that extra time to enjoy life.

The last time America experienced a financial crisis of the magnitude of the present one was in the Great Depression era, for about ten years from 1929. During that volatile time in the stock market, there were six complete bear and bull cycles. As history tends to repeat itself, you might be interested to know what happened to the S&P 500 over that time.

If you are a glass-half-full kind of person, you will look to the Bull periods of the Great Depression where the gains were as follows: (1) 148 days/+46.8% (2) 98 days/+111.6% (3) 344 days/+113.7% (4) 723 days/+106.9% (5) 223 days/+62.2% (6) 200 days/+29.8%.

On the other hand, the duration and magnitude of the six phases of the Bear period were: (1) 783 days/-83.0% (2) 173 days/-40.6% (3) 401 days/-31.8% (4) 390 days/-49.0% (5) 150 days/-26.2% (6) 916 days/-43.5%.

At the beginning, on 11/13/29, the S&P was at 17.66. At the end, on 10/25/1939, it was 13.21, a loss of -25.2%.

On average, the Bear periods lasted 469 days with a loss of -45.7%, and the Bull periods lasted 289 days with a gain of +78.5%.

The bottom line is that through the 1930’s, while there were six Bull runs averaging +78.5%, most investors lost immense wealth.

Are we currently repeating a similar cycle? If so you may want to re think the buy and hold approach that most advisors recommend.

THINK ABOUT IT...

William A. Kent wrote the following excerpt in “The Journal of Personality and Social Psychology:

“At two race tracks interviewers questioned 69 horse players on their way TO the $2 window and 72 others on their way FROM the window. The interviewers asked all bettors to rate their chances of winning on a scale of 1 to 10. The result was that the bettors returning from placing their bets had significantly MORE confidence in their choices than those interviewed BEFORE their bets were made. Thus, bettors facing doubts as to whether they had bet on the right horse relieved their tension by believing even more after the fact that they had done the right thing.” From a psychology point of view, the aforementioned quote suggests that in order to reduce the anxiety of decision making people perceive things in ways that may or may not be logical. Simply stated, people talk the way they bet. From a stock market perspective this means that the interpretation of economic and market news varies in direct relationship to the investor’s bullish, bearish, or cautious market position. At the race track if too many participants bet on the same horse the betting odds on that horse go down. In other words, if the horse is “heavily bet” he becomes the favorite and therefore even if he wins the payout is small. Q.E.D., popularity reduces the reward.

Similarly in the stock market, if too many participants put their money on the same stock, and it become a market favorite driving the price ever higher, the upside potential is diminished. Hereto, popularity reduces the potential reward. Just listen to what Benjamin Graham has to say about this in the book titled “The Intelligent Investor:” “The intelligent investor realizes that stocks become more risky, not less, as their prices rise – and less risky, not more, as their prices fall. The intelligent investor dreads a bull market, since it makes stocks more costly to buy. And conversely (so long as you keep enough cash on hand to meet your spending needs) you should welcome a bear market, since it puts stocks back on sale.” Graham goes on to note, “The value of any investment is, and always must be, a function of the price you pay for it.” This viewpoint is directly opposed to the Jeremy Siegel school of thought that suggests 7%+ per annum returns over the long-term are a “divine right.” The main point is that “cognitive dissonance,” once recognized, should probably be bet against. To wit, when everybody bets on the same horse, stock, or market direction, it often pays to go against the crowd. In our business we call this strategy “contrary opinion” investing. While Ben Graham states it much more eloquently, we have often referred to this type of strategy as “buying the flop,” except in this case we are not referring to the card game “Texas Hold ‘em,” but as legendary investor Jim Rogers puts it – buy panic and sell euphoria.

Thanks for your trust & confidence,

* The Standard & Poor's 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general.
* The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks.
* The Nasdaq Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System.
* Yahoo! Finance is the source for any reference to the performance of an index between two specific periods.
* Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.
* Consult your financial professional before making any investment decision.
* You cannot invest directly in an index.
* Past performance does not guarantee future results.