BY GEORGE P. STASEN, CO-EDITOR
Introduction
Most asset allocation models rely on historic performance and the performance relationship between alternative asset classes (i.e. stocks, bonds, and cash). There is, however, a basic problem with the methodology: markets change, market relationships change, and historic market relationships seldom repeat in the future. History is a good teacher, but a poor leader.
Perspective
After the crash of 1929 and during the ensuing decades, common stocks were largely purchased for their dividend income. When the dividend yield of stocks exceeded the yield of bonds, stocks were viewed as attractive investments. That made sense. After all, stocks were, and remain, a riskier asset class than bonds. When the yield on bonds exceeded the dividend yield on stocks, stocks were viewed as less attractive, and bonds were accumulated. This was formula plan investing. Keep in mind that historic databases cover this period and are frequently employed by the “Wizards of Wall Street” in asset allocation models.
With the arrival of the 1960’s, Wall Street discovered growth. Of course, that’s analogous to Columbus discovering America. The ancestors of Native Americans discovered America, but because Europeans didn’t know about it, it didn’t exist. Gravity also existed before Galileo and Newton. With the discovery of growth, Wall Street “found” growth stocks. The void had to be filled. Columbus would have been a superb Investment Banker. He raised money for a highly speculative venture without knowledge of the payoff, opportunity, likely success, or a business plan. Keep in mind that he had nothing to lose; he was using OPM (other people’s money). Of course, he provided the sweat equity and the concept. It sounds like an early “Internet” play – a new channel of distribution with first mover advantage. His investors were told, “This time it’s different”. Earlier speculative voyages included the search for the Golden Fleece and the search for Golconda, the mythical city of gold. “This time it’s different” – that’s the euphemism Wall Street always uses when economic rationality becomes an irritant.
The validity and accuracy of Wall Street research has been subject to scrutiny since the first investment research report was published. The famous phrase “Where are the customers’ yachts?” is as valid today as it was in the 1920’s. If Wall Street research provided sound, prescient analysis, then the mutual funds managed by the Wall Street powerhouses would exhibit superior, if not solid, performance. Analysis demonstrates that the mutual funds managed by the major investment banking/brokerage firms lag behind their Non-Wall Street peers in terms of performance. That fact alone should dissuade rational individuals from seeking the guidance of Wall Street.
A true bull market occurs every generation after the previous generation is financially exhausted. A new bull market began in 2008. Was there a signal? Yes! The same signal that announced the dawn of every bull market, everyone wanted out, they were afraid. They wanted to sell their stocks and in the absence of buyers their fears created opportunity. Markets decline for a simple reason; there are more sellers than buyers. But there are some investors, very few, that truly understand the nature of the market. One of which is Warren Buffet, who made a killing buying at the bottom of the “08” bear market. Mr. Buffet was quoted as saying in a 2103 interview “be fearful when others are greedy and greedy when others are fearful.” That is the essential wisdom of investing.
That is nothing new, after all the mantra of Bank Rothschild since the 1700’s was “buy on the cannon and sell on the bugle”. They were saying the same thing. And the great stock market manipulator Joe Kennedy announced that he sold all of his stocks before the crash of 29 when his shoe shine boy offered him a stock tip.
Investment success requires common sense, patience, a disdain for greed, and a reasonable time horizon. It also requires the ability to take risks in order to achieve a return. There is no such thing as a free lunch. If someone had a better “market mousetrap”, they wouldn’t tell anyone, because the “market mousetrap” wouldn’t work if it were deployed on a large scale.
Keep in mind that most market bubbles are fueled by easy money, real estate and / or bad government policy, all three of which involve government. The crash of “29” was the result of poor government policy, in that case the “Smoot Hawley Tariff Act” which turned nations against each other and created economic warfare. The great depression continued through the end of World War II. The depression was prolonged due to government tinkering and blocking the free market. In the past, recessions had a short life; the free market is a self-correcting mechanism. Prosperity returned when the returning troops started to spend their money. You will never find truth from government, the class room or Wall Street.
Wisdom not knowledge wins the day.
Surprise – common stocks are risky. The stock market is necessary for a free market system and investors can reap the benefit of the growth it creates.
Markets are strange mechanisms. They represent the opinion of the masses and they are driven by fear and greed. Bull markets are driven by excessive optimism and bear markets are driven by excessive despair. Markets are a reflection of the Manic / Depressive behavior of an unruly mob – individual and professional investors. As a result the consensus opinion will be wrong. If everyone is pessimistic, it is time to buy.
Market behaviour is, if nothing else, fascinating. When it comes to investing – “that which is worth knowing is not known and that which is known is not worth knowing”.
Markets go down because there is more selling than buying and the decline stops when the sellers are exhausted. “Markets will do that which is necessary to hurt the greatest number of investors.” Research demonstrates that a consensus buy opinion is a sell signal.
Finally – It is government and the Federal Reserve System that has always created chaos and economic cycles. The economy, in a free market system, is a self-correcting mechanism. History demonstrates that Government and Central Banks are always the problem.
Investment Conclusion – Buy mature companies with solid fundamentals and a dividend, and hold for the long run. But, most important, when everyone is selling, be a buyer and when everyone is buying, be a seller.