Never make predictions, especially about the future
Although I’ve quoted Yogi Berra before, I believe this is baseball player and manager Casey Stengel’s first trip to the plate with a title for one of my articles. As nonsensical as his statement might seem at first glance, there’s a certain practical truth to it. Even with computerized equipment and PhDs providing interpretation, weather forecasts aren’t always right. Sports betting has been popular since the time of the ancient Greeks precisely because no one knows the outcome of a contest until it’s over. At the beginning of this year’s baseball season, the odds of the Cleveland Indians winning the World Series were given as 125:1, third worst in the major leagues. At the end of May, the team had the best record in baseball with 26 wins vs 15 losses.
If most people understand that predicting the weather and the outcome of sporting events is chancy, why do so many try to predict the movements of the stock and bond markets or seek out the predictions of others? Consider this scenario: suppose on January 1st of this year, you had been able to accurately foresee the natural disasters in Japan, the turmoil sweeping the Arab world, continued woes at EU banking institutions, spiking commodity prices and Standard and Poor’s threatened downgrade of our government’s debt. How would you have thought the stock market might react? I doubt if many would have guessed the S&P 500 would gain over 7% by the end of April.
Since it isn’t possible to predict the future, let alone the market’s response to it, what’s an investor to do? A good place to begin is remembering that the market is a leading indicator. That is, it broadly reflects investor expectations for the future rather than today’s headlines. I learned the aphorism “buy the rumor, sell the news” more than twenty years ago as a newly minted stockbroker. Since markets tend to act before things happen, the effect of any one event is likely to be minimized by the time it actually occurs. Another way to say this is that the effect of an event has already been “priced into” the market. Although markets are truly unpredictable, the collective intelligence of investors tends to respond to changes in the investing landscape with reasonable efficiency. I’ve heard the stock market described as the place where the smartest people in the world meet to trade but I’ve rarely heard it described as rational. It isn’t logical to think of the market as having a mind of its own but it’s certainly true that the collective decisions of all those thoughtful investors must make a certain amount of sense - even though the results regularly surprise us. The remarkably effective concept of crowd sourcing has been well described in the book “The Wisdom of Crowds…” by James Surowiecki. I have a copy to lend or it’s available at Viewpoint and elsewhere.
Headlines are specifically written to command our attention so, since markets generally move in advance of reality, it’s rarely profitable to base investment decisions on the daily news. Establishing an appropriate long term investment strategy makes it easier to avoid responding instinctively to negative news. A carefully considered portfolio can provide a useful counterbalance to any single day’s headlines. During the market correction of 2008, some investors became afraid and started withdrawing their assets from the markets. The more sellers there were, the further prices fell and the more difficult it became to resist responding to the admittedly scary news. However, those investors who withdrew from the market then faced what I think is the greater quandary of correctly timing their re-entry. Those who decided to “wait until things look better” certainly bought back in at higher prices. In fact, they may not have returned to the market yet, missing out on a significant upward move which includes that 7% gain from January through April this year.
Let me be clear that Warren Ward Associates has no special insight into what the future holds. Nothing about the future is predictable, including interest rates, inflation and the other factors which move markets. Knowing that, we attempt to structure a suitable investment portfolio for each client, considering both time horizon and tolerance for risk. We believe that, with appropriate planning, it is possible to weather the day-to-day storms and achieve a reasonable long term return.
I’d like to close with a quotation from someone nearly as famous as Casey Stengel. “When the number of factors coming into play in a phenomenological complex is too large, scientific method in most cases fails. One need only think of the weather, in which case the prediction even for a few days ahead is impossible.” Who said that? None other than Albert Einstein, who might have made a pretty good financial planner if he hadn’t been distracted by other pursuits.
Bubble, Bubble, Toil and Trouble
| Let me begin by extending apologies to William Shakespeare whose line from Macbeth actually begins “Double, Double…”. I’d like to spend a few minutes following up on my recent article ’til the Music Stops by commenting on the social networking company Linked-In and other tech companies which have recently “gone public”. This process, through which funds are raised (and founders and early investors take personal profits), is known as an Initial Public Offering or IPO.
Linked-In’s share price famously doubled by the end of its first trading day. That has encouraged other tech companies to consider doing their own IPOs and brings the tech stock bubble of the late 1990′s to mind. Most people agree that it began with Netscape’s extraordinary valuation in 1995. A very inventive company, Netscape produced the first dominant web browser as well as SSL security and JavaScript, both of which are still in wide use today. Unfortunately for investors, Netscape is now an almost invisible part of AOL. Many such companies went public and made headlines but few survived. Well-known on-line retailer Amazon continues to be an investor favorite but other stars of the tech boom have not done quite so well. For example, Monster.com (now known as Monster Worldwide) currently trades at something close to its IPO price of $15 but, during the bubble, its shares went to almost $88. After spending many millions of dollars on Super Bowl ads, other briefly famous companies which have disappeared include Pets.com, Compuserve (also part of AOL) and Hot Jobs.com (now part of Monster). Of course investors’ money disappeared along with them. After reading about Linked-In’s great success and hearing that Microsoft recently paid over $8 billion for Skype, individual investors have been asking once again how they can get their share of the easy money from investing in tech IPOs. Headlines make it seem that significant returns are the norm but University of Florida Professor Jay Ritter has written extensively about IPO pricing and suggests something quite different. His research indicates that in most cases high prices are simply not justified. I am a subscriber to the wireless access provider Boingo. I know it to be an excellent company providing dependable service at a reasonable price. It went public in May at $13.50, ended its first day at $12.10 and currently trades for around $9. I think this example might help put a more personal face on Professor Ritter’s somewhat dry academic research. Twitter is among the companies expected to go public in the near future. Average monthly usage has fallen over 10% in the past year and nearly half of all Twitter accounts are now inactive. Is that slippage a harbinger of its future profitability? If so, how should potential investors respond? Warren Ward Associates avoids investing in IPOs as a matter of policy. We are simply not interested in any investment about which there is little or no publically available information on which to base an opinion. This stance might sound familiar to some long time readers. In 2005, I wrote about a potential housing bubble in an article titled Tulip Bulbs, Tech Stocks & Housing Prices, In it, I mentioned the book Extraordinary Popular Delusions and the Madness of Crowds, noting that its author catalogued multiple economic bubbles. Here’s a quote from my article: “neither Tokyo’s housing bubble of the late 80s nor the “dot com” stock bubble of the late 90s is mentioned at all. Perhaps that’s because, as wise as the author is, the book was published in 1851. Although times change, human nature, by and large, does not.” Please remember that in the case of both the tech and housing bubbles, consensus that prices had become unreasonably high formed only in hindsight. From the investment advisor’s point of view one problem with bubbles is that there is always money to be made during the run up, even though losses are assured when the bubble eventually pops. As I pointed out last week, investors make money as long as the music is playing but stand to lose much, perhaps all, of it when the music stops. We believe those clients who trust us to manage their assets consider us their “get rich slowly” advisors. Our approach tends to offer protection from market corrections, partially due to practices such as avoiding IPOs. Let me close with another line from Shakespeare’s mordant play. Following a series of deaths, Macbeth faces his own with these words: “It is a story, told by an idiot, full of sound and fury, signifying nothing.” That’s a very pessimistic comment, one I hope will not be repeated by those individual investors who try and fail to get a share of the easy money hoped for in the IPO markets. |
