Investors seem to believe that (1) the popular averages (the Dow and S & P 500) accurately reflect the direction of the entire stock market; (2) that the Dow contains only the best of the best U.S. companies; (3) that most professional money managers are unlikely to outperform the market averages; (4) that personal investment portfolio market values are married to the market averages.
Actually, the market averages reflect what investors expect from the economy, interest rates, politics, climate change and many other variables. They are also trailing indicators of what investors actually know about things such as corporate earnings, tax policy, unemployment rates and regulation. The market averages report the direction and show the trend of past prices of the limited number of securities they contain, and are subject to massive short-term gyrations caused by all kinds of current events.
The DJIA contains just 30 stocks — 27 NYSE and 3 NASDAQ. The S&P 500 is much more diverse, but neither is designed to reflect the price performance of any particular mix of securities based on the quality of their earnings or the safety of their dividends. The "Blue Chip" Dow average, for example, contains 17 stocks that are less than "A" rated and 13% of the companies are rated below investment grade.
The Investment Grade Value Stock Index (IGVSI) is designed to report the historical price movements of NYSE, B+ and better rated, dividend-paying U.S. companies. At the moment, there are only 352 companies that qualify — so at least 30% of the S&P 500 cannot possibly contain Investment Grade Value Stocks. The actual number is less than half. Over the past several years, the IGVSI has outperformed the popular averages significantly.
Most professional money managers are in charge of public-access, open-end Mutual Funds. Their decision making is influenced by their corporate investment committees, performance ranking agencies, and the uninformed, ill-trained, investment public that is up to its armpits in self directed IRA, 401(k) and other investment portfolios. Most investors are required to use open-end mutual funds; the remainder are encouraged to use passive speculation vehicles — go figure!
When the lemmings head for the cliffs, managers must sell securities; when greed infects the masses, managers must buy into the bubble. It is not the managers who underperform the averages, it is their bosses on Wall Street and on Main Street who are always push-pulling in the wrong direction. Market Cycle Investment Management (MCIM) users are likely to outperform the markets over the course of most market cycles.
Personal portfolio market values are a function of their investment plan, content and management. Clearly, those that are passively managed (an oxymoron) and/or managed by the mutual fund mob can expect only to mirror the market averages. However, investment portfolios can be self-directed for better results.
There is no reason for anyone to have had negative growth in market values over the past dozen years — as is the case with the market averages. Wall Street wants you to accept mass produced mediocrity, and they have fostered ancillary misconceptions designed to "make it so."
Investors need "experts" to determine when it is safe to enter or prudent to leave the investment markets — without distinctions regarding quality or purpose of the securities involved.
The stock market, you see, is the only place on the planet where higher prices have become a "call to the mall." The higher the market averages, the more furious the feeding frenzy becomes, and the more IPOs and other exotic ideas that are brought to the attention of speculators.
Another misconception is the notion that someday there will be a market rally that never ends — stock prices will go forever higher. This is predicted by the very same experts who, just five months ago, were certain of a return to financial crisis lows!
Finally, and mainly because it is rarely even mentioned, there is a between the lines wealth of conventional wisdom that reinforces the myth that one's income needs can be dealt with later — because your portfolio will be at an ATH at retirement. Yeah, right.
There is more in those five little words (Is this the real thing?), but the point of this message is not. "The Market" has never and will never be a one way "ticket to ride" (everyone in my generation should now be smiling) — at first, and then thinking about the dozens of times they neglected to take their profits in previous rallies.
None of the important aspects of the "ride" (length, breadth, height, duration, sector participation, decline) are predictable by anyone, no matter how overpaid or well credentialed. It has become clear to me over the 40 or more years that I've muddled through the exercise, that most mistakes are made by people who either over-complicate the process or who seek to avoid the investment work entirely.
There is no real need for rocket science in investing — no correlations, standard deviations, coefficients, Alphas, Betas or Zetas are required. Similarly, passively managed, index derivatives are just a lazy man's way of reinforcing the myth that active management is ineffective.
One can have science without creating complex, inexplicable monsters. One can be creative without manufacturing hedges, swaps, games and probability scenarios. One can understand enough about investing to figure out that he is being conned.
Successful investing requires some knowledge of business operations, market, economic and interest rate cycles, management techniques, a touch of retailing, some psychology, a dash of organizational skills, and a pinch of rudimentary economics. It's also helpful to be focused, decisive and disciplined.
Simply put, your portfolio is a shop with two businesses inside. On the retail side, you inventory quality merchandise for later sale at an easy-to-achieve target. On the office side, you accumulate income-producing instruments designed to pay current expenses and to prepare for future income needs.
As the owner of the enterprise, you must have a disciplined plan, rules, procedures and controls. The only additional feature needed is the time to guide your train to an actual and long-predetermined destination. You may just have to find a qualified conductor to do this — a direct decision-making employee, as opposed to a product salesperson. But you need to understand the process.
So yes, this is the real thing — a very high-priced stock market that will eventually correct. No one knows when, but there is no question that it will. All decision making is done under uncertain conditions, and no person ever became poorer by taking a profit.
During stock market rallies, when portfolio market values are at or near all-time highs, always, yes always, sell too soon.
Author: "The Brainwashing of the American Investor: The Book that Wall Street Does Not Want YOU to Read" This morning's classic E-mail question wondered: "Is this the real thing?"
About the author:
sanserve (at) aol.com
Professional Portfolio Management since 1979
Author of: "The Brainwashing of the American Investor: The Book that Wall Street Does Not Want YOU to Read", and "A Millionaire's Secret Investment Strategy"