Reacting to headlines is perilous!

You can avoid plenty of grief by reading headlines and as George Costanza (from the popular sitcom Seinfeld) says: “Do the opposite.”

You might notice that the average ‘Joe’ was far more concerned about his job (justifiably) until we began seeing headlines such as ‘Dow Hits Highest Close Ever.’ All of a sudden the stock market is once again a worthy topic for discussion and it’s okay to actually speak to one’s investment advisor. Judging by money flows it’s a good bet that clients are instructing their advisors to buy stocks, EFT’s, equity mutual funds or whatever it takes to get them invested and fast. There’s nothing but good news. As I type this, ‘Stocks resume winning ways’ appears on the TV screen (CNBC).

Before succumbing to the urge to herd let me take you back to June of 2010.

In the first chapter of A Maverick Investor’s Guidebook (Insomniac Press, 2011) I wrote the following:

In one newspaper, under the title “Economic crisis,” I found the headline: “World recovery under threat as growth slows, stimulus wanes.” On the same day in another newspaper, under the title “Recovery angst” was the similarly ominous caption: “Economic trouble is all investors see.”

If you are spooked by such nonsense and inclined to adopt a ‘wait-and-see’ approach before investing any of your money at all in financial markets, then give your head a shake. These headlines are gold!

I went on to pose the question: “If the press is even partially representative of what economists and strategists are recommending, and if investors all share the same sentiments, then what happens when there’s some good news?”

There was plenty of good news even in 2010, but it was generally delegated to those pages in the back of the newspapers which people seldom read. One example, and a very important one for stocks, was rapidly improving corporate profitability.

While the general mood was (and continued to be) let’s say ‘despondent,’ institutional and retail investors kept taking money out of stocks and channeling it into money market funds and bonds – to take advantage of what tiny returns were available in those securities (yes, I am being sarcastic).

Meanwhile in answer to my rhetorical – because it should have been obvious what the answer would be – question in 2010 we certainly know now what happened when there was good news. Stocks skyrocketed and recently surpassed their previous highs.

My concern today is that investors will make the same mistake they always seem to make. Rather than ‘interpreting’ headlines, they will simply take them at face value and chase the stock market at an inopportune time.

I am paraphrasing, but I’ve heard and read nothing but good news of late such as:

  • “It’s definitely a ‘risk on’ market.”
  • “Don’t fight the FED!”
  • “Looks like we might avoid the usual summer slowdown this year.”

Most worrisome: Kramer (wait long enough and you’ll eventually be right) is more wound up than a four-year old high on chocolate. I do believe that stocks are a better investment than bonds over the next several years, but the trend in corporate profitability (and consumer sentiment, GDP and job growth) will be interrupted – count on it – affording convenient opportunities to get invested. With nothing but good news and euphoria, what happens if we get some bad news? A chance to invest at lower price levels. Right now, ‘risk-on’ is exactly what you should expect if you respond to headlines.

Click on this link for a chuckle: George Costanza Does the Opposite

Mal Spooner

 

 

 

 

 

You want back into stocks…but should it be growth or value?

Decades ago, the academic community and financial services industry, in an effort to better understand what causes good versus bad rates of return in stock markets, began studying differing styles of investment management. There isn’t a hope of my staying awake long enough to cover even a sampling of the variety of styles that are out there, so I’ll keep it simple. Two styles in particular get plenty of attention: growth and value.

With the growth style, portfolio managers use their ingenuity to identify companies that are growing most rapidly. Since I carried around a BlackBerry (aka CrackBerry) for many years, I’ll use its creator Research in Motion (RIM) as an example. When the company was first getting its legs, it offered me and other research analysts a free trial of a little device with a monochrome screen that allowed you to send and receive text messages. We became addicted to them overnight and believed that this kind of service would catch on. Early movers can grow businesses very quickly with sufficient research depth, management expertise, and capital. We professional money managers provided the capital to RIM and the rest is history.

Early on, RIM was a growth company because even though they weren’t profitable and wouldn’t be making money for many years, the company kept selling more and more units. Revenues grew like crazy and, with some occasional disruptions (a market crisis, the technology bubble bursting), so did the stock price.

Portfolio managers who specialize in companies such as RIM are commonly called growth managers. The funds they manage are “growth funds.” The portfolio will usually have many stocks in various industries. They can be fast growing companies in slow growth industries or companies benefitting from an industry that is suddenly growing. Growth stocks can be very expensive. Investors expect the company to grow fast and so are willing to pay a higher price. However, you’ll have to buy a book explaining price/earnings (P/E) ratios, P/E to growth rate ratios, price/sales (P/S) ratios if you really want to get into security analysis yourself.

A value manager is more interested in buying and owning cheap stocks. Some companies grow slowly but pay their shareowners high dividends as compensation. A stock can be in an industry that is out of favour with the investment herd, or an industry can be out of favour entirely, making all the stocks in the sector cheaper. There are measures such as price/book ratios (P/B) and price to net asset value ratios that analysts use to gauge whether a stock is cheap or not.

Growth funds are considered riskier or more volatile than value funds. For instance, if the market is going higher because of a particularly strong economy, then the growth fund should go even higher still. A value manager might not perform as well as a growth manager in a bull market but won’t do as poorly in a bear market. A value manager is therefore considered more conservative.

A strategist friend of mine of TD Newcrest Research allows me to use his charts on occasion.  One of the most telling charts compares growth stocks in the S&P 500 Index to Value stocks.  The adjacent chart is an older one.  When the line is rising, growth stocks are significantly outperforming value stocks.  You can see vividly the technology bubble – growth stocks skyrocketing relative to value stocks – prior to the bubble bursting in the year 2000.

The shaded areas are periods of economic stimulation (US Federal Bank monetary easing).  During these periods it’s not unusual for growth funds to perform much more strongly than value-oriented funds.

Conventional wisdom says that conservative investors who can’t stomach as much volatility should use value funds and that investors who don’t mind a wild ride should use growth funds. Alternatively, you can invest most of your money into a value fund while also putting some into a growth fund so that you might occasionally get more returns in a buoyant market with at least a portion of your savings.

Why not growth when growth is performing and value at other times?

There are portfolio managers like me who hate being pigeonholed into either one of these styles. However, it is inevitable that one label or the other will be associated with a money manager because of the way consulting services are compensated and the way mutual funds are marketed (when growth is sexy, it only makes sense to promote the growth manager).

A maverick investor who understands the ebbs and flows of market sentiment will want to be invested in their favourite growth fund at the right time and to switch into a value fund at other times.

Whenever I’ve recommended a more active approach to selecting mutual funds in print or on television, such as using a growth fund and switching into a value fund when appropriate, I always get the same question: “How do you know when to switch?”

There is an easy answer, but nobody likes hearing it. The answer is: “You will know!” You should switch when your intuition or emotions tell you not too. It is that simple. If the fund you own has been doing extremely well and drifted up towards the top quartile or is now in the “best performing funds” category (rankings are available from a wide variety of publicly available services) and so you’ve begun to love it dearly, it’s time to switch into a different style of fund.

Here is a more current chart.  In this case the shaded areas are periods of recession, and we are all aware that for the past few years monetary stimulus has been the norm.  Not surprisingly then, growth stocks – avoided by most investors like the plague – have been outperforming value stocks.

As investors divest their income biased stocks (and bonds) they will naturally be tempted to move the money into the better performing growth style.  However if history (and experience) is any guide, they’d be well advised to focus their attention on stocks and funds that have not yet participated in the recent market rally.  In the event that government policy, encouraged by the rebound in the housing market, strong corporate earnings and slowly improving employment outlook, becomes less stimulative then value will in all likelihood become the place to be.

Mal Spooner