Confirmation Bias

None of us likes to be wrong. It’s human nature and certainly the nature of investment “aftercasting.” Friends and colleagues who are active in planning their investments may well have cornered you with a glass in hand and related their brilliant investment choices.  The worst ones lie dormant. I am still hearing about the Microsoft investment from the early 1990’s that paid for college. The best part of that decision was that the tuition bills were paid (i.e. sale was forced) before Microsoft went into a ten year slumber. I had a client who called his swimming pool, the pool that Sun Microsystems built. His wisdom lay more in when he wanted the pool than when he wanted to sell.  Sun’s stock price crashed and burned in the early 2000’s.

 The truth is that we see what we want to see and often only that. If one is a conservative, Fox news confirms our views. If liberal, Rachel Maddow of MSNBC gives every reason to confirm what we already knew.

 Reading a recent edition of Barron’s, the weekly investment newspaper, I was struck by the statement given in the opening opinion column that, “the Dow industrials, Standard & Poors 500 index and Nasdaq finished the week less than 3% from their record highs, set earlier this year.” As I write this the Nasdaq 100 is less that 2% below its record high set in March of 2000, a mere fifteen years ago. The S&P 500 is a lofty 1.3% higher than it was fifty-two weeks ago. Neither a loss of 2% in a decade and a half or a gain of less than 2% in a year strikes me as the stuff of breathless reportage.

During years in the commodities business I had ample opportunity to listen to what customers, competitors and reporters had to say about markets. People “talk their book.” They will say whatever will further their own purpose whether it is to get you to buy a newspaper or an investment. Listen carefully to what is said and not said. Even your own beliefs require harsh observation and context.

Rolling toward reality

It is not without some trepidation that I take exception to last weeks Goldman Sachs projection of S&P 500 at 2100 by year end.  I recall during the tech bubble war of 2000, the press made great import out of an apparent difference of opinion between Steve Roach, Morgan Stanley's head of research and Abby Joseph Cohen of Goldman Sachs.  The headline made them disagree, when in fact one was talking of level and the other about time.  Both were right if one cared to read what they actually said.

Following the Federal Reserve decision to leave interest rates unchanged last week Goldman presumably turned more bullish.  I doubt it. 

 This weekly chart of the S&P 500 shows the index rolling out of the remarkable bull market that has been devoid of correction since 2012.

Although I would be the first to admit that the stock market does not necessarily reflect the general economy I believe it too early to infer a disconnect yet.

The global economic outlook is moderating and forward looking indicators are not constructive.  China is still digesting a slowdown.  Valuation of the S&P is not remarkably lofty but is still on the high side of average.  Interest rate policy has created a no alternative investment climate.  If pension funds are to possibly approach their projections, fixed income investments cannot reach performance benchmarks.

The 2007 mortgage debacle was created because no fixed income investments could provide returns needed.  The investment community satisfied the need with mortgage backed securities (housing has only ever gone up was the cry).  The combination of leveraging what had previously been a conservative investment sector and destroying the quality of such loans with No-Doc and similar over engineered lending criteria (i.e. none) created a global crisis the likes of which hadn't been seen since the 1930's.

Stock market performance based in general on two psychologies.  Valuation is the first and most frequently spoken of.  When a stock is bought it is the purchase of the long term dividends of a company.

The second aspect of market movement are the animal spirits of acceptance of risk.  Recently we have been seeing a lessening of risk tolerance as shown by stock market internal indicators.  Fewer and fewer companies have been responsible for market performance.  The breadth of the market has narrowed significantly.

The daily chart indicates a broad market no longer particularly oversold, but today buyers are absent.  In order to take the market back to the 2100 level a herculean effort will be required at best.  If the S and P 500 should manage to get back to 2100, I project the sellers will come out in droves to take advantage of the temporary reprieve.  Timing is the only arguable point in the development of this equity market.

While I foresee no global meltdown a la 2007, I believe the best outcome will be a long lackluster market until we can grow into the valuations already baked into the cake.  Today's financial markets are not known for patience so an expectation of volatility to get us to "reasonable" is probably not misplaced.

Coincidentally a 38% retracement (fibonacci) takes the market back to the top of the 2007 market collapse.  Just to put my neck out, I project an S and P level of 1575 in the next six to twelve months. 

Better to be lucky than good?

Within twenty-five miles of where I sit are two casinos.   This is Pittsburgh not Las Vegas.  Anyone who is a legitimate high roller is more likely to hop a plane to Nevada rather than ramble off in the Chevy Impala to the local Western Pa slots parlor.  For the most part these casinos are alternative entertainment to the cineplex or  Steeler's game.  A group of girlfriends head down to the casino for a night of possibility or a few couples meet with understanding that the winner pays for dinner.  One's financial future is not at stake.

If one views the stock market like a casino, but the ultimate outcome determines personal future well being now is a good time to align risk with needed outcome.  The financial press is rife with pronouncements that the ten percent correction is behind us, excesses have been relieved and we can look ahead to risk free  blue skies ahead.  It is too early to assess the outcome of last weeks plunge and subsequent rebound but internal market indications are that risk tolerance is declining.  While valuation is the arbiter of long term returns, risk tolerance is the short term driver of market direction.  It appears that the market as a whole is eyeing the exits, just in case.

Current valuation of the market is still double historical norms.  The corollary of high valuation is low return.  Projecting ten year returns from current valuation still produces a calculated zero return.  In other words, "do you feel lucky?"  As the market has gone from over valued to extremely overvalued to wow!, this is a good time to review portfolios.  Speculative holdings should be assessed for fundamental strength and market sensitivity. 

Stocks with low beta should be considered as replacements for high beta speculative holdings.  The saying,  "no one ever went broke taking a profit", may be worth considering now.  Biotech stocks have had a spectacular run in recent years and while the future looks bright in the industry many analysts agree valuations are ahead of current realities.  Other market favorites such as Google, Apple and Disney have had spectacular runs and are apt to react strongly to news the market perceives as negative.  Such household names remain excellent long term holdings but should be assessed in line with an individual's timing for withdrawals and risk tolerance.  If one particular success has taken on a larger than prudent portion of a portfolio it is worth considering judicious pruning.

The market has been enamored with companies with steady histories of dividend payment.  The ability to pay and growth dividends can go a long way toward ameliorating stock volatility.  The concept of  "getting paid to wait," is worth considering.  If dividends are important to an investor, the market gyrations of a company like Exxon, Johnson and Johnson, Pepsi or Coca-Cola can be weathered adequately while waiting for broad market valuations to provide a better time to add to such holdings.

If a portfolio is your casino keep your fingers crossed.  If it's your retirement it's worth being good and not just lucky.

Zoom out

There is a saying for market observers who use charts as part of their analysis.  When in doubt, zoom out.  It is all too easy to be absorbed by the minutiae of investment information that tosses us around from one uncertainty to another.  Following a 300 point Dow drop yesterday it can feel like the end is nigh, the end is past or like the proverbial tennis shoe in the drier, it's just confusing chaos..

In the past twenty years investors have endured two mighty bear markets.  Various market pundits announced we've entered broad bear market territory.  Depending on ones constitution it is possible to think the worst is over and opportunities abound suddenly.  Maybe.  But first some visual perspective is in order.

Both the internet bubble and mortgage banking crisis make yesterday pale in comparison.  It is not necessarily too late for portfolio caution.  The chart below shows the past twenty years of the S&P 500, including yesterday up in the upper right corner.

Zoom out.  Add some distance.