An article in the Wall Street Journal today states that many stock pickers are having trouble beating the market lately. (See the whole article here: http://online.wsj.com/article/SB10001424052748704190704575489743387052652.html)
The reason is that stocks are being driven by macroeconomic events, such that they are all moving in lockstep. Because of this, a stock with great fundamentals will do no better than one with bad fundamentals. Everything goes up during one week when good news occurs, everything goes down the next when bad news occurs. It is stated int he article that this has rarely happened, and that the last time it did to this extent was during the Great Depression.
It is often the case that when there are big events, good and bad, all stocks will behave in the same way. The old joke is that during a bull market everyone is a genius. There are definitely many who bought shares of some stocks that were beaten down on a whim in early summer 2009 who have seen their investments grow handsomely. The fact is that with the rally that occurred, for the stocks that survived most of them went up and up by a lot.
During the great route of 2008, most stocks, good and bad, also declined severely. Look, for example, at the share price of the insurer AFLAC: http://finance.yahoo.com/echarts?s=AFL+Interactive#chart2:symbol=afl;range=5y;indicator=volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=on;source=undefined
This stock went from the mid $60’s to a low of $13.5 in less than a year, with the stock free-falling during th last few weeks. Immediately after the worse was seen as over, once it was verified that the world did not come to an end, the stock sprang back, hitting a high of $55 in less than a year before falling back a bit again with the recent weakness in the economy and the effects of the European debt crisis.
There are many stocks that have similar pricing patterns over that period. Look through the stocks of any growth stock form the 2000’s and you’ll probably see the same, “V” pattern. These companies are not seeing their businesses approach failure and then suddenly recover. These companies are simply being dragged around by the market, which went from a bull market, into a panic, and then rallying back to correct for the over-sold condition.
Usually this trend would end and the good stocks would start to outshine the bad. Certainly there are good companies that should succeed and bad companies that should not. There is a question this time, however, whether there are other forces at work that have “changed the rules of the game.”
Specifically, are the various investment funds that allow investors to buy whole market segments causing the market to move more in lockstep than before? Is this new correlation of stock movements a permanent feature? Certainly there is quite a bit of market volume now driven by these funds – up to 30% in some cases.
I’ve found in general, however, that whenever someone says that things are different, that is about the time things change and revert back to the old rules. During the dot com bubble I was hearing that the old valuation measures such as earnings no longer mattered. It was just important “to get big fast.” There were start-up companies with expansive offices in multiple states. As we all saw, however, earnings did matter and when it was realized that many of these companies had little of substance, the whole deck of cards collapsed.
Likewise in 2007, we were told that the old rules in real estate did not matter. No one put 20% down for a house. The new norm was to put 0% down, and maybe even borrow more than the value of the house. Real estate would go up by 10-15% or more per year forever. And then it didn’t.
So, while I would be tempted to put some funds in index funds (it never hurts to match the market) I would not give up stock picking. The truth is that when everything is going down – good stocks and bad – it is a great time to load up on the good stocks. Mr. Market is offering you prime filet mignon at chuck steak prices. Why wouldn’t you stock the freezer? Even if the market stays in lockstep and never goes anywhere, if these companies are making more money than their peers, eventually they will start paying this out in bigger dividend yields or the companies will be bought out for larger sums of money.
Also, if things do continue to move in lockstep forever, it will not matter what you buy. The natural tendency is for stocks to go up since companies expand and make more money over time, resulting in higher dividends. If you match the market, that will be fine. It is very difficult, however, to try to play the macro economic game, moving in and out of the market just in time. Everyone knows what you do about the news and state of the economy. As soon as news happens, the markets have already moved. Making a successful bet — buying at just the right itme or selling right before the collapse — is just luck.
Because of the risk discount, however, it is possible to find stocks that will stand a good chance of returning more than inflation over the long-term. Look for stocks that have steadily growing earnings, a good management team, and room for growth. Pick the best stocks in each industry. If the old rules start to matter again, you’ll be in a great location to welcome the return.
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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing