Many investors seem convinced that the equity investment markets are dead. Finished. Kaput. Money is leaving stocks and going to cash and debt securities. Thrift Savings Plan investors are abandoning the stock-based C, S and I funds in favor of the more conservative G and F funds.
Why? In some cases, it’s out of fear. In others, it’s greed. These are the two most important influences on short-term market pricing. Oh, there’s usually some attempt to disguise the true rationale for investors’ behavior. They’ll cite predictions about the effects of this economic factor or that demographic change, this political pressure or that conspiracy theory abound. But how reliable are those predictions?
I’m not certain the world isn’t coming to an end tomorrow, but I’m certain that, if it is, these people won’t be the first to know about it. And, that’s the kind of foresight it takes to predictably beat an investment market.
So what if markets are down today, or this month, or this year? Are you cashing in your chips?
If you own a home, its value has probably fallen 10 percent or more over the past year or two. Do you feel motivated to rush out and sell it? No! Why? Because you are confident that it has inherent value. While it’s not pleasant to have a home decrease in value, you’re not afraid that its value will fall to zero. If you don’t own a home right now, you’re probably thinking about buying one, which would be smart. Because a home is tangible — you can see it, touch it, live in it — you have a clear understanding of its true value.
The problem with stocks and bonds is that it’s hard to comprehend a similar kind of value. But value is there. To fear that a particular stock might lose all of its inherent value — the value of the company’s assets and ability to generate a profit, now or sometime in the future — is, in some cases, a rational fear. That’s why you should diversify. The fear that public companies, in the aggregate, will lose all of their value, is not rational. The bulk of human effort in the developed world is focused on building and running enterprises capable of making as much money as possible.
Worldwide business has not lost its value. Investors’ perception of that value changes on tick-by-tick basis. The aggregate price investors have been willing to pay for the stocks of large domestic companies — as represented by the TSP’s C Fund — has fallen a little over 20 percent since its all-time high last October. Has the inherent value of the companies fallen by that same amount? Not likely.
Fear is the culprit in investors’ decisions today. But the fear will subside and investors will start to see opportunity. Then optimism — greed — again will rule the day — for a while.
Take a look at a long-term chart of the S&P 500 stock index. Yahoo offers a nice one that goes back to 1950. Here’s how to find it:
Go to finance.yahoo.com. On the left side of the page, under the Market Summary/U.S., click on “S&P 500.” On the left side of the page that comes up, under Charts, click on “Interactive.” Now you’ll see a chart showing the S&P’s market activity for the day.
Now, make two modifications to the chart. First, at the top of the chart under Chart Settings, drop down the menu, hover over the Chart Scale option and click on “Logarithmic.” Second at the bottom of the chart, click on “Max” — this will display S&P data back to 1950.
Take a look. Does the slide in the index’s value over the past year look catastrophic to you? You’ll find that it doesn’t even look particularly significant in the context of the big picture.
The greediest investors would like to avoid the kind of downhill slides we’ve recently experienced and participate only in the uphill sections of the ride. If you could cut out all of the largest downward moves in that historical price chart and then add up only the upward moves, you’d wind up the richest person ever. Unfortunately, that prospect has been spoiled by lots of other people, some of them maybe even smarter than you, trying to do the same thing.
And, there lies the rub. Gaming the markets is a long-odds bet. Pick an appropriate investment allocation, rebalance it periodically, keep costs low and take home as much of what the markets give you as possible. That’s the smart bet.
Written by Mike Miles
For the Federal Times
Publication September 15, 2008