Sound Advice

The Market Drops Every Year . . . and Ends Up Higher Over Time The market drops I refer to take place over a period of a few months within one year or starting in one year and running into another.   These short periods of weakness are not to be confused with 12-month changes from yearend to yearend. Since 1980, the Standard & Poor's 500 Index has had average interim drops of 14.3%.   In more than half of those years, the corrections, as they are euphemistically known, were 10% or more.   We hit the worst air pocket back in late 2008 to early 2009: 49%. When this happened, more than a few investors started to wonder what was going on. Yet each time, the pullback was followed by a full recovery and annual returns ended up positive in three out of four years. The lesson learned from this pattern is that short-term movements are for the most part reflections of changes in investor psychology.   One day, there may be a series of encouraging earnings reports. ...

Technical Analysis, a.k.a. Voodoo   Among Wall Street researchers, there are two main approaches: fundamental analysis and technical analysis. Fundamental analysis subscribes to the belief that the shares of companies will reflect changes in forward progress and financial health. In contrast, technical analysis concentrates on stock price action and how such changes reflect shifts in investor psychology. Technical analysis is totally indifferent to underlying company developments. Therein lies its fatal flaw. As one might suspect, there are different approaches to technical analysis and there is what purports to be an academic treatise on the subject: Technical Analysis of Stock Trends , the Ninth Edition of which devotes nearly 800 pages to the subject. Devotees worship this tome much as fundamental analysts pay homage to Security Analysis, by Graham & Dodd. The book is filled with all kinds of lines, shapes, and other graphic devices in a comprehensive attempt to convince...

Compound Interest Compound interest refers to the phenomenon in which the interest associated with an investment increases exponentially—rather than linearly—over time since the periodic gains on the investment increase the size of the principal that is the basis for the total return (dividends and capital gains). The term compound interest can be confusing and misleading, especially in view of the current historically low interest rates.   The word interest as it used here refers to gains on investment, not interest on the funds invested.   Compound interest refers to the gains on your investment as well as the gains on those gains over the period the funds are invested. Here’s an example.   Let’s assume we begin with an account of $1,000,000 with a total return of 10% a year.   If that total return of 10% (or $100,000) is withdrawn each year, the total return over time is nothing more than $100,000 times the number of years the funds are invested.   Thi...

The ABCs of Stock Picking After decades of analyzing stocks (and funds) and investing for clients, I'm happy to share in plain English what's involved, what works, and what doesn't.  Keep in mind the reality that successful stock picking is an effort to maintain a good batting average. In baseball, a batting average of .300 or better is considered quite good.  With stock picking, you need to do better than .600, which means you have many more winners than losers. No one gets it right all of the time.  It's not even close.  Wall Street shops all have their recommended lists and the financial media regularly hawk 10 stocks to buy now. Following that road usually is a direct route to disaster.  Don't be tempted. Let's begin with the big picture: The stock market goes up and down over time, but the long-term trend is up.  When there's a rally under way, everyone feels like a genius.  When the market hits an air pocket, though, with few exception...

Ka-Ching   Ka-Ching was the sound made by old-fashioned, mechanical cash registers before electronic terminals took over.   These days, it’s a term used to refer to lots of money. For investors, the critical question is what lies ahead for the stock market, not in the next few weeks, but in the next few months or years.   That depends on where the economy is headed.   Over extended periods, the path is upward, though there is always slippage along the way, sometimes relatively minor and at other times quite nerve-wracking. The driving force behind the economy is consumer spending, which typically accounts for about 70% of the U.S. Gross Domestic Product.   Consumer spending peaked at $13.4 trillion in the fourth quarter of 2019, plunged to $11.9 trillion two quarters later, then rebounded to $13.0 trillion in the most recent quarter. What lies ahead?   A further rebound. During the closing months of 2020, consumers started to loosen their purse st...

Pullbacks “R” Us The long-term trend of the stock market is up.   Period.   To reinforce that statement, take a look at the closing levels of the Dow Jones Industrial Average over the last 100 years: The average annual rate of return over this period was 10.5%.   That was before inflation, which averaged about 3.1% a year.   The real return, net of inflation, was 7.4% a year. The advance has not been straight up.   Quite the contrary.   A study by JPMorgan (see below) found that although the market advanced in three out of four years, there was an average intra-year drop of 14.3% during the period measured (1980-2021). At current Dow levels, that would be a reduction of 4,500 points. Nearly half of the pullbacks were less than 10%; five were more than 30%.   In all cases, stocks recovered and continued to climb. Over extended periods of time, equities have delivered the highest average annual rate of return of all asset classes.   Along th...

The Impact of Psychology: Beyond The Numbers However much analysts attempt to parse corporate data and extrapolate into the future, the reality is that this is a fruitless quest.   Whether one’s goal is divining a reasonable price for an individual stock or the stock market as a whole, the hitch is the same.   Over time, there is a distinct correlation between changes in company fundamentals and the values given to those fundamentals, but at any given time there is frequently a disconnect between what one might consider fair value and the actual market price.    On occasion, there may be parity between the two, though more often than not the market price will be above or below the level that might otherwise be viewed as normal. The variances are largely explained by attitudes toward the future.    At times when prospects are rosy, investors tend to be generous with their valuations and stock prices may rise well above benchmarks considered reasonable....