Back on May 1st, the WSJ's Brett Arends spun out "12 Rules for Investing in the Next Bull Market," most of which are insightful and helpful. We generally like Arends' work and this piece is no exception. Though we're quibblers by nature, this is pretty strong stuff and it deserves your consideration. Here are a few of Arends' rules followed by our comments:
If you buy or sell heavily in one shot you're taking a needless risk. And waiting for the right moment to make your move is futile. You probably won't catch the bottom or the peak anyway. If a market trend has much further to run, then what's the rush? And if it doesn't...what's the rush?
No quibbles here. This is exactly right.
That means investing across a spread of different asset classes and strategies. As investors discovered last year, "large cap value" and "mid cap blend" funds don't offer diversification. They're just marketing gimmicks.
Though it's true that correlations rose sharply among risky asset classes during the last 20 months, we aren't willing to concede this point. There are ways to slice the market too narrowly, but historically there have been--and, we think, will be again--material differences in the risk/return profiles of various classes of equities. Tilting strategic portfolios in one direction or another by weighting assets classes isn't just a marketing gimmick. Or, to be more precise, it isn't necessarily, or always a marketing gimmick.
Investment opportunities are like buses. If you missed one, you don't have to chase it. Relax. If history is any guide, others will be along shortly.
You'll probably end up splurging at the last moment. If you are afraid to invest, do it early, little, and often.
After all, an investment is just a claim check on future cash flows, whether it be a company's profits, a bond's coupons or an annuity's income stream. By definition, shares in a solvent company are twice as good at half the price...and vice versa. It's amazing how many people get suckered into thinking it's the other way around.
But then there's this morning's Arends column, in which he taps some recent research suggesting that near-term economic prospects have almost nothing to do with stocks' long-term returns, which in turn makes the notion of "price" a little less concrete that most investors--and certainly less concrete than most fundamental analysts--would like to believe. Here's an excerpt:
The stock market jumped 6% last week on growing hopes of an imminent economic recovery. It has risen 39% from the March lows on similar hopes. Of course, it had previously fallen nearly 60% on fears of a slump.
All these moves have one thing in common: Millions of investors have acted on the belief that share values are closely related to what will happen in the economy in the next few months and years. But are they right?
Not according to Ben Inker, director of asset allocation at contrarian fund company Grantham Mayo Van Otterloo & Co. In a recent and fascinating note ("Valuing Equities in an Economic Crisis, or How I Learned to Stop Worrying about the Economy and Love the Stock Market"), Mr. Inker persuasively argues that the next moves in the economy shouldn't actually matter too much to investors at all.
Why? Two reasons.
First, because most of the value of shares really depends on the cash they will generate many years, even decades, ahead. The next few years are only a minuscule part of the equation. "Since stocks do not have an expiration date and dividends grow over time," Mr. Inker argues, "the duration of stocks is extremely long. If we assume that half of the return from stocks in a given year comes from the dividends and half from the growth in dividends, most of the value of stocks comes from cash flows in the distant future."
(The second reason is that short-term deviations from long-term trends in economic growth are typically resolved back toward those long-term trends within a few years.)
"This sort of analysis is a useful antidote to stock market moods," writes Arends. Maybe. But the other way of looking at Inker's research is that all we really have in the short run is "stock market moods." Which means you either trade on the technicals (with some attention to short-term expectations of the fundamentals, as in a Keynesian beauty contest) or, like Joshua in War Games, refuse to play the short-term trading game in the first place.*
* It's one of the great lines in movie history: The rogue computer program "Joshua," having realized that "global thermonuclear war" produces no winners, declares that "the only winning move is not to play."
Brett Arends, "12 Rules for Investing in the Next Bull Market," Wall Street Journal, May 1, 2009
Brett Arends, "How to Value Stocks? Ignore Economic News," Wall Street Journal, May 11, 2009
Ben Inker, "Valuing Equities in an Economic Crisis," Grantham Mayo Van Otterloo & Co., April 6, 2009 (registration required)