Correction Is Here, Finally

After more than four years of steady climb, the markets finally experienced a correction — all major indices are now 10% or more below their peak.  On average, market corrections occur every 18 month, so this particular one was long overdue.  In a way, it is a good thing to have that correction box checked — investors who were sidelined waiting for the correction will now how have one less reason not to be in the market.

The market drop over the last few days was, for all intents and purposes, made in China.  Fears of slowdown in Chinese economy and its market crash of over 40% caused worldwide equity rout.  Whether the extent of the drop was warranted is hard to say.  Note that the Chinese economy slowed from 7% yearly growth to probably around 5% – a number that is still much higher than the growth of any developed country.  Also, Chinese stock market had a huge rally earlier this year, and even after that 40% crash, it is still at the level of the beginning of 2015.

What happens now is anyone’s guess.  Often, and especially in situations like these, daily fluctuations of the markets are not driven by economic fundamentals, but by hordes of traders unable to control their emotions.  Historically, once the markets decline by 10%, there is a 50% chance that they will continue to decline further into bear market — that is, a drop of 20% or more from the peak.  That’s the bad news.  The good news is that there is 86% chance that the markets would be at least 50% higher in 5 years.  These are pretty good odds!

What is happening in the markets now is completely normal.  That is what markets do, once in a while.  It is the nature of the beast. The last few days were not fun, and the roller coaster ride will probably continue.  But days like these are the reason why equity investors in the long term are paid more, a lot more, than any other kind of investor.

The financial media thrives when markets are volatile.  You are going to hear all kinds of experts predicting the future, and stories of high-profile investors and entrepreneurs in the likes of Bill Gates or Mark Zuckerberg who lost billions of dollars in a few days.  But after the dust settles and the markets continue their inevitable climb to new highs, it will be clear that they didn’t lose anything.  Because, chances are, they didn’t sell.  And neither should you.

August 25, 2015 at 11:11 pm Leave a comment

Nasdaq at All Time High Again

It took just over 15 years for Nasdaq to finally exceed its previous peak reached in March 2000.  The only comparable event in U.S. stock market history is reclaiming pre-depression 1929 high — and it took Dow 25 years to do that.  So how does Nasdaq of today compare to 15 years ago?

The short answer is, there is nothing in common.  In 2000, internet exuberance affected valuations of most companies.  Even leaders of that era, like Microsoft and Cisco, sported tripe-digit PEs, and of course many dotcoms not only had no current earnings, but no prospects of getting any in the future.  Today, while there are a number of richly valued companies, most of them are solidly profitable with proven business models.  And today’s industry leaders like Google or Apple trade at reasonable forward PE in the teens.  Investor attitude also changed markedly.  In 2000, your taxi driver or your barber was ready to give you hot stock tips.  Today, more than half of U.S. population, burned by market crashes in 2000 and then again in 2008, eschews equities altogether (missing on the gains of this six year old bull market).

With earnings season underway, the results so far are similar to those of several prior quarters: about 70% of companies that reported so far exceeded earnings estimates.  These estimates were previously reduced, however, due to strong dollar and poor results by energy companies because of the fall of oil prices.  For the next couple of quarters, earnings are expected to stay flat or even decline, and that may make it difficult for the market to advance.  While there is no bubble to speak of, we may finally get that long-awaited 10% correction.

Or maybe not.  With no inflation in sight and strong dollar, there is little likelihood of Fed raising interest rates soon, and equities will continue to be the investors’ choice to generate reasonable returns.  But it is not useful to speculate on the direction of the overall market – instead, as always, it is much more productive and profitable to concentrate on the companies in your own portfolio.

April 24, 2015 at 7:53 pm 1 comment

Know When to Sell

Most investors would agree that a decision to buy a stock is much easier than a decision to sell.  Watch the video below to see when it is a good time to sell and when it is not.

March 3, 2015 at 11:35 pm Leave a comment

Investing and Emotions Don’t Mix

For many people, investing can be very emotional.  In declining markets, fear takes over and the natural reaction is to sell to prevent further losses.  In advancing markets, greed is in control and produces a desire to buy more.  These emotions are extremely dangerous to the health of your portfolio and if followed through, will inevitably lead to regrets later.  Emotions do not belong at all in investing, only hard logic and reasoning does. For Star Trek fans, you should always be Mr. Spock as far as your portfolio is concerned.  Live long and prosper!

February 25, 2015 at 5:22 am Leave a comment

A Common Misconception of Index Funds

It is now a well known fact that 80% to 90% (depending on the study) of actively managed funds underperform S&P 500 index funds.  The reason for that is two-fold.  First, active fund managers charge higher fees.  Second, they tend to trade often which results in commission costs, unfavorable capital gains tax treatment, and most importantly, underperformance due to continued attempts to time the market  stemming from frequent trading.  Index funds, on the other hand, change composition very rarely and thus almost never trade.

As a result, there is a flow of cash from actively managed funds to index funds.  Many prominent investors, including Warren Buffett, advocate to consider only index funds for individuals.

However, many investors don’t understand exactly how index funds are structured.  Most indices, including S&P 500 index, are not equal weighted, but instead market capitalization weighted.  This means that dollar amount of each fund holding is proportional to its market cap.  So if you invest $1,000 into S&P 500 index fund, you will not put $2 into each of 500 companies.  Instead, you will own approximately $50 worth of Apple, $30 each of Microsoft, Google and ExxonMobil, etc. — because these are highest market cap companies in the index.  And you will invest only $10 combined into hundreds of mid-cap and smaller companies with less than $5 billion market cap.

While market capitalization is appropriate to measure performance of the overall market, no reasonable investor will construct his or hers individual portfolio in the above manner.  The best way is to select high quality companies with excellent management teams and own these companies for a long time, selling only if business fundamentals deteriorate.  That way, you can have your own properly constructed “index fund”, and without market timing, it will have a good chance of beating the venerable S&P 500.  This is exactly the strategy I use for my clients’ and my personal portfolios.

February 22, 2015 at 1:58 am Leave a comment

Market Timing Doesn’t Work

Since 2011, investors have been waiting for a correction, which has not yet materialized.  Meanwhile, the market has been climbing steadily and hitting new highs.  I am sure a correction will happen sooner or later, but trying to time the market this way never works.  Watch this one minute video for details.

February 16, 2015 at 9:49 am 1 comment

Market Update

We are well into the first quarter earnings season, and the results are not quite as robust as they used to be.  Many prominent mega-cap multinational corporations, like Caterpillar, Dupont, ExxonMobil, Pfizer, etc. either missed earnings estimates or provided cautious guidance going forward.  There is nothing wrong with these businesses — the reason is our strong currency which reduced dollar-denominated sales overseas.  This affects all companies with significant business abroad.  Thus, we may witness a shift in market leadership toward domestic companies, which tend to be smaller.  It is about time — large cap stocks outperformed smaller companies last year.

Meanwhile, in addition to never-ending “Grexit” concerns, deflation is a new market bogeyman.  Indeed, deflation would be bad news for worldwide economies, and in order to prevent it, several European countries now sport negative interest rates (which causes weakness in Euro and other currencies and leads to dollar strength — see paragraph above).  With no inflation in sight, I don’t think Fed will raise interest rates anytime soon — doing so will only strengthen the dollar even more.

As a result of this very low interest rates environment, S&P 500 dividend yield is now higher than 10 year U.S. Treasury rate.  There is always a possibility that one or several multinational companies chooses to cut its dividend, and that may well trigger that long-awaited correction.  However, at this time, equities remain essentially the only game in town for investors expecting a reasonable return.

February 10, 2015 at 10:58 pm Leave a comment

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Leon Shirman's long-term investment philosophy is summarized in his book, “42 Rules for Sensible Investing”, also available from Amazon.

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