As published in the Shore 2015 Edition of NJ Lifestyle
Traditional finance has long held to the notion that investors are rational, unbiased, and risk averse. It also professes that investors’ comfort level for risk is essentially stable and individuals will only accept higher levels of risk if offered adequate returns. Many of us have learned from real world experience that this is not always true. To explain the realities of investing a new field of study has emerged, behavioral finance. The new discipline portrays investors as being regularly overconfident, chronically emotional, and habitually biased.
There are many psychological propensities leading to investment missteps identified in the behavioral finance literature. This article discusses three axioms that can be used to illustrate how psychological factors can cause investors’ mistakes that lead to market inefficiencies. By understanding the tendencies and biases of human nature, we will be better able to avoid them and generate better investment results.
In 1987, U2 released a song titled “Running to Stand Still.” Although the song describes Dublin’s heroin epidemic in the 1980’s, the title could also describe the movement of the stock market through the first quarter of the year. The market has experienced heightened volatility, yet the S&P 500 finished the quarter up only 0.44%, while the Dow was -0.26%. The S&P 500 traded near an all-time high on March 2nd, and then subsequently fell 2.5% the following week. From February 18th through March 30th, the S&P 500 failed to generate two consecutive positive trading days. This 28 day stretch is extremely rare for the market, but offers some promise. The last 6 times the market has experience a streak of 25 days or longer without back-to-back gains, the market has averaged 2.77% for the 1 month following the end of the streak.
2014 was an extremely challenging year in managing a diversified portfolio. In the end, US equities delivered superior returns compared to most other investment opportunities. Extreme volatility returned to the capital markets during the entire 2nd half of the year, and in particular, during the fourth quarter which included minor corrections in early October and early December followed by strong relief rallies during the months of November and late December. A huge draw down in the global price of oil was the main culprit, responsible for the ensuing market volatility which was further exasperated by weak foreign currencies. An accommodative Federal Reserve also played a role in the appreciation of non-commodity assets.
As published in the Holiday 2014 Edition of NJ Lifestyle
Much is written in the investment world about active vs. passive investing. It probably makes sense to define both before continuing to address the argument for one over the other.
Passive investing (also called passive management) is a financial strategy in which an investor (or a fund manager) invests in accordance with a pre-determined strategy that doesn’t entail any forecasting (either market timing or stock selection for example). The idea is to minimize investing fees and to avoid the adverse consequences of failing to correctly anticipate the future. The most popular method is to mimic the performance of an externally specified index. Active investing is just the opposite.
Equity Market Overview
The 3rd quarter of 2014 trended in monthly directional movements both upward and downward but at the end of the day (quarter) major US indices were little changed from that of the end of the prior quarter. A July selloff followed by a steady August rally and a mixed September left major stock indexes just slightly up from where they were at the end of the June. Year to date, the DJIA is only up 2.81% while the broader S&P has advanced by more than double that mark at 6.70%.
As Published in the Summer 2014 Edition of NJ Lifestyle
WE HAVE ALL HEARD THE NUMBER ONE RULE OF INVESTING – BUY LOW, SELL HIGH. Simple in theory, yet counter intuitive to what our emotions dictate. Many times as the markets are soaring to new highs, our emotions tell us to, as Jim Cramer would say, “buy – buy – buy.” March 2009 proved to be one of the best investment opportunities with a nearly 200% gain since; however, our emotions at the market bottom begged us to sell. Keeping our emotions in check, especially fear, greed, and regret, is vitally important for the long term success of any investment portfolio.
As Published in the Shore 2014 Edition of NJ Lifestyle
UNDERSTANDING AND EVALUATING THE BUSINESS CYCLE CAN OFFER valuable information in formulating expectations for the economy and your optimal portfolio allocation. The business cycle is defined as fluctuations in GDP (Gross Domestic Product) in relation to long-term GDP trend growth. The typical cycle usually lasts 9-11 years and can be broken down into five phases, starting with an initial recovery and ending with a recession.
The initial recovery is the phase of the business cycle where the economy starts to pick up from its previous slowdown or recession. Often times this phase is accompanied by easy monetary policy in the form of low interest rates and/or a budget deficit. Business confidence starts to pick up as can be seen with higher inventory purchases, while consumer confidence may remain low as the unemployment rate is high. Inflation during the initial recovery continues to fall, putting downward pressure on government bond yields and the gap between long-term GDP trend growth and actual GDP remains large. As fears of a longer recession subside, the stock market may rise substantially with investors attracted to the riskier assets of small caps, emerging markets, and high yield bonds.
With the 2014 calendar year eclipsing the 1/2 way mark, the world financial markets including most asset classes, have oddly rallied in unison higher. This last occurred in 1993. Accordingly, if you maintain a balanced account which we always advocate at CRA, it most likely advanced in its entirety throughout the quarter, albeit a slow grind upward.
World Stock including Developed International and Emerging Market, the entire bond market, REITS, MLPs, and even commodities all have risen in 2014. The “melt up” reflects market resilience amid uneven US growth, and political and economic unrest in the Ukraine and the Middle East. Much of the market’s broad lift is attributable to sustained and continued efforts of the world’s central banks to a commitment of keeping interest rates low to ensure that their own economies continue their painfully slow recoveries, which in some cases began nearly five years ago.
As Published in the Spring 2014 Edition of NJ Lifestyle
Dividend paying stocks have received a lot of attention over the last few years as interest rates have fallen. With the yield on the 5-year Treasury note dropping below 1%, investors shifted their focus to stocks as prices were down and the yield on the S&P 500 surpassed 2.5%. As of July 2013, nearly 30% of the stocks that make up the S&P 500 Index had dividend yields that surpassed the yield on the 10-year U.S. Treasury. Low fixed income yields coupled with favorable tax treatment on dividend payments and the ability of dividends to help mitigate market volatility have made dividend paying stocks an important component of investor returns for decades, and can be a powerful tool for your portfolio.