Words of Wisdom

On volume far lower than we saw in the first week last year, the S&P500 rose 1.6%. Volatility declined.    Yet, the retail investor has been fleeing—and continues to flee—the stock market. According to the ICI (a firm that monitors retail money flows), the retail investor has pulled money OUT of the US stock market for 34 out of the last 35 weeks, ending the year with one of the largest total net outflows in years.  Yet somehow the US (unlike pretty much every other major stock market in the world) is holding up admirably.

Economic news in the US was mixed. In Europe, on the other hand, a serious recession has started to bite.  From Italy, to Spain, to France and even to Germany, most leading and coincident indicators are pointing down. In the US, ISM manufacturing, while weak, was slightly better than expected. ISM services, on the other hand, disappointed. Factory orders also disappointed. Initial jobless claims matched expectations. The big number of the week, the jobs report, beat expectations, at least on the surface. Headline unemployment dipped to 8.5%, while the broadest measure (U-6) was still at a horrific 15.2%. The broader–and thus harder to manipulate–measures were grim. The labor force participation rate and the employment to population ratio both came in at or near multi-decade lows. Also, the workforce dropped by about 50,000 people—not a sign of an improving job market (which would show a growing workforce). Finally, as economist Dean Baker pointed out, the positive surprise on jobs was misleading and all of it had to do with season hiring that will promptly be reversed in the next two jobs reports.

Technically, the S&P is at the upper end of the declining trend first established in May and June of last year. Seemingly, while the rest of the world’s equity markets have deteriorated between 10% and 25% from their 2011 highs, the S&P has massively outperformed the rest of the world. In the upcoming weeks, we’ll see if the US markets (about 25% of global market capitalization) or the rest of the developed and developing markets (about 75% of global market cap) are correct. One of these two groups is “wrong” and will very likely converge with the other.

Last year, Howard Marks (the founder and chairman of an investment fund with $80 billion under management) released a book titled “The Most Important Thing: Uncommon Sense for the Thoughtful Investor”.

As a value investor, with over 40 years of investment management experience, Marks assembled a series of tips for investors who wish to succeed over the long-term, as he has.

And coming from the Graham & Dodd (Warren Buffett) school, Marks builds on the hugely successful (yet so difficult to replicate) foundation established by them almost 100 years ago.

Marks goes on to add several critically important pieces of advice, advice that he’s used to build his 40 years of success.

One that stands out is the importance of taking the temperature of the economy, the markets, and investor psychology. Even if only once or twice a year, it’s imperative that investors determine if these three areas are too hot, too cold, or just right. Notice that Marks is NOT suggesting that it’s important to determine where the markets are going in the FUTURE. Most of such forecast research is not consistently accurate; in short, it’s not possible to do this consistently. Instead, Mars is suggesting that it’s important to determine where things stand RIGHT NOW; in short, this is very doable–consistently and accurately.

If they’re too hot, investors must reduce risk, by selling risky assets such as stocks. If they’re just right (which is much of the time), then investors can stay invested. If, finally, they’re too cold, then investors must, add risk, by purchasing assets such as stocks.

Marks observes that almost all market participants will do the exact opposite—they’ll buy when things are booming (hot), and they’ll sell when things are gloomy (cold).

This presents the astute investor a huge opportunity:  to buy low and to sell high……as most participants claim they actually want to do.

But Marks also adds some words of caution. He points out that by following such a “contrarian” investment strategy, an investor must be prepared to spend long stretches of time looking like he was wrong, before the markets (and the economy and psychology) revert back to more normal levels…..proving that the astute investor was ultimately doing the right thing.

These can be lonely times for such investors. But history suggests—very clearly—that although they don’t capture most of the gains in up markets, they do avoid most of the losses in down markets. And by doing so, they manage to stay in the game, and ultimately….over the long-term….have superior track records.

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