As long time readers know, the purpose of our daily and weekly state of the market reports is to identify the drivers of the current market action. And as I’ve mentioned a time or thirteen over the years, the thinking here is simple: If we can stay in tune with what is driving the market in one direction or the other – regardless of whether or not we agree with the reason, or even if said driver is intuitive – then we should (always a key word) be able to stay in tune with the prevailing forces of the market and, perhaps more importantly, avoid being surprised by any big moves the markets might make.
For example, I have been submitting over the past month that the current joyride to the upside in the stock market is being driven primarily by the expectation that the FOMC is about to mount their white horses again. Of course, there are other factors involved, and personally, I don’t particularly agree with the idea that this heads-stocks-win, tails-stocks-win-too rally makes sense. But, the key point is that this theme appears to be the driving force behind the rally right now.
The next key point to understand about Ms. Market’s little game – at least in my humble opinion – is that the “driving force” tends to be a moving target. And this is what makes the stock market game so interesting – it’s always changing.
Think back to 1999. Did anybody care about valuations, interest rates, the economy, or China? Nope, all we cared about was the internet (and how high Cisco would go)! But then during the 2001-2002 time frame, valuations were suddenly the name of the game. In 2004 it was the hoped-for soft landing in the economy. In 2008, there was that little problem with mortgage-backed securities. In 2009 it was first about the death of the U.S. banking system and then about the funeral being called off (and the idea that the country would recover). In February through early-April of 2010, it was all about the idea that the economy was going to rebound faster than expectations. The summer of 2010 was about the PIGI’S. And now, well, it looks to me like it’s all about Bernanke.
Again, we don’t have to agree with whatever the drivers are. In fact, I take a lot of heat sometimes because people confuse my observations with my actual opinion on the subject (which I try to hide as much as possible). Remember, I don’t have to like or agree with what drives the market. But I DO feel it is vital to recognize what the heck is in traders’ collective heads on a daily basis. However, it is safe to say that not everyone agrees with my approach to the game.
Was He Kidding?
I was at an invitation-only conference this week with about 50 fellow independent investment advisors. This was a pretty sophisticated bunch that collectively is responsible for more than $10 billion in client assets. There was a wide range of company sizes in attendance with some managing as little as $10 million while others run more than a billion. But the bottom line is that most of those in attendance were fellow market geeks.
One of my biggest takeaways from the conference was that size doesn’t equal smarts. For example, one of the panel discussions included three “big boys” from the investment world. One was a global fund manager who travels the world talking to companies (a great gig if you can get it), one was an economist from Russell (who was most impressive and fun to listen – a combination not readily found in economists), and the third founded what is now a fairly well known mutual fund family. The idea was to bring in some “big boys” to help us “little guys” understand what was going on in the economy and the markets during this crazy period.
While two of the three panelists presented well thought out arguments that, regardless of your point of view, caused you to stop and think, the third presented – at least in my opinion – a complete lack of understanding of what drives the market!
The gentlemen in question has an impressive resume and is founder and President of a mutual fund family. He is the guy standing in the middle of the company’s fund managers in their photo. He has a long resume and presumably earns a very good living managing money for lots and lots of individual investors.
However, I couldn’t have disagreed more with just about every position and argument he presented relating to the stock market. First, he suggested that he doesn’t believe in secular market trends and expects things will go swimmingly for investors from here. Next, he opined that unemployment isn’t out of whack. Deflation? Never mind, it’s fictitious. And then, the most astounding argument (well, to me, anyway) was his assertion that stocks are always driven by two things: interest rates and earnings. In short, nothing else needs to be considered. And as such, investors got “gypped” during the last decade.
According to this value manager’s argument, due to the fact that interest rates are now quite low and earnings growth is actually quite high, stocks should soar going forward. (Oh, and they never should have dropped over the past ten years either!) As for what lies ahead – no worries, with rates so low and the growth rate of earnings high, it’s all good.
Later that evening at our pre-dinner cocktail party I asked several of my “small” asset manager cohorts what they thought of these arguments. The responses were refreshing because during the presentation I wanted to jump up out of my seat and yell “Are you kidding me with this stuff?”
Before you come to the conclusion that I have lost my mind, yes, there are times that earnings drive the market. And there are also times when falling interest rates are indeed good for stock prices. But in this instance, interest rates are only “low” because of the greatest global economic calamity of our lifetime. In addition, earnings are only growing briskly because when knocked down far enough, a strong growth rate off of the bottom is inevitable.
The first colleague I queried on the subject (this gentleman manages something on the order of about $80 million of client assets and has about 25 years experience in the business) responded with, “I thought he was out of his mind.” The next said, “Yea, what was THAT about? How’d he get a job?” And finally, one manager responded with, “No comment… I want to be invited back next year – did you see the menu for dinner?”
What Should We Take Away?
The key point I’d like to leave you with this weekend is that just because someone has some letters after their name, has lots of experience, or even runs a mutual fund doesn’t mean they “get” the current market environment. This is indeed the problem with so many mutual funds
So tell me this. Are these big boys paid to hand out good advice and the best ideas for us consumers? Or, are they paid to SELL SELL SELL so that somebody in the shadows can make more money? BTW, ignore the little man behind the curtain. The Great Oz says so.