By Lance Roberts
The Missing Ingredient
I have been in the "money game" for a long time starting with a bank just prior to the crash of 1987. I make this point only to say that I have seen several full market cycles in my life, and my perspectives are based on experience rather than theory.
In 1999, there was a media personality who berated investors for paying fees to investment advisors/stock brokers when it was clear that ETF's were the only way to go. His mantra was "why pay someone to underperform the indexes?" After the subsequent crash, he was no longer on the air.
By the time the markets began to soar in 2007, there was a whole universe of ETF's from which to choose. Once again, the mainstream media pounced on indexing and that "buy and hold" strategies were the only logical way for individuals to invest. Why pay someone to underperform the indexes when they are rising. Then came the crash in 2008.
Today, we are once again becoming inundated with articles bashing financial advisors, money managers, etc. for underperforming the major indexes during the Fed induced market surge. It is once again becoming"apparent" that individuals should only be using low-cost indexing strategies and holding for the "long term."Of course, the next crash hasn't happened yet.
My point here is this. There is a "cost" to chasing "low costs." I do not disagree that costs are an important component of long-term returns; however there are two missing ingredients to all of these articles promoting"buy and hold" index investing: 1) time; and, 2) psychology.
As I have discussed previously, the most important commodity to all investors is "time." It is the one thing we can not manufacture more of. Individuals that experienced either one, or both, of the last two bear markets now understand the importance of "time" relating to their investment goals. Individuals that were close to retirement in either 2000, or 2007, and failed to navigate the subsequent market drawdowns have had to post-pone their retirement plans, potentially indefinitely. While the media cheers the rise of the markets to new all-time highs, the reality is that most investors have still not financially recovered due to the second point of "psychology."
Despite the logic of mainstream arguments that "buy and hold" investing will work, given a long enough time frame, the reality is that investors generally don't invest "logically." Almost all investors are driven by"psychology" in their decision-making which results in the age-old pattern of "buying high" and "selling low."This is shown in the 2013 Dalbar Investor Study, which stated "psychological factors" accounted for between 45-55% of underperformance. From the study:
"Analysis of investor fund flows compared to market performance further supports the argument that investors are unsuccessful at timing the market. Market upswings rarely coincide with mutual fund inflows while market downturns do not coincide with mutual fund outflows."
What the mainstream media misses, because the majority have never actually managed money, with respect to the "buy and hold, low-cost indexing" theory is that individuals can not, and do not, invest that way. If you are paying an investment advisor to index your portfolio with a "buy and hold" strategy, then"yes" you should absolutely opt for buying a portfolio of low-cost ETF's and improve your performance by the delta of the fees.
However, the real goal of any investment advisor should not be to "beat the index" on the way up, but to protect capital on the "way down." It is capital destruction that leads to poor investment decision making, emotionally based financial mistakes and destruction of financial goals. It is also what advisors should be hired for, evaluated on, and ultimately paid for as their real job should be to remove the emotional biases from your portfolio management.
Biggest Support Of Bull Run Is Fading
No, I am not talking about the inflow of liquidity from the Federal Reserve's ongoing QE program, although it too has been a major source of support for asset prices, but rather the decline in corporate share buybacks.
According to a recent Financial Times article:
"The boom in buybacks also owes much to the Federal Reserve’s suppression of long-term interest rates via quantitative easing and stagnant growth in Europe, an important foreign market for many S&P 500 global companies.
Record low interest rates in the corporate bond market have helped fund large buybacks, but with the central bank on course to conclude buying bonds under QE in October,fuel for buybacks is ebbing and non-financial debt issuance has slowed.
Andrew Lapthorne at Société Générale says companies have exploited the generosity of financial markets to fund their share buybacks and as that fades, the equity bull market faces losing a key source of support."
Share buybacks have grown by $1.56 Trillion since 2011, but those repurchases peaked during the first quarter of this year at 159.28 billion before sliding back to $120.21 billion in Q2. The risk for the markets here is that with the Federal Reserve reducing the flow of cheap liquidity, and potentially raising borrowing costs in 2015, two of the major supports of the markets will be removed.
This will leave the markets depending on the underlying fundamental drivers of the markets which are by no means cheap.
This Won't Last
Both stocks and bonds can not be right. While stocks have risen to new all-time highs in recent days, bond yields have fallen toward the lows of the year. As shown in the chart below, there has historically been a correlation between interest rates and the financial market from a risk on/risk off indication.
It makes some sense given that when the markets have a preference for risk, asset allocations are shifted from bonds to equities and vice versa. As the demand for bonds falls, and the demand for stocks rise, yields rise. However, the current decline in yields, amidst a very low volume ramp-up in stock prices, suggests that the demand for safety is outweighing the demand for risk.
If historical correlations reassert themselves, the deviation between stock prices and bond yields will be corrected and likely not to the favor of the bulls.
Art Cashin summed this concern up well noting that this week is historically a very light trading week with a mild-upward bias. He also noted that the 1929 high was made the day after Labor Day.
"Thin markets can be tricky..stay wary, alert and very, very nimble."
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