The Top Ten Market Mysteries
To paraphrase Mark Twain, "It isn't the stuff you don’t know that will kill you – it's the stuff you're sure about but is totally wrong that will do you real harm." As a corollary to this fateful phrase, Convergx's Nick Colas has collected a list of market "knowledge" that is questionable at best and harmful at worst.
Via ConvergEx's Nick Colas,
For years I had a pet theory about how your abilities improve over time in any given vocation. My thought was that every year you work, you learn one critical aspect of the job. Over the first few years, the percentage improvement in your knowledge is quite impressive: 50% in the second year, 33% in the third, and so on as you pick up new and important insights. And while years 15-20 might offer up slower growth, you also have less competition from your more junior peers. They’ve figured out fewer points, after all.
A few examples of these critical lessons from my 20+ years analyzing stocks, markets, and the economy on both the buy side and sell side:
Rule #1: The marginal buyer and seller set prices for everything. You may have point of view on value, but the actors setting the price don’t care about your opinion. Seriously – they don’t.
Rule #2: If you don’t know what to do or say, don’t do or say anything. Boredom is investor’s greatest enemy. Thrashing around is for mosh pits and three year olds.
Rule #3: If you can’t explain your competitive advantage in three sentences, you don’t have one. That’s true for analysts, portfolio managers, company executives, startup companies, writers, etc.
Rule #4: It is OK to be wrong. Just don’t lie to yourself or anyone else about being wrong.
The second part of my imaginary rule set was that there were 20 questions that mattered to any job, so two decades of experience should get you to the end of the journey. I can tell you that, with 22 years in the business of analyzing financial assets, this part is wrong. And in keeping with Rule #4, I am fessing up. The true count is probably more like 100, which is why only vampires have a shot of figuring everything out. Zombies would have a shot, too, if it weren’t for the whole mindless existence thing.
To be fair, part of the problem of harvesting those elusive 20 – 100 points from the sea of capital markets aphorisms and rules is that there are so many false leads. At first they look useful, but like a poorly made tool they eventually shatter under heavy use. Since I am prone to list-making, I have also kept a short collection of these false gods.
The balance of this report is a Top 10 list of those as well as a brief assessment of where and why they go off the rails. I use questions rather than statement to lead off each point. After all, these are points that seem right but are – ultimately – misunderstood.
#1 – Why the fixation on price earnings multiples? Say a stock trades for 10 times projected earnings. Does that make it a better investment than one trading for 20 or 100 times? The short answer is no. Valuation is a three dimensional chess game of the returns a business can generate, its competitive position, and its growth prospects. No matter how much you try to stuff the duffle bag that is P/E analysis with those bulky items, you simply aren’t going to get them all in.
#2 – Why do technical analysts use an arithmetic price axes instead of log scales? Don’t get me wrong – I love good technicians. They are the shamans and storytellers of the capital markets, drawing pictures and relating price levels to events in the past. But look at the average technician’s work and you’ll see that all the price charts treat the move from $10 to $20 the same way as $90 to $100. One is a double; the other is only an 11% move. That could all be solved with a logarithmic scale for the Y-axis, but very few people do it that way.
#3 – Why do investors care about the price at which a company buys back its stock? It isn’t the Chief Financial Officer’s job to figure out if his/her stock is over or undervalued. That’s for investors to do; it’s pretty much the job description, actually. Stock buybacks return money to shareholders rather than allowing the company to reinvest it in the business. That’s it. Now, if a company is going to blow a quarter, maybe the CFO should lighten up the repo and buy lower. Fair enough. But CFOs aren’t stock pickers. So if the market tumbles and company with a repurchase plan in place happens to buy higher than current prices, don’t complain. Stock picking is your job.
#4 – Why does the negative case for an investment always sound smarter than the positive one? Remember that over the long term (really, really long term, anyway), most equities rise in value. Short sellers therefore typically have to do more work to find the right ideas. Their rap is, therefore, generally stronger than the “Sit tight, be right” crowd. I think, however, that humans are generally wired to be scared by a negative story and it therefore holds our attention better. It’s not always right, but our innate biases make us remember it.
#5 – Why is there a Nobel Prize in Economics? There are only five “Real” Nobels, instituted by the old man himself: Peace, Chemistry, Physics, Medicine/Physiology, and Literature. Alfred Nobel invented dynamite, among his +300 patents, and these prizes were essentially a way of being remembered for something other than arms dealing and the industrializing of human misery. Unlike these awards, which started in 1901, the Economics “Nobel” is a newcomer, with the first prize given in 1969 by Swedish Central Bank. Putting the social science of economics on par with either the hard sciences or human ideals such as peace or literature seems odd, at best. At worst, it imbues the discipline with a notional precision that it can never attain. If you need any further proof, consider this year’s award to Gene Fama and Robert Shiller. One believes markets are efficient, one doesn’t. Its sort of like the committee is saying “You figure it out…”
#6 – Why is investor and social attention negatively correlated with stock market direction? When the global equity markers were imploding in 2008-2009, cable business news channels enjoyed relatively high ratings. Now that the U.S. equity market is hitting new highs, no one but Wall Street seems to tune in. We’re used to equating social attention with value (the valuation of social media stocks is a great example), but with the stock market, the opposite is true.
#7 – What ever happened to “Growth” and “value” investing? When I started in the business, mutual fund and other institutional managers differentiated themselves by these monikers. The hedge funds came along, with much broader mandates. After that, passive management with low fees and transparent trading through exchange traded funds became popular. Managers still use the terms, to be sure, but the delineation is nowhere near as rigid as it used to be. Most investors just want to find stocks that go up.
#8 – Why does it take capital markets so long to embrace technological change in its own back yard? Over the last 20 years, equity trading has moved from three exchanges to scores of virtual venues. You can see the same process occurring throughout modern society. Online shopping supplants old brick and mortar retailers. Mobile apps replace singles bars. You can play scrabble with a friend in another country on your smartphone. Yet, somehow, the clever people in capital markets seem shocked that their jobs are subject to the same technological advances. There’s no going back to the old days… Sorry.
#9 – Why does anyone doubt the value of gold? Humans have valued gold for 5,000 years. Some of the first money – coins minted in ancient Anatolia – was minted with the stuff. The world functioned on a gold standard of sorts until 1971. I think the reason some people dislike gold as an investment is because it reminds them that humans are the same across space and time. We like to think we are “Better” than the ancient Romans with their gladiatorial spectacle and will never again need a portable method of transferring wealth like the European refugees of the 1940s and 1950s. Gold was the fiscal anchor of the former and the salvation of the latter. Are we so different? Let’s see how the next 100 years turn out.
#10 – Why do humans always fight the last battle rather than focus on future challenges? Put another way, would it be so bad if we banished the word “Bubble” from our collective consciousness for the next decade? Humans are prone to herd behavior – we like the security of crowds. If our ancestors had been rugged individualists they would have never made it out of Africa. And if any of them were, they certainly succumbed to the local fauna. And their genes died with them. Bubbles are as much a part of human behavior as breathing, and it will always be thus. At the same time, not everything that rises quickly in value is a bubble. Using that rubric and hearkening back to other asset price collapses is lazy, at best.
Now - watch CNBC for an hour and check off how many of these 'red flags' you hear...
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