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Sell? To Whom?
The availability of indexed investments, particularly in the form of exchange-traded funds, has had a strangely perverse effect in the markets widely varying from the original conception of the uses of index funds. The academics that have pushed the concept of index investing generally assumed that since you no longer were trying to beat the market or consider the relative merits of individual stocks, there is no incentive to sell your index holding until you need the money for spending.
Where are the Brakes on This Thing?
Active, value-oriented managers typically keep a cash reserve to take advantage of market opportunities. In a severe market decline, they put this cash stash to work buying perceived bargains. Their behavior acts as a natural brake on what otherwise could turn into a more sudden and severe decline. Investors evaluate index funds solely on “tracking” error – how closely they follow their benchmark index.
Who is Minding the Store?
As indexing popularity has increased, active managers argue that index investors are free riders on their research and activities that make the prices of stocks commensurate with underlying corporate values.
Investing is a Social Science, Not a Natural Science
Investor behavior changes market outcomes, many times in erratic and volatile fashion. Human psychology can be capricious, impacted by new technology, new philosophies of investing and the recent performance of different types of assets, among many other factors. Because of fickle behavior, taking even good ideas to extremes warps the reality of the markets in risky and unpredictable ways.
FANG, Indexing and Mystery Meat
Our spirited political environment now may include debate over the definition of what constitutes “news,” but this is not new. In Hollywood, public relations hype precedes every new supposed blockbuster. In sports, endless analysis precedes each week’s Game of the Century. In the investment world, repeated stories assess whether active investment managers as a group beat their index benchmarks.
The Magic Window
Imagine you have a window in your house. Whenever you look through the window, you see only what you desire. Is having that window a good thing or a bad thing?
Why Does Anyone Pay Attention to These People?
Optimism is supposed to be a virtue, and nowhere is this virtue stronger than Wall Street. Market strategists most commonly assess stock index valuation by comparing current prices to the level of future earnings predicted by the consensus of investment analysts. Stock prices are supposed to discount the present value of everything we expect is coming. Why pay attention to the past when what matters is the future
Dow 20,000 – A Brief History of Magic Market Levels
Investors obsessively focus on round numbers for the Dow Jones Industrial Average. More than half a century ago, in late 1965, Wall Street breathlessly observed the Dow approach 1,000. In both January and February 1966, the index surpassed the magic level intraday, only to slip back by the market close. A bear market ensued, shaving a quarter off the index value, and excitement subsided.
You would think that 2016, above all other years, would have cured people of seeking predictions of the future, even leaving aside the Chicago Cubs. The United Kingdom voted to leave the European Union and Donald Trump won the presidency, neither predicted by Las Vegas betting lines, political polls or prediction futures markets. Despite having failed in every possible way they could fail during the political season, pundits now confidently predict the aftermath. New Year’s predictions abound.
Annual Chart through 2016
Below is our annual listing of different asset returns (large U.S. stocks, small U.S. stocks, foreign stocks and U.S. bonds) with a box around the best-returning asset for each of the past 51 years. The 2016 winner was small large company U.S. stocks, by far the worst of the four assets, and therefore the most in disfavor, the previous year. The ebb and flow of each asset’s returns show that good years may just be “borrowing” future returns. Just about the time you fall in love with an asset, it is about to under-perform. Everyone’s attention is on large U.S. stocks now, but they have been the best fewer times than the other three. Rather than being disappointed by the market’s inability to conform to our predictions, we act to adapt our investments to maximize the chances of achieving realistic goals.