November 2017

  • November 2017 A Favorite Indicator for Market Valuation

    A Favorite Indicator for Market Valuation

     

    Warren Buffett is well-known when it comes to investing.  While he’s made a few bad calls occasionally, there’s no denying that he is among the best long-term investors of all time.  One of his favorite valuation tools for looking at the overall market is one that looks at the ratio of total market capitalization (total market value) versus the U.S GDP number.  A data provider called “GuruFocus” tracks the data back to 1970 using the Wilshire 5000 as proxy for the total market cap number.

    So, how is that ratio looking today?  You would think that after the market hitting all-time highs recently this ratio would be pretty high; and you would be right.  Inexpensive is not a word that comes to mind.  Not even close.

    U.S. stocks are valued at approximately 132 percent of GDP.  Early last year it was 118%.  That’s not as high as the 148 percent we saw during the extremes of the late 1990s tech bubble.  But it’s still extremely expensive.  The ratio would have to drop by 20 percent just to get back to the levels of 2007, just before the 2008 meltdown started.  I’m not saying that the market is about to turn soon, but it should certainly be getting your attention.

    Suffice it to say, the market is far from cheap, and that implies weak returns for the next several years, especially after the stunning performance through the 3rd quarter of 2017.  Investment returns are a product of three factors: dividend yield, economic growth, and change in valuation.  None of the three look great right now.

    Market dividend yields are a modest 2 percent these days, and GDP growth has been just muddling along.  A 2 percent dividend and 2 to 3 percent economic growth would get us to 4 or 5 percent stock returns. (Forget the 4 percent GDP growth that some political officials are forecasting if certain bills are passed.  There is no way 4 percent GDP growth is going to happen in the current environment).  While not very exciting, 4 or 5 percent stock market returns are not a terrible return in this interest rate environment.

    But then we get to valuations.  Assuming that the market returns to its long-term average “market-cap-to-GDP” ratio, the years ahead don’t look so hot.  GuruFocus crunched the numbers and, based on current valuations, the market should return a measly 0.5 percent per year average over the next eight years.

    Obviously, a lot can happen in eight years, and who knows what surprises are in store for us.  But I think it’s fairly safe to say that the odds are not in your favor right now if you’re a buy-and-hold type of investor.  If you want to earn a respectable return over the next several years, you’re going to need to be a lot more active and consider strategies you might never have considered before.

    Some people are value investors who enjoy looking for bargains.  Others tend to focus on momentum strategies.  Both value and momentum, if done well, have proven to be winning strategies over time.  In my opinion, there is a time and a place for a buy-and-hold strategy, but this isn’t it unless you have a very long time horizon.  Whatever strategy you choose, make sure it gives you the ability to take risk off the table when necessary.  At today’s prices, the next eight years looks like it will be a very rocky ride.  Thanks for reading.

     

    Nick Massey is President of Massey Financial Services in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.


  • October 2017 Selling at a Loss is a Psychological Challenge

    Selling at a Loss is a Psychological Challenge

     

    “The most difficult thing is the decision to act.  The rest is merely tenacity.”  So said Amelia Earhart in one of her famous quotes.  She would certainly know.

     

    Human emotion is a powerful force and plays a big role when it comes to investing our money.  While the Efficient Market Hypothesis long assumes investors are purely rational actors, weighing the costs and benefits of every decision and acting always in our own best interest, much of the research coming from the behavioral finance camp suggests otherwise.

    Sometimes, we act quite irrationally.  Often it’s our difficulty in regulating our natural emotions that trips us up.  We all have emotions.  There’s no such thing as an emotionless investor.  But we all have the opportunity to make conscious decisions about how we deal with our emotions. And those decisions have a tremendous impact on our success as investors.

     

    One of the most common questions I get asked is, “Should I sell a particular stock?”  The question and answer is pretty much the same whether you are sitting on a loss or a gain.  My standard answer is, “If you didn’t already own it, would you buy it today?”  Simple question but sometimes a complicated answer.

     

    Perhaps the stock is at an all-time. Would you buy it today if you didn’t already own it?  To answer yes you have to believe that there is more upside potential over the short or long term.  If you can’t answer yes, then you might need to consider selling it.

     

    What if it is down 10, 20 or 30 percent from where you purchased it?  Would you buy it today if you didn’t already own it?  To answer yes you have to believe that the worst is over and it will recover at least back to what you paid for it, or perhaps more.  If you can’t answer yes, then you need to consider taking your loss and move on.  Even if you think it might recover, you still have to weigh keeping it versus putting the money into something else that could go up also, or have even more potential.

     

    The problem is something we call the disposition effect.  We feel a strong urge to hold unprofitable investments too long simply because we can’t stand to admit defeat and the pain we feel when we lock in a loss is dramatically greater than the joy we feel when we lock in a win.  There is no shame in being wrong and taking a loss.  Even Warren Buffett is wrong quite often.

     

    Of course, it’s never quite that simple.  There may be other considerations at play, such as tax implications of the sale, or maybe knowledge of the industry or the company that gives you reason to believe that buying or hanging in there might be worth it.  But at least looking at it from a rational point of view gives you a non-emotional reference point from which to make you decision.  Thanks for reading.

     

    Nick Massey is President of Massey Financial Services in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.