January 7, 2011

Market Bulls: Get a Life!

Beware the dangerous seductiveness of the return of active stock picking

“Simplicity, simplicity, simplicity! I say, let your affairs be as two or three, and not a hundred or a thousand; instead of a million count half a dozen, and keep your accounts on your thumb-nail.”

Henry David Thoreau’s Walden articulates a philosophy that could not be more opposite of today’s stock market ethos, where high-frequency tradingaccounts for some 70% of daily market volume, and programs with names like CNBC’s “Fast Money” are all the rage.

Stock gurus on TV, Internet blogs and radio pontificate about the latest investing themes, having shifted out of yesterday’s top stocks, which perhaps you just bought.

The typical investor is often easily confused by all this information.

After narrowing down his buy list, he buys a promising stock with an exciting story (as told by a media stock guru) and keeps another exciting stock on his watch list.

The stock he didn’t buy goes up a little bit the next day, a little bit more the following day. Our investor figures he’ll buy it on the next dip.

After a 33% percent gain in a period of two weeks, our cringing investor just can’t stomach buying the stock. While it ends up doubling, the stock he did buy has lost 20%. And the media gurus give every impression of rolling in the dough.

There’s got to be a better way. There actually is, but “buy and hold” has been out of fashion since the credit-crisis market crash.

Its death has been repeatedly re-assessed and re-announced since that time.

The average holding period for stocks is reportedly just 2.8 months, down from two years in the 1980s, according to CNBC, which confirms that buy and hold is still dead.

Joseph Dancy’s Financial Sense blog gives voice to today’s market sanguinity by noting the decoupling of markets that had been highly correlated until recently — such as the stock and bond markets — as well as other trends that suggest that these are the best of times for stock pickers.

He cites a recent Bloomberg report saying: “The 30-day correlation coefficient measuring how often the S&P 500 index moves in tandem with 10-year Treasury yields fell to -0.42 from a record 0.89 in June.”

This means the two markets are getting nearly opposite results.

Dancy also shares the findings of a recent Barclays' report indicating that sectors within the S&P 500 are also rapidly pulling apart — well below their 10-year average.

The media chatter and the data all seem to argue for active portfolio management, but count me as a skeptic.

The hedge fund managers and other stock jocks move at the speed of computerized trades. Plus, their performance over the long-term is usually abysmal, with few active managers beating their benchmarks.

Though this may be a time favoring stock selection, who will send you the memo warning you of the next shift?

When Spain or California hit the skids, a Chinese real-estate bubble pops or North Korea attacks the South, those decouplings will re-correlate faster than you can say “secular shift." 

We live at a time when macro events have a profound influence on markets. Ireland’s woes sent global stocks downward because they portended serious trouble across the euro zone and beyond.

A buy-and-hold portfolio will surely also suffer in the next crisis.

But I would argue that very few people have the capability to respond to the fast-moving events and high-speed trading that move stocks.

Those few people hold high positions in the world of finance, and they are sometimes diametrically opposed — as in the case of Bruce Berkowitz and David Einhorn taking the long and short ends of the trade in St. Joe Company (JOE) shares.

The buy-and-hold investor who held tight during the recent market crash saw his shares recover; those who bailed sold low, and may only now be buying high before the next crash.

A diversified portfolio of ETFs or mutual funds, combined with long-short or managed futures funds, allow investors to participate in the long-term growth of business (Note: holding a stock for 2.8 months is speculating, not investing!) and gain downside protection while also having a life.

Keeping “your accounts on your thumb-nail” relieves you of the responsibility of adding hedge fund manager to whatever other job you work at.

The stock gurus read a dozen or more market commentaries and stock charts before the opening bell, and they can’t eat dinner with their families without worrying about tomorrow’s trades.

Thoreau found that simple living was the key to survival in the face of hostile elements and historical change, and he was right. The hurly burly of active trading often ends up unrewarding in one way or another — being caught on the wrong end of a trade or, worse, missing out on life.

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