When I broke into the stock market in 1961 the world of investing was radically different than it is today. The market was dominated by the individual investor and not by the institutional investors. In addition, I would strongly argue that the markets were far more rational than they are today. By rational I mean that stocks fluctuated in a rather tight band. They would oscillate in a reasonably tight range of value for a reasonable period of time and then gradually rise or fall in value based on market dynamics as investors assimilated new information and data.
In other words markets made sense. What did not exist is today's whiplash markets. Which remind me of nothing so much as a monkey being violently jerked around on a chain.
There has been tremendous damage done by this change. And it has hurt our economy badly. Our markets are no longer delivering honest prices that can be trusted. These violent gyrations make it impossible for investors, businesses and governments to engage in rational planning and make rational decisions. Something has gone seriously, seriously wrong with our markets.
When I look back across the decades and ask where did it go wrong? Two changes stand out. One change is fairly obvious and the other is hiding in plain sight.
The obvious change of course is the rise of the institutional investor to market dominance. In other words fewer and much larger decision makers results in more violent price fluctuations. When you combine this fact with their undeniable tendency to engage in cattle stampede behavior, you have solved one part of the puzzle.
I addressed the institutional part of the puzzle in a companion piece called, "TODAY'S IRRATIONAL MARKET AND THE RISE OF THE PROPELLER HEADS." This companion essay can be found at my blog fortyyearsaspeculator.blogspot.com.
The stranger and perhaps the most important part of the puzzle is hiding in plain sight and no one recognizes it. And what a strange puzzle it is. It is the law of unintended consequences writ large.
On May 1, 1975 fixed commissions were outlawed on Wall Street. Stock commissions immediately dropped 40% and have been falling ever since. Prior to this time the commission,to trade a stock had been so expensive that the type of in and out trading for small profits that is so common today would have been impossible. The commissions would have eaten you alive. The only people who could afford to be day traders or to trade for small profits were the professionals who owned seats on the New York and the American Stock Exchanges and therefore paid no stock commissions. In those days the NASDAQ scarcely existed.
The unintended consequences of this change were amazing. Prior to this time if you were wise,you had to have a strong opinion about a stock before you invested in it. Hopefully, an opinion based on your research. Unless you had a strong conviction you could not afford to sell a stock just because it fell five or ten percent. You could not buy a stock for no other reason than it was trending up in the absence of a strong conviction. If you did this the commissions on excessive trading would kill you.
Today the commissions are so low that people can buy and sell on the weakest of whims. Changing your mind about a stock today is almost cost free as far as the commission is concerned.
The combined impact of institutional investing and today's low commissions has had a devastating impact on rational markets. It has given rise to the cult of the trend chaser or price chaser. This buffoon neither knows nor cares what the intrinsic market value is of any stock that he buys or sells. Why should he? Research and having a soundly arrived at opinion of value is now regarded by armies of investors as a dangerous waste of their valuable time.
After all having an opinion of value is dangerous. What happens if your opinion is opposed to the trend of the market? The horror of it all! Why it would interfere with your trend chasing. And where would you be then?
In a world in which the huge majority of investors are trend chasers sound market values are obliterated. There are fewer and fewer investors who are engaging in honest research and who are making their investment decisions based on their own estimate of market value. Yet, this is precisely what is required for markets to function correctly.
The result is today's whiplash markets where thundering herds of mindless trend chasers stampede stocks way above and then way below any intelligent estimate of market value in oscillating cycles. The stock market has become a perpetual overreaction machine.
Markets are no longer delivering honest, reliable estimates of intrinsic value that can be trusted. Investors, businessmen and governments can no longer engage in rational investing,business planning or government decisions based on these highly flawed markets.
Indeed as the numbers of investors who are actually attempting to ascertain market value keeps shrinking. The mindless herd of trend chasing, stampeding cattle who have the nerve to call themselves investors keep growing, in both numbers and influence. It is calling into question how much longer we will have anything that truly resembles a market as we have understood the term.
Fred Carach is the author of the recent book, "Forty Years A Speculator." His blog is fortyyearsaspeculator.blogspot.com
1 comment:
This is what I wrote in my weekly financial letter about this great book.
Wednesday May 6, 2009.
In 1940 the typical investor-holding period was almost ten years.
In the 1950’s and the 1960’s it fluctuated at around seven or eight years.
By 1975 it had fallen to five years.
Today it is eleven months.
This is one of the many interesting facts one can find in Forty Years a Speculator written by Fred Carach.
This short term thinking is undoubtedly behind today’s volatility in the stock markets.
Since last September, we have already had two panic sell-offs followed by two euphoric rallies.
Even if one is a long term value investor, it is hard to stick to a buy-and-hold strategy in this environment.
When I bought Hochtief because it was hugely undervalued, I expected to probably double my investment over two years.
As Carach puts it, you need time for the market to realize that it has mispriced your stock.
My problem, and many of us are facing it, is that it took only two months to reach my target price.
What does one do? Sit on it and wait two years just because one does not want to be called a trader?
Or enjoy the ride with the momentum investors?
Time and patience is always on the side of the smart investor.
Well, not always. In today’s volatile markets one has to move quickly.
Unless one thinks this is the beginning of the next bull market, taking profits seems to be the adequate strategy.
I sold two thirds of my Hochtief position and invested the proceeds in the boring 9% yielding France Telecom.
The two recent very brisk rallies are reminiscent of what happened in the Japanese market in the 1990’s.
Investors then as now had not yet accepted the new paradigm.
They continued to believe that the market was going to resume its long term trend.
I read some reports from strategists advising to move out of “defensive” stocks and back into “cyclicals” to take advantage of the bottoming out of the economy.
Let me quote Carach again: “There are no rewards for betting that tomorrow will be like today.”
We have entered a new economy where the governments will play a bigger role and the American consumer will no longer be the engine of global growth.
This is a game changer. This binary thinking is nonsensical.
Here too Carach was quite prescient when he wrote a couple of years ago that the Asian Mercantilist export model was doomed.
It has resulted in an export sector that is dangerously overdeveloped.
“Since the United States is the bag holder for the world, what Asia is doing in effect is lending the US the money to buy its products.”
I could not have said it better. Today, however, Asia is still lending us money, but we are no longer buying their products.
Why then would they continue to lend us the money?
That leads to another of Carach’s conviction: the collapse of the dollar.
I do not subscribe to his desire to go back to the gold standard, but he has a point when he writes that every paper currency ever created has ended up with zero value. “There aren’t any exceptions to this. None!
So what about gold?
Needless to say, Fred Carach likes gold.
Here is, I think, the most compelling argument he makes for gold:
What if Asian central banks decide to convert some of their massive dollar hoards into gold?
Even if one is not as sanguine about the future of the dollar, the huge deficits we are creating may scare the Chinese and the Japanese to do just that.
Herve' van Caloen
Du Pasquier Asset Management
212 624 2051
Herve.vancaloen@dupasco.com
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