These are testing times, with no clear direction in the markets, having just come off a horrendous 5 weeks in most western stock markets, which put a halt to a 14 month bullish spree since originating in March 2009. The so-called “perma-bears” such as Nouriel Roubini and Marc Faber are back in vogue once again, continuing their warnings. But it’s not just the usual suspects that are showing concern.
Even investors that have done remarkably well in the recent past by venturing into oversold assets as of early 2009 are swelling their cash balances in the absence of opportunity. Recent interviews suggest that cash balances, a.k.a. “dry powder among value funds stands as high as 20 to 25% of assets.
Is it hence the time to heed the advice of index investing advocates?
There’s much to be said for it, indeed recent reading of Charles Ellis’s “Wining the Loser’s Game- Timeless Strategies for Successful Investing pointed me in these direction… On the same note, a recent talk by my former MBA Professor of Finance, Javier Estrada, provided a wealth of data to support the virtues of an equity-weighted, index-wide, geographically diversified, long-term, buy & hold strategy.
Admittedly, obtaining the returns of a market-wide benchmark over a long period of time, say 15-20 years is an attractive proposition under any scenario.
And yet despite all of these sound arguments and substantiated research I can’t bring myself to just track the market. Why does this happen? Haven’t we learnt our lesson? Is it not yet clear that we as investors are the market and as such any sustained out performance requires sustained under performance by equally informed and trained counterparties? What is it that makes us (or at least me, in this case) think that we can do better than the rest?
Call it what you will, but for me it comes down to a competitive nature and the remarkable and defining impact of human emotion.
Personally I have over time, though not always, increasingly relished in acting in a way that is contrary to conventional thinking in matters economic. From renting real residential estate in a market where said action is deemed almost a social failure, to investing in equities throughout 2008 and 2009 when the world “stood on the brink”, to borrow for the Economist.
Throughout this period and to this day, I can’t lay claim to performing deeper research than full time professional investors or to have access to more complete data than other investors. My sources of information are not only free and non-proprietary but more importantly, widely available to any potential investors. As such the opportunities I review and act upon are readily available to any interested party.
Where I think the difference lies however, between myself and other stock market players, both active and index investors is in our emotional interpretation of the context surrounding securities pricing. Let’s take an example that has been front-pager news for some 6 weeks now:
British Petroleum’s (BP) massive Gulf Cost spill.
How do we react to BP? When is the price drop large enough to discount even the worst-case scenario? (Dividend removal included!). When do we allow the numbers to take the front seat as opposed to the Congressional grilling of BP execs or worse still, the underwater web cam and its relentless images of a real-time environmental tragedy?
I say about now!
By consciously opting to:
1. Remove the noise. i.e. turn off the TV and just gather the facts
2. Ignore the crowd. i.e. see above
3. Look into the few key numbers (e.g. long-term trailing average cash-flow generation) and compare this to both potential downside and long-term value of the enterprise.
All effort should be aimed at determining if there is a substantial gap between BP's current price and its cycle-resisting intrinsic value. Should the answer be positive, this surely represents the triumph of overcoming emotions and actively exploiting other's errores over conceding to a passive index strategy.
Time, as always, will tell.
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