Paradoxically, liquidity is a very important component to success at long term investing. Stocks have a good long term record, if you measure in decades. Real estate is less profitable overall, but is the long term investment of choice for many Americans since they are homeowners. Having to sell unexpectedly early, though, can ruin the value of either stocks or real estate as investments. If markets are shaky when you have to sell, you can be a big loser.
To increase your chances of long term success, you need liquidity--cash to keep you going without having to sell your long term investments. This includes having a bulked up emergency fund to cover unexpected cash needs (like unemployment or a medical crisis). It also means having a stable source of cash for a long period of time. Most people work for that stable source of cash. Those with pensions have a steady cash flow in retirement. Highly rated bonds and stocks with a strong record of paying dividends can also serve this need. Immediate fixed or inflation adjusted annuities from highly rated insurance companies can provide long term liquidity. Don't forget Social Security. It's like a pension. Even if it doesn't cover all your needs, its predictable inflation-adjusted monthly payments are the financial foundation for most retired Americans.
If your day-to-day liquidity needs are met, you can hold your long term investments until the moment you, and not circumstances, choose as the time of sale. Avoid borrowing to meet these liquidity needs. Debt tends to destabilize your finances. (See http://blogger.uncleleosden.com/2010/07/why-you-should-avoid-debt.html.) Instead, securing a steady income and living within your normal cash flows can give you a good chance to win over the long haul.
Showing posts with label invest for long term. Show all posts
Showing posts with label invest for long term. Show all posts
Wednesday, October 26, 2011
Thursday, January 7, 2010
Jobs Growth May Not Reduce the Unemployment Rate
The stock market eagerly awaits tomorrow's unemployment numbers. Economists, on average, predict that job losses will have stopped, but that jobs growth hasn't resumed. The unemployment rate, last reported at 10%, is expected hover around that level, with perhaps a minor increase.
This data, whatever it turns out to be, will probably tell us less than the stock market seems to think it means. Employment levels must be viewed in a dynamic context. The labor force keeps growing, whether or not there is a recession. Kids reach adulthood, and immigration continues (although it's now at a much lower level because of the recession). To deal with population growth, we need 100,000 new jobs a month or more simply to keep the unemployment rate level. It's been close to 2 years since the number of jobs in the U.S. has increased. Even if it turns out that job growth has resumed, the unemployment level could increase if the number of new jobs isn't enough to accommodate the entry of new workers into the labor force.
Aside from population growth, another confounding factor is the return to the labor force of discouraged workers. The Bureau of Labor Statistics includes unemployed persons in the labor force only if they have actively sought work during the last 4 weeks. Those who want jobs but are too discouraged to look for them aren't counted in the labor force. In other words, increased despair lowers the unemployment rate. Conversely, as the economy swings back toward recovery, discouraged workers may become hopeful again and start actively searching for jobs. Those that do so are deemed to have re-entered the labor force, and their re-entry can worsen the unemployment rate by increasing the numbers of unemployed persons actively seeking work.
The stock market is always looking for short cuts, simple ways of telling if things are getting better or worse. But economies and financial systems are complex and sometimes opaque. Life is difficult. Monthly unemployment figures are sometimes revised in subsequent months. You need to look at a lot of data and information to figure out where the economy is and where it is going. Don't read too much into tomorrow's unemployment numbers. Invest for the long term.
This data, whatever it turns out to be, will probably tell us less than the stock market seems to think it means. Employment levels must be viewed in a dynamic context. The labor force keeps growing, whether or not there is a recession. Kids reach adulthood, and immigration continues (although it's now at a much lower level because of the recession). To deal with population growth, we need 100,000 new jobs a month or more simply to keep the unemployment rate level. It's been close to 2 years since the number of jobs in the U.S. has increased. Even if it turns out that job growth has resumed, the unemployment level could increase if the number of new jobs isn't enough to accommodate the entry of new workers into the labor force.
Aside from population growth, another confounding factor is the return to the labor force of discouraged workers. The Bureau of Labor Statistics includes unemployed persons in the labor force only if they have actively sought work during the last 4 weeks. Those who want jobs but are too discouraged to look for them aren't counted in the labor force. In other words, increased despair lowers the unemployment rate. Conversely, as the economy swings back toward recovery, discouraged workers may become hopeful again and start actively searching for jobs. Those that do so are deemed to have re-entered the labor force, and their re-entry can worsen the unemployment rate by increasing the numbers of unemployed persons actively seeking work.
The stock market is always looking for short cuts, simple ways of telling if things are getting better or worse. But economies and financial systems are complex and sometimes opaque. Life is difficult. Monthly unemployment figures are sometimes revised in subsequent months. You need to look at a lot of data and information to figure out where the economy is and where it is going. Don't read too much into tomorrow's unemployment numbers. Invest for the long term.
Thursday, December 3, 2009
Warning from the Price-Earnings Ratio
The price-earnings ratio is one of the most widely used investing metrics. Simply put, it's the ratio of the price of a share of stock compared to its earnings per share. One can use past earnings (typically, the past 12 months), or predicted future earnings (typically, the next 12 months). Past earnings tend to be a more solid number, although they didn't work out real well in the case of Enron, or some other companies that turned out to have fabricated earnings. Predicted future earnings is theoretically a more significant number, since stock values tend first and foremost to be based on anticipated future performance of the company. But one investor's prediction is another investor's fantasy. The accuracy of the prediction makes all the difference in the world.
Low p/e ratios are viewed as indicating stocks are cheap. High p/e ratios are usually taken to mean stocks are expensive and perhaps headed for a fall, or else speculative (i.e., based on the hope of a rise, and perhaps a big rise, in future profits).
By and large, the S&P 500 has a historical average p/e ratio of around 15 (based on past earnings). In the stock market boom of the late 1990s, the S&P 500's p/e ratio spiked up into the 40s. In the late 1990s, the U.S. economy was riding a wave. A huge peace dividend from the end of the Cold War pumped up the private sector as defense spending fell. The United States avoided major military conflicts, and enjoyed large gains in productivity. The economy benefited from cheap money provided by the Federal Reserve (probably too much and too cheap). The Silicon Valley and other tech centers blossomed. The economic outlook was rosy, and avid investors pushed the p/e ratio to 40+. We now know it meant stocks were quite speculative and volatile.
After the 2000-01 tech stock crash, the S&P 500 settled into the mid-20s during the early to mid-2000s. Last year, when the stock market crashed, the ratio dropped to the 15-20 range. Considering how gloomy things looked, a p/e ratio of 15 may have seemed pretty optimistic.
One might argue that this year's stock market rally vindicated last fall's relatively congenial p/e ratio. But the economic picture creates cognitive dissonance. We have a feeble real estate market, rising unemployment, spasmodic job creation, likely federal tax increases, limited ability of the government to authorize more stimulus spending, and an American public scared shirtless into saving. Just about the only thing that explains the 60% rally this year is the relentlessly accommodative Fed, which pumped out printed money like it was beer at a frat party. That money wasn't loaned to Main Street, but had to go somewhere. The stock market was one popular destination.
Today's S&P 500 p/e ratio based on the past 12 months of earnings is 72.83 (see http://online.wsj.com/mdc/public/page/2_3021-peyield.html). That's well above the speculative peak of the tech stock boom. When almost all prognostications for economic recovery are guardedly cautious, or else cautiously guarded, such a high p/e ratio seems to indicate that corporate profits will grow at a dazzling rate next year, or that the market is on very thin ice. Few predict the former. At the same time, the Fed can't keep pumping out printed money. It may even take the radical step of withdrawing a bit of it. Think of what happens to a frat party if the beer runs low. Today's p/e ratio tells you that if you buy the market now, view your investment as a long term bet.
Low p/e ratios are viewed as indicating stocks are cheap. High p/e ratios are usually taken to mean stocks are expensive and perhaps headed for a fall, or else speculative (i.e., based on the hope of a rise, and perhaps a big rise, in future profits).
By and large, the S&P 500 has a historical average p/e ratio of around 15 (based on past earnings). In the stock market boom of the late 1990s, the S&P 500's p/e ratio spiked up into the 40s. In the late 1990s, the U.S. economy was riding a wave. A huge peace dividend from the end of the Cold War pumped up the private sector as defense spending fell. The United States avoided major military conflicts, and enjoyed large gains in productivity. The economy benefited from cheap money provided by the Federal Reserve (probably too much and too cheap). The Silicon Valley and other tech centers blossomed. The economic outlook was rosy, and avid investors pushed the p/e ratio to 40+. We now know it meant stocks were quite speculative and volatile.
After the 2000-01 tech stock crash, the S&P 500 settled into the mid-20s during the early to mid-2000s. Last year, when the stock market crashed, the ratio dropped to the 15-20 range. Considering how gloomy things looked, a p/e ratio of 15 may have seemed pretty optimistic.
One might argue that this year's stock market rally vindicated last fall's relatively congenial p/e ratio. But the economic picture creates cognitive dissonance. We have a feeble real estate market, rising unemployment, spasmodic job creation, likely federal tax increases, limited ability of the government to authorize more stimulus spending, and an American public scared shirtless into saving. Just about the only thing that explains the 60% rally this year is the relentlessly accommodative Fed, which pumped out printed money like it was beer at a frat party. That money wasn't loaned to Main Street, but had to go somewhere. The stock market was one popular destination.
Today's S&P 500 p/e ratio based on the past 12 months of earnings is 72.83 (see http://online.wsj.com/mdc/public/page/2_3021-peyield.html). That's well above the speculative peak of the tech stock boom. When almost all prognostications for economic recovery are guardedly cautious, or else cautiously guarded, such a high p/e ratio seems to indicate that corporate profits will grow at a dazzling rate next year, or that the market is on very thin ice. Few predict the former. At the same time, the Fed can't keep pumping out printed money. It may even take the radical step of withdrawing a bit of it. Think of what happens to a frat party if the beer runs low. Today's p/e ratio tells you that if you buy the market now, view your investment as a long term bet.
Wednesday, November 11, 2009
Techniques for Retirement Saving
Technique matters a lot in tennis, golf, basketball and a host of other sports and activities. It also matters to investors. If a middle income American approaches investing--especially long term retirement saving--the right way, he or she can be hundreds of thousands of dollars better off when receiving the retirement watch, than someone's whose technique is poor. Here are a few basic pointers that can take you a long way.
Calculate your net worth regularly. Keeping score is essential. You have to know if you're making progress. You'll need to know when you're not making progress or losing ground, so you can take action to turn the tide. Knowledge can be painful in times of market downturns, but avoiding reality won't improve your retirement finances. You may or may not have a fixed saving goal. Having a goal is good, but not essential. See http://blogger.uncleleosden.com/2007/04/goals-for-retirement-saving-and-why.html. But it's essential to know where you stand. That knowledge alone will keep you focused on building wealth for the future. Calculate your net worth at least every three months. See http://blogger.uncleleosden.com/2007/04/secret-to-building-wealth.html.
Automate the saving process and use retirement accounts. Participate in any 401(k) or equivalent retirement plan your employer may offer. Maximize the amount you contribute. Some people think you might want to contribute only enough to get an employer match and then contribute to a Roth IRA; this isn't a bad idea but you have to be conscientious about the Roth contributions because they aren't necessarily automatic (read on for the solution to this problem). If you don't have access to an employer sponsored plan, open an IRA--or a Roth IRA if you think your future tax rates will be higher than today's--and arrange with your bank to have funds transferred every month (or every two weeks if you are paid on a biweekly basis) to the IRA. It's a good idea to use retirement accounts like 401(k)s and IRAs because they are separate from your regular bank and securities accounts, and the money in them is harder to spend before retirement. For more information, see http://blogger.uncleleosden.com/2007/04/automate-to-accumulate.html.
Average returns take you to Lake Wobegon. Money managers (such as those at actively managed mutual funds) usually don't perform as well as market averages like the S&P 500. There are a number of reasons for this, including their higher trading costs and their compensation. But the bottom line is you are likely to end up with less. Focus on long term gains. Stick with index funds and other low cost investments. If you aim to get the market average for a return, you'll probably end up doing better than average. For more, see http://blogger.uncleleosden.com/2007/06/why-average-investor-does-well.html.
Keep it simple. Investing is, among other things, a sales transaction. A financial firm is the seller and you're the buyer. Complexity favors sellers and places you at a disadvantage. The seller will naturally know more about the product than you will. The law requires that sellers of financial products make a variety of disclosures to buyers. But even if those disclosures are made, the seller will probably still have a better understanding of the product than you will. So you may have trouble figuring out if the product is truly to your advantage. The complexity of some annuities and other insurance products, and some leveraged ETFs, is so great as to make them virtually opaque. Investing in opacity isn't a good idea. Complex products also tend to have higher costs, which negatively impact investor returns. Stick to index funds, and maybe some individual stocks and bonds. Plain old bank CDs aren't bad when the markets seem turbulent. If you don't understand a financial product, avoid it.
The easiest budget of all--save a good percentage of your income (especially if you're self-employed). Budgeting sucks and it seems like every month something comes up that you didn't anticipate. Then, there are the "discussions" with your significant other about how much should be allocated to what expenses, and also last week's rampage off the budget. If you want a simple way to budget, don't focus on how much you spend, but instead on how much you save. Target a good-sized percentage of your monthly income (10% is good, 15% is much better, and 20% is a home run), and make sure that come hell or high water you save at least that much. If replacing your car's exhaust system one month prevents you from hitting your goal, then add enough more the next month or two so that you backfill the deficit. The percentage-of-income-saved method allows you to avoid a lot of handwringing over lattes or not, and inter-spousal sniping, while meeting retirement goals. If you can consistently save 15% to 20% of your earnings over the course of a 30 to 40 year career, you could end up with enough to pretty much maintain your pre-retirement lifestyle during your golden years. If you're self-employed and have an uneven income, it's particularly important to save a good-sized percentage of your income because you can't easily automate the saving process. For more, see http://blogger.uncleleosden.com/2009/07/simplest-financial-plan-of-all.html.
Build your benefits. Even though private sector employers are abandoning pensions faster than New York high society abandoned Bernie and Ruth Madoff, just about everyone has the equivalent of a pension through the Social Security system. Although much maligned and stereotyped, Social Security is the port in the storm for tens of millions of Americans. The longer you work, the greater your benefits will be. Even though the level of Social Security benefits is subject to the whim and caprice of Congress, the tenure of members of Congress is subject to the whim and caprice of voters (including most of the tens of millions of Social Securities recipients). Whatever Congress may do in the future about Social Security benefits, it won't destroy the system and you'll be better off by working longer. If you're fortunate enough to have access to a pension, work as long as you can to boost your benefits. You'll sleep better, without having to buy a new mattress, if you can count on the automatic deposit of a monthly check. For more, see http://blogger.uncleleosden.com/2007/05/how-to-retire-without-saving.html.
Attitude. Perhaps the most important factor, but the hardest one to control, is how you view money and saving. If you look at them the right way, you'll do fine. Understand that you have a finite stream of income during your life. If you spend your money, you can't save it. It's gone forever, and you're left with the now diminished remainder of your finite stream of lifetime income. Saving is a choice, not a sacrifice. Money saved now builds security for the future. Because your lifetime income is finite, you can economize now or economize later. Consider that eating dog food in your old age probably won't be a high point of your life. Remember that savings generate returns that can be compounded, so they may increase your finite lifetime income. Save enough, and you'll hit a financial home run by compounding. (See http://blogger.uncleleosden.com/2009/09/if-you-love-compounding-compounding.html.) This isn't about being greedy in an unseemly way or living like a pauper during your working years. It's about common sense and living within your means. If you adopt the right attitude, you'll establish control over your finances, and that will give you a very good feeling.
Calculate your net worth regularly. Keeping score is essential. You have to know if you're making progress. You'll need to know when you're not making progress or losing ground, so you can take action to turn the tide. Knowledge can be painful in times of market downturns, but avoiding reality won't improve your retirement finances. You may or may not have a fixed saving goal. Having a goal is good, but not essential. See http://blogger.uncleleosden.com/2007/04/goals-for-retirement-saving-and-why.html. But it's essential to know where you stand. That knowledge alone will keep you focused on building wealth for the future. Calculate your net worth at least every three months. See http://blogger.uncleleosden.com/2007/04/secret-to-building-wealth.html.
Automate the saving process and use retirement accounts. Participate in any 401(k) or equivalent retirement plan your employer may offer. Maximize the amount you contribute. Some people think you might want to contribute only enough to get an employer match and then contribute to a Roth IRA; this isn't a bad idea but you have to be conscientious about the Roth contributions because they aren't necessarily automatic (read on for the solution to this problem). If you don't have access to an employer sponsored plan, open an IRA--or a Roth IRA if you think your future tax rates will be higher than today's--and arrange with your bank to have funds transferred every month (or every two weeks if you are paid on a biweekly basis) to the IRA. It's a good idea to use retirement accounts like 401(k)s and IRAs because they are separate from your regular bank and securities accounts, and the money in them is harder to spend before retirement. For more information, see http://blogger.uncleleosden.com/2007/04/automate-to-accumulate.html.
Average returns take you to Lake Wobegon. Money managers (such as those at actively managed mutual funds) usually don't perform as well as market averages like the S&P 500. There are a number of reasons for this, including their higher trading costs and their compensation. But the bottom line is you are likely to end up with less. Focus on long term gains. Stick with index funds and other low cost investments. If you aim to get the market average for a return, you'll probably end up doing better than average. For more, see http://blogger.uncleleosden.com/2007/06/why-average-investor-does-well.html.
Keep it simple. Investing is, among other things, a sales transaction. A financial firm is the seller and you're the buyer. Complexity favors sellers and places you at a disadvantage. The seller will naturally know more about the product than you will. The law requires that sellers of financial products make a variety of disclosures to buyers. But even if those disclosures are made, the seller will probably still have a better understanding of the product than you will. So you may have trouble figuring out if the product is truly to your advantage. The complexity of some annuities and other insurance products, and some leveraged ETFs, is so great as to make them virtually opaque. Investing in opacity isn't a good idea. Complex products also tend to have higher costs, which negatively impact investor returns. Stick to index funds, and maybe some individual stocks and bonds. Plain old bank CDs aren't bad when the markets seem turbulent. If you don't understand a financial product, avoid it.
The easiest budget of all--save a good percentage of your income (especially if you're self-employed). Budgeting sucks and it seems like every month something comes up that you didn't anticipate. Then, there are the "discussions" with your significant other about how much should be allocated to what expenses, and also last week's rampage off the budget. If you want a simple way to budget, don't focus on how much you spend, but instead on how much you save. Target a good-sized percentage of your monthly income (10% is good, 15% is much better, and 20% is a home run), and make sure that come hell or high water you save at least that much. If replacing your car's exhaust system one month prevents you from hitting your goal, then add enough more the next month or two so that you backfill the deficit. The percentage-of-income-saved method allows you to avoid a lot of handwringing over lattes or not, and inter-spousal sniping, while meeting retirement goals. If you can consistently save 15% to 20% of your earnings over the course of a 30 to 40 year career, you could end up with enough to pretty much maintain your pre-retirement lifestyle during your golden years. If you're self-employed and have an uneven income, it's particularly important to save a good-sized percentage of your income because you can't easily automate the saving process. For more, see http://blogger.uncleleosden.com/2009/07/simplest-financial-plan-of-all.html.
Build your benefits. Even though private sector employers are abandoning pensions faster than New York high society abandoned Bernie and Ruth Madoff, just about everyone has the equivalent of a pension through the Social Security system. Although much maligned and stereotyped, Social Security is the port in the storm for tens of millions of Americans. The longer you work, the greater your benefits will be. Even though the level of Social Security benefits is subject to the whim and caprice of Congress, the tenure of members of Congress is subject to the whim and caprice of voters (including most of the tens of millions of Social Securities recipients). Whatever Congress may do in the future about Social Security benefits, it won't destroy the system and you'll be better off by working longer. If you're fortunate enough to have access to a pension, work as long as you can to boost your benefits. You'll sleep better, without having to buy a new mattress, if you can count on the automatic deposit of a monthly check. For more, see http://blogger.uncleleosden.com/2007/05/how-to-retire-without-saving.html.
Attitude. Perhaps the most important factor, but the hardest one to control, is how you view money and saving. If you look at them the right way, you'll do fine. Understand that you have a finite stream of income during your life. If you spend your money, you can't save it. It's gone forever, and you're left with the now diminished remainder of your finite stream of lifetime income. Saving is a choice, not a sacrifice. Money saved now builds security for the future. Because your lifetime income is finite, you can economize now or economize later. Consider that eating dog food in your old age probably won't be a high point of your life. Remember that savings generate returns that can be compounded, so they may increase your finite lifetime income. Save enough, and you'll hit a financial home run by compounding. (See http://blogger.uncleleosden.com/2009/09/if-you-love-compounding-compounding.html.) This isn't about being greedy in an unseemly way or living like a pauper during your working years. It's about common sense and living within your means. If you adopt the right attitude, you'll establish control over your finances, and that will give you a very good feeling.
Saturday, October 3, 2009
Why It Feels So Rough in the Stock Markets
If investing in stocks feels like you're riding through white water, you're not imagining things. It is rough in the market. Let's look at the data.
The 1920s were a period of secular, or long term, market rise. Then, the 1929 market crash knocked the market for such a loop that it did not recover on an inflation adjusted basis until 1953. Then the market enjoyed a secular rise until the end of 1972. However, with the malaise of the 1970s setting in, the market fell and did not recover on an inflation adjusted basis until 1991. Between 1991 and early 2000, the market rose on a long term basis. However, after peaking in March and April 2000, the market has never fully recovered. Currently, adjusted for inflation, the market is at 1997 levels; it's gone nowhere for the past 12 years.
In all, since 1920, the stock market has, on a long term basis, risen a total of 37 years. It has been in a losing position (compared to the preceding peak and adjusted for inflation) for a total of 50 years. No wonder stock market investing makes a lot of people seasick.
Of course, the good years saw gains that greatly exceeded the losses in seasick years. Overall, since 1920, the market has been a very good investment on a long term basis. But, as John Kenneth Galbraith put it, in the long term we're all dead. If your time horizon is about 15 or 20 years, you should be cautious with stocks. Some equity exposure is prudent, because there will be mid and short term rallies even during long term downturns. But you should use bonds or comparable investments to stabilize the value of your portfolio. If your time horizon is short, like a few years or less, it's best to step back from stocks. You may miss out on some gains. But you don't want to lose your child's college tuition money, the down payment on your house, or the funds for Mom or Dad's assisted living expenses.
Even though diversification isn't a bulletproof investment strategy, it still makes sense for many people on a long term basis. If you're taking too many painkillers because of your stock investments, reduce your equity exposure. Put it all in bank CDs if that let's you sleep. Keep your portfolio simple. (See http://blogger.uncleleosden.com/2009/04/investing-in-discouraging-times-can-be.html.) Whatever you do, don't stop saving. People who don't prepare for the future won't have much of one.
The 1920s were a period of secular, or long term, market rise. Then, the 1929 market crash knocked the market for such a loop that it did not recover on an inflation adjusted basis until 1953. Then the market enjoyed a secular rise until the end of 1972. However, with the malaise of the 1970s setting in, the market fell and did not recover on an inflation adjusted basis until 1991. Between 1991 and early 2000, the market rose on a long term basis. However, after peaking in March and April 2000, the market has never fully recovered. Currently, adjusted for inflation, the market is at 1997 levels; it's gone nowhere for the past 12 years.
In all, since 1920, the stock market has, on a long term basis, risen a total of 37 years. It has been in a losing position (compared to the preceding peak and adjusted for inflation) for a total of 50 years. No wonder stock market investing makes a lot of people seasick.
Of course, the good years saw gains that greatly exceeded the losses in seasick years. Overall, since 1920, the market has been a very good investment on a long term basis. But, as John Kenneth Galbraith put it, in the long term we're all dead. If your time horizon is about 15 or 20 years, you should be cautious with stocks. Some equity exposure is prudent, because there will be mid and short term rallies even during long term downturns. But you should use bonds or comparable investments to stabilize the value of your portfolio. If your time horizon is short, like a few years or less, it's best to step back from stocks. You may miss out on some gains. But you don't want to lose your child's college tuition money, the down payment on your house, or the funds for Mom or Dad's assisted living expenses.
Even though diversification isn't a bulletproof investment strategy, it still makes sense for many people on a long term basis. If you're taking too many painkillers because of your stock investments, reduce your equity exposure. Put it all in bank CDs if that let's you sleep. Keep your portfolio simple. (See http://blogger.uncleleosden.com/2009/04/investing-in-discouraging-times-can-be.html.) Whatever you do, don't stop saving. People who don't prepare for the future won't have much of one.
Sunday, July 15, 2007
Why the Stock Market Bounces Around
On Thursday, July 12, 2007, the stock reached a record high, with the Dow Jones Industrial Average rising 283.86 points to close at 13,861.73. What the heck happened? News reports attributed the market jump to positive news about retail sales and the announcement of a planned acquisition of a Canadian aluminum company, Alcan Inc. But were those stories really the cause? People still flock to the malls and someone wants to buy an aluminum company? Or was there more to it?
The stock market is the aggregation of the interactions of many thousands of persons and institutions. They buy and sell stocks, options, ETFs and other investments. All of their transactions, put together, create the image of beehive activity that you get from the financial news on cable TV. But the markets today are dominated by large, institutional investors--hedge funds, mutual funds, investment banks, pension funds, insurance companies, and the like. These players are so big that sometimes one of them can alone have a noticeable impact on the market.
For example, let's look at an enforcement case brought by the SEC in 1996 against an investment fund management firm called Tudor Investment Corporation. The SEC's order in this case told the following story. Tudor Investment had a trading strategy that involved selling a large quantity of stocks included in the Dow Jones Industrial Average. It believed that on a particular day, March 16, 1994, the prices of the Dow Jones Industrial Average stocks were going to swing upwards at the end of the trading day (i.e., 4:00 p.m. Eastern Time). Beginning at approximately 3:39 p.m., Tudor Investment traders began to sell, in the hope of profiting from the expected upswing in prices. They managed to sell over 1 million shares of stock in the last 21 minutes of the trading day. In the last 4 minutes of the trading day (i.e., from 3:56 p.m. to 4:00 p.m.), the Dow Jones Industrial Average dropped 16.45 points (or about 0.43%) of the index's value at that time. The SEC asserted that Tudor Management's sales toward the end of the trading day "were a significant factor" in the 16.45 point drop.
The SEC charged that Tudor Investment violated the short sale rule, a regulation that limits the circumstances in which a person or institution can sell stock they don't own. (As odd as it may sound, you are allowed in the stock market to sell stock you don't own--it's a way of betting that the stock will drop in value.) Tudor Investment settled the case without admitting or denying the SEC's charges. (That's another oddity of the stock markets--legal settlements where a party neither admits nor denies breaking the rules.) If you want to read the SEC's order in this case, here's the link: http://www.sec.gov/litigation/admin/3437669.txt.
The important point here is that a single player in the market "was a significant factor" in a noticeable market move. Taking the July 12, 2007 closing value of the Dow Jones Industrial Average, 13,861.73, a 0.43% change would be about 59 points. If you could apply the events of March 16, 1994 to today's market, a single player might be able to move the Dow by 59 points. Today, it would probably take much more than the purchase or sale of 1 million shares. But, these days, big institutional investors command portfolios containing much more than 1 million shares of stock.
The stock market has undercurrents and riptides that are difficult or impossible to see from the outside. If you're an active market player, you might feel their tug. But you'd probably have a hard time figuring out where they are coming from or where they are going. Only in those unusual situations where the SEC or another regulator finds something to frown about will information surface publicly as it did in the Tudor Investment case. The rest of the time, you probably won't know what happened, and will probably never learn. Retail sales and the Alcan acquisition probably did help to push the market up on July 12, 2007. But were there other factors? Did some foreign investors, anticipating interest rate increases in their home countries, decide to shift money into the U.S. market? Did some large institutional investors decide to reallocate their increasing exposures to rising foreign markets and move assets into the U.S. markets? Did some institutional investors losing money in subprime mortgage-backed CDOs decide to cut their losses and shift their money into stocks? These are only a few of the possibilities.
So how can you get a read on the markets? One way to separate the wheat from the chaff is to look at market movements from week to week. Pick one day a week--Friday is a good choice--and look at the closing prices on that day for each week. You'll see that week-to-week movements of the market are much smoother than day-to-day movements. By looking at the market on a weekly basis, you sift out some of the riptides and undercurrents caused by large investors, and can get a better handle on overall market trends.
Another lesson here is that day trading stocks, and other short term trading, is very dangerous for the individual investor. If you try to profit from one day's news about retail sales or aluminum companies, you're playing bumper cars where you have a subcompact and the big investors are driving tractor trailers. They can easily overrun you and never notice. You can't predict where your stocks will go short term because you never know when a big tractor trailer will barrel over your trading strategy. Pick an investment strategy that smooths out the bumps in the road. Invest for the long term, on a diversified basis.
Crime News: If you're confronted by a robber, try offering a glass of wine and a hug. http://www.wtop.com/?nid=456&sid=1188465.
The stock market is the aggregation of the interactions of many thousands of persons and institutions. They buy and sell stocks, options, ETFs and other investments. All of their transactions, put together, create the image of beehive activity that you get from the financial news on cable TV. But the markets today are dominated by large, institutional investors--hedge funds, mutual funds, investment banks, pension funds, insurance companies, and the like. These players are so big that sometimes one of them can alone have a noticeable impact on the market.
For example, let's look at an enforcement case brought by the SEC in 1996 against an investment fund management firm called Tudor Investment Corporation. The SEC's order in this case told the following story. Tudor Investment had a trading strategy that involved selling a large quantity of stocks included in the Dow Jones Industrial Average. It believed that on a particular day, March 16, 1994, the prices of the Dow Jones Industrial Average stocks were going to swing upwards at the end of the trading day (i.e., 4:00 p.m. Eastern Time). Beginning at approximately 3:39 p.m., Tudor Investment traders began to sell, in the hope of profiting from the expected upswing in prices. They managed to sell over 1 million shares of stock in the last 21 minutes of the trading day. In the last 4 minutes of the trading day (i.e., from 3:56 p.m. to 4:00 p.m.), the Dow Jones Industrial Average dropped 16.45 points (or about 0.43%) of the index's value at that time. The SEC asserted that Tudor Management's sales toward the end of the trading day "were a significant factor" in the 16.45 point drop.
The SEC charged that Tudor Investment violated the short sale rule, a regulation that limits the circumstances in which a person or institution can sell stock they don't own. (As odd as it may sound, you are allowed in the stock market to sell stock you don't own--it's a way of betting that the stock will drop in value.) Tudor Investment settled the case without admitting or denying the SEC's charges. (That's another oddity of the stock markets--legal settlements where a party neither admits nor denies breaking the rules.) If you want to read the SEC's order in this case, here's the link: http://www.sec.gov/litigation/admin/3437669.txt.
The important point here is that a single player in the market "was a significant factor" in a noticeable market move. Taking the July 12, 2007 closing value of the Dow Jones Industrial Average, 13,861.73, a 0.43% change would be about 59 points. If you could apply the events of March 16, 1994 to today's market, a single player might be able to move the Dow by 59 points. Today, it would probably take much more than the purchase or sale of 1 million shares. But, these days, big institutional investors command portfolios containing much more than 1 million shares of stock.
The stock market has undercurrents and riptides that are difficult or impossible to see from the outside. If you're an active market player, you might feel their tug. But you'd probably have a hard time figuring out where they are coming from or where they are going. Only in those unusual situations where the SEC or another regulator finds something to frown about will information surface publicly as it did in the Tudor Investment case. The rest of the time, you probably won't know what happened, and will probably never learn. Retail sales and the Alcan acquisition probably did help to push the market up on July 12, 2007. But were there other factors? Did some foreign investors, anticipating interest rate increases in their home countries, decide to shift money into the U.S. market? Did some large institutional investors decide to reallocate their increasing exposures to rising foreign markets and move assets into the U.S. markets? Did some institutional investors losing money in subprime mortgage-backed CDOs decide to cut their losses and shift their money into stocks? These are only a few of the possibilities.
So how can you get a read on the markets? One way to separate the wheat from the chaff is to look at market movements from week to week. Pick one day a week--Friday is a good choice--and look at the closing prices on that day for each week. You'll see that week-to-week movements of the market are much smoother than day-to-day movements. By looking at the market on a weekly basis, you sift out some of the riptides and undercurrents caused by large investors, and can get a better handle on overall market trends.
Another lesson here is that day trading stocks, and other short term trading, is very dangerous for the individual investor. If you try to profit from one day's news about retail sales or aluminum companies, you're playing bumper cars where you have a subcompact and the big investors are driving tractor trailers. They can easily overrun you and never notice. You can't predict where your stocks will go short term because you never know when a big tractor trailer will barrel over your trading strategy. Pick an investment strategy that smooths out the bumps in the road. Invest for the long term, on a diversified basis.
Crime News: If you're confronted by a robber, try offering a glass of wine and a hug. http://www.wtop.com/?nid=456&sid=1188465.
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