Rational investing in an irrational world
The continuing backsliding in stock prices has taken the overall market into a 10% “correction.” During the market’s almost uninterrupted 60% surge from March 2009 to the spring of this year, popular market commentators kept warning us that we could expect a 10% “correction” at any time. Well, they finally got the “correction” they had been predicting and now these commentators are proclaiming that their predicted “correction” is the end of the market rally.
They could be right, of course, but this looks to me more like those moments in a football game where overeager players anticipate a play and jump offside. The resulting five-yard penalty seldom changes the outcome of the game. This does not look like a game where an outweighed team is steadily forced back play after play. The momentum of the global economic recovery from the financial crisis was checked by fiscal problems in Southern Europe but not reversed. Momentum is a powerful thing.
So is irrationality. John Maynard Keynes, British economist and successful stock portfolio manager, said, “The market can remain irrational longer than you can remain solvent.” Weakness in Greek government bonds recently irrationally expanded into down markets for global stocks, energy prices and even the price of gold, the traditional haven in times of trouble.
Price weakness across the board in all asset classes is often due to selling by overly leveraged holders who must meet the demands of their lenders by selling whatever they can, not what they should. The resulting irrational markets provide opportunity for investors who have preserved capital reserves. This indicates the way to take advantage of Lord Keynes’s observation, not by complaining about irrationality but taking advantage of it.
This requires avoiding borrowing, committing only capital not likely to be needed for other needs, sticking to quality investments and avoiding reacting to news events or popular trends. These disciplines are rewarding. Over the last 20 years, the S& P 500 stock average has yielded slightly over 8% annualized. Meanwhile, the average stock fund investor has made 3% annually.
The primary reason for this difference seems to be selling during market dips from fear, never a rational force. This is aggravated by ego-driven attempts to avoid any perceived losses, thus the huge amounts of cash still held in money market funds despite their almost invisible yields. Studies suggest that some investors even equate a loss of personal control over investments as an investment loss and insist on deposits in their local branch bank to insure only their own hands are on the controls.
Better returns are available without going to the other extreme and tossing your capital to people like Bernie Madoff. I continue to recommend closed-end bond funds like Alliance Global High Income (AWF-$12) or Credit Suisse Income (CIK-$3). Their share prices dipped along with everything else but neither owns Greek bonds, their income streams were unaffected and each now yields over 9%, paid monthly.
Even better potential lies with stocks of dividend paying growing companies. Clorox (CLX-$63) and Occidental Petroleum (OXY-$79) both raised their dividends and forecast continuing growth. Insurance companies MetLife (MET-$39) and Prudential (PRU-$56) have enduring cash flow. DuPont (DD-$35) has survived business cycles since 1802 and yields 4.5%. Core Labs (CLB-$1301) is ideally placed to benefit from maximizing use of existing oil reservoirs and shale deposits. Apple (AAPL-$245) and Google (GOOG-$477) don’t pay dividends but their growth adds rational returns in an irrational world.
Corrections happen and markets fluctuate. It is their nature. Keep your capital working for you. Avoid leverage. Stay rational.