What happened last week? The Dow Jones Industrial average gained and lost a total of 2,134 points for a net change on the week of down 175 points, or down 1.5%, which is not exactly the end of the world. The S&P 500, the broader index we really care about, lost 1.6% on the week, 8.7% so far in the month of August, 10.5% on the quarter, is down 14.0% from the April 29th 4 year high and is down 24.7% from the all-time high set October 9th, 2007. The volatility is NOT rational. The equivalent would be selling your home on Monday, buying it back Tuesday, selling it Wednesday, buying it back Thursday and adding on a bedroom Friday.
Who wins from the volatility? "High frequency trading" firms that can effectively manipulate the markets by placing thousands of one sided trades (all bids, or all offers) on individual stocks, or even more effectively on thinly traded ETF's, to force the market one way or the other. There are no uptick rules and no margin requirements preventing these firms from setting up an initial position (long or short), manipulating the market in the right direction, and closing out the trades with a profit a few minutes (or moments) later. Who loses? Pension plans, endowments, mutual funds, individual investors and corporations (who will find it ever harder to raise equity capital.)
Driving Buffalo over a Cliff!
Here's a colorful analogy. In the pre-Columbian era, Plains Indians were at quite a
disadvantage hunting the American Bison or Buffalo. A mature bison weighs between 1 ¾-2 ¼ tons and can cover ground in short spurts of up to 35 MPH. A Native American of the era weighed about 140 lbs, could run perhaps 10 miles an hour (horses were not known in the New World until after the 1500s) and was armed with mere stone tipped spears and arrows. In a head to head contest, the Indians had no chance!
However the Native Americans developed a technique to use the buffalo's strengths against itself. In certain areas, of the American West, contours of the land created natural funnels which lead ultimately to a cliff. The Indians would pile rock cairns along these contours to simulate people, then start whooping and hollering at the back of a herd of buffalo, ultimately starting a stampede. By the time the buffalo realized there was a cliff ahead, it was too late to stop or they'd be pushed over by the buffalo behind. No doubt there were a couple of buffalo that refused to be stampeded; and those buffalo, of course, survived.
We refuse to be stampeded when it comes to stock investing. We have seen so many 10% stock declines since 2000, not to mention the 55% decline in 2008-9, yet stocks always recover. We sell stocks because the valuations are too high, not because everyone else is selling. We avoid other assets, such as gold, because we perceive overvaluation, not because everyone else is buying.
We have had quite a few e-mail and phone conversations with our clients this past week. We didn't sell anything this week and our only regret is that we didn't buy more! The bottom line is that the stock market is now "commoditized." Investors don't appear to do original stock research anymore, instead reacting blindly to the "macro" concept of the day, for example, the downgrade of the US credit rating to AA+, as we saw this week. Commodity markets are generally volatile; oil for example was at $71/barrel in August 2010, peaked at $114 in April, hit $79 earlier this week and closed at $85.38. Stocks (pre 2000) were a lot less volatile, but are now equally volatile.
We expect that millions of Americans sold stocks and mutual funds this month (In July, retail investors sold $25.4 billion in classic "buy high/sell low" behavior.) Of great interest to us: corporate executives directors are on a buying spree, with MTD purchases of $861 million. At this rate, they'll exceed the $1 billion purchased on March 2009, which in hindsight was extremely well timed.
Couple of questions from e-mail
"Did you see that JPM just predicted gold at $2500/oz by year end. Are you a buyer at today's price?" Nope, this chart from Doug Short says it all. Yes there is some upside potential, but the downside is a loss of 50-90%. Read this article "The Shape of Market Bubbles" for the full analysis.
"It seemed just a bit off to suggest that Nantucketers represented the direction of purchasing decisions for the rest of the economy. Isn't the opposite true? The folks summering there are the ones that have lobbied (directly and indirectly) for the increasing wealth disparity and middle class hollow-out we've seen over the last couple of decades exacerbated by the kind of "Big Short" behavior where a $2 Billion benefit on one side for a hedge fund comes with a 2 trillion loss for the other side of the bet (your example from a year ago)."
The majority of the wealthy people who summer in Nantucket achieved that wealth building great companies over time. There are of course a number of people who are here because of a career in finance, or simply because they inherited wealth. This past week, we were curious as to whether the stock market gyrations would affect visitor behavior. In fact, Main Street was packed with shoppers, bars and restaurants still had 30 people standing outside, and we haven't seen so many 130' yachts in the marina since 2000. Bottom line, the moneyed class just isn't as worried now as in 2009. Please let that translate into some hiring this fall!
We are happy to say that some of our clients are adding cash to their portfolios, which we will invest in stocks as appropriate over the next month. It would be awesome if the SEC acted to rein in "High Frequency Trading," but we have zero expectation of that happening, so volatility is here to stay. Accordingly, stock investments are reserved for assets not needed for at least 5 years.