December 2009
The Recovery That Can’t Get Respect
The United States economy is in a V shaped recovery after hitting bottom during the panic of 2008. A vast majority of the data signals a very sharp recovery from the lows last winter. Commodity prices, stock prices, department store sales, housing, manufacturing, credit spreads and many other measures reflect a recovery. Even the unemployment rate, always a lagging indicator for economic recovery, had its first positive move last week. Stack it all up and it should be apparent the economy is on the mend. By no small coincidence, when the economic data began showing signs of bottoming in March (as I wrote in my April newsletter) till today the market is up a whopping 66%, bringing the year to date Dow Jones return through December 4 to 21.5%. I am pleased to report that the composite return of Shapiro Asset equity only clients continues to exceed the market results, with a composite return of 27.5%.
So why then, no matter where I go or whom I talked to the past eight months, optimism is argued against, put down, dismissed or ignored? Commonly the responses I hear are “the market has gone up too far and fast. We are due for a correction” or its corollary, “I know the markets are going to pull back and I will put money to work then.” Phrases such as these stem from emotion and as famed investor Benjamin Graham once said, “Individuals who cannot master their emotions are ill suited to profit from the investment process”. Mr. Graham knew that having control over your emotions when investing can make the difference between success and failure. That being said, we are not computers and emotions will always be part of investing. The phrases above reflect personal confirmation bias and anchoring. Confirmation bias occurs when investors filter out relevant evidence about their investments that contradict their beliefs, and most importantly, their past judgments. With so much information available to investors, they latch onto what they want to hear. In a new bull market this bias causes investors to ignore information that the economy and markets are recovering because they were wrong about their recent decision to sell or not buy. The result is that they sit on the sideline letting investment opportunities pass them by.
Additionally, the expectation of a market correction can also stem from anchoring. Anchoring is when an investor assigns a reference point, such as the market low in March, to compare the current price of an investment. Because the market is up sharply they reason it has to be overpriced and therefore due for a correction and a cheaper entry point. Unfortunately, the stock markets past price movements are historically poor predictors of future price performance. Whether or not an investment has risen or fallen in the past tells little about its current fundamental valuation and long term prospects, which are constantly changing.
The question is just how strong and long the economic rebound is likely to be. It is tempting to try to forecast short-term stock market swings, but I prefer to focus on our primary goal of building wealth through equities over time. I am optimistic about the long-term prospects for U.S. equities. Shapiro Asset remained committed to its core strategy –fundamentally investing in equities to reflect each client’s risk tolerance profile and time horizon. This strategy has allowed clients to participate in the market upturn during the past eight months and will allow them to do so going forward.