/ Terry’s Columns / Making Sense of Stocks

Making Sense of Stocks

By Terry Savage on July 15, 2020

The stock market has proved in recent days that it can exceed its all-time highs, depending on which indexes and stocks you are watching. Given market volatility, as you read this it could be lower, or even higher. But one thing is sure: in no way is the economy in better shape than it was in January before the Covid 19 pandemic started, and when most previous records were set.

Why is the stock market soaring amidst double-digit unemployment, renewed business closings, and uncertain corporate earnings? Wall Street pundits give simple answers. The market is fueled by money – and the Fed has created a seemingly unlimited supply of liquidity to prop up the financial world. Much of that money is flowing into stocks. Also, the market is always looking beyond current economic conditions and earnings to a future time when momentum is regained, likely because of a successful vaccine.

Agree to Disagree

But is the market correct in its judgment? Of course it is. The market is ALWAYS right. The stock market is the place where investors agree to disagree. At any given moment a stock price is a perfect compromise: it is the price at which a knowledgeable buyer decides to make a purchase at the very same price a knowledgeable seller decides to get out. Thus, the stock market is always right – in the moment.

But how can intelligent, knowledgeable people agree on a price, yet disagree on future direction – all at the same time? That depends on your time horizon and risk tolerance and investment goals.

A day-trader might have a very short-term time horizon, perhaps only a matter of hours. Even if she thinks the market is going much higher, it could be time to take short-term profits. A long term investor might be well aware that there has never been a losing 20-year period for the S&P 500. But that investor is now older, and might need to withdraw money for retirement living within the next 10 years.

Each has a different reason to sell now. But other investors with differing market opinions or time horizons might think it is a perfect time to buy. They think the sellers at this price are making a foolish mistake. Only time will tell.

Do the Pros Know Better?

It’s tempting to believe that some expert money managers just know the “secret” to beating the markets. But the newly-released S&P Dow Jones Indexes Persistency Scorecard blows that idea out of the water!

It says that over the past 20 years (May 2000—May 2020), an investor in an actively-managed fund had a roughly 90% chance of being outperformed by the corresponding S&P DJI benchmark index.

Or put it this way, investors in funds managed by professional stock-pickers paid a lot of money in fees for only a 10% chance of beating the relevant index benchmark!

How much money did index buyers save? S&P DJI estimates it was a cumulative saving of $320 billion in fees – between 1996 and 2019. And with management fees of index funds dropping to mere pennies, the discrepancies will grow.

This report compares only the survivors of the turbulent 21st century. During the last 20 years nearly two-thirds of actively managed funds were merged or liquidated. And the Persistence Report has consistently shown that even the top funds in one measurement period are unlikely to retain their ranking in the next. Or as they say in the industry, past performance is no guarantee of future results!

The only sensible way to approach the stock market is to make a calm assessment of your own time horizons, and your own tolerance for losses. Then buy low-cost funds and stick with them to avoid being whip-sawed by market moves that are built on emotions. Over the long run (if you have the long run) that’s the way to come out ahead. And that’s The Savage Truth.

money

ASK TERRY

a personal
finance question