Opportunity doesn’t come labelled…more so in the Stock Market

‘If you don’t know who you are, the stock market is an expensive place to find out…’ (Adam Smith)

Growth or Value, Large Cap or Small Cap, Domestic or Foreign, Active or Passive… which label do you swear by.

It actually doesn’t matter. Every equity styles over long windows of time will give similar returns, it is the nature of Capital Markets (Efficient Hypothesis). Just like water flows from high pressure to low pressure, Capital flows from high valuation/ high returns to low valuation/ low returns equity classes. Think about it… if it did not, all one had to do was buy in to the higher returning asset class and watch it go higher and higher. Doesn’t happen.

Hence, a passive strategy is perhaps the best alternative. Just buy a broad market ETF, put it away and get equity like returns over long windows of time. Yes, that works. Except, many studies including one from DALBAR show the average equity mutual fund investor underperformed the S&P500 by 8.19% in 2014. The average hold period of an equity fund was 4.19 years which doesn’t quite cover an average economic cycle. Now if you are one who is the exception to the above, stop reading. You are all set. Most others it seems, looked at the account statement, peeked at the online account and sold and sold in 2008/09 and stood on the sideline waiting for the all clear while markets moved higher in 2011/12.

There is another approach, it’s not anchored in Growth, Value etc. It has no label. It is the approach of applying “Capital Market Technology”, which at its core asks‘what’s your edge’?… have you figured out something that most have not, do you see something that others are yet to connect the dots on, and if not go back to passive investing. It is a view in which opportunities are found by the application of imagination, the puzzling out of possibilities, while staying critical of them, till they are distilled to a simple action item. Long ‘x’, Short ‘y’. Example in point, everyone in 2012/13 talked about fracking and how it was either good or not good for the environment or how abundant sweet crude was going to be. Many missed what that meant for airlines who were not hedging crude or how car insurers were going to be impacted with lower gasoline prices leading to more miles being driven, so loss ratios were going to be higher. So, buy ‘airlines’, sell ‘insurers’. Another example is the view still prevalent, that somehow the Fed and other Central Bankers are propping up the stock markets with quantitative easing (QE’s). That’s a myth… connect the dots on M2 (money supply) to excess bank reserves, to bank lending and the yield curve and one can perhaps see that QE is actually bad for stocks (QE flattens the long end of the yield curve, thus incenting banks not to lend, despite abundant reserves which instead are parked at the Fed reserve account, hence lack of inflation (no multiplier effect, despite the Fed creating money). Once QE is fully withdrawn, while many will fret over its absence as a headwind for the market, bank stocks are a reasonable buy and bonds are reasonable sell.

That is the game, a wonderful global one.

Luck and pesetas!

 

Update : This article is an update of a prior article published on October 2015.

 

**Past performance is no guarantee of future results. A risk of loss is involved with investments in capital markets. Please consider investment actions in light of your goals, objectives, cash flow needs, time horizon and other lasting factors