Market Envy

November 15, 2002

Finally, a good month for investing. October, a notoriously stormy month on Wall Street, turned out to be about as good as it gets. We saw a near complete reversal in the market behavior of the last few months. Areas that were beaten down the most, like telecom took off and tech and large cap growth stocks were hot. Bonds, particularly the safe government type everyone wants to own these days, were one of the few weak spots. The weak month for bonds reversed a long trend of gains.

We'd love to report that the good month was due to some fundamental strengthening, but we can't. While there has been good news on some economic fronts, the sad fact is most of the activity in the markets is primarily from two forces: 1) the alternatives to stocks are bleak 2) the nagging feeling among investors that they if they don't get in now they could miss out on some action.

Last month I talked about the fact the main reason stocks looked reasonably priced was that investor's choices, cash, real estate, bonds, etc, did not look very appealing at current prices and yields. That realization hit people when the Dow flirted with the 7,000 level. But that is not the only reason the markets are higher today.

There is a great deal of money managed - especially by 'professional' investors - a little too actively. What we mean is while the primary story behind how a lot of money is invested is to try and "buy future earnings potential at a reasonable price" or some socially acceptable explanation, the dirty secret is a whole heck of a lot of investing takes place for reasons that have nothing to do with current valuations or future earnings potential.

Some people buy stocks merely because stocks have recently gone down. It's as if what a business actually does is meaningless; sometimes all an investor needs to look at is the past movement in the stock price to divine the future. Sometimes this seems to work. There was a time when dot-com stocks where good investments because they "always" doubled when they went public.

Many more institutional money managers, including mutual fund portfolio managers, have certain benchmarks like the S&P500 they are judged against by their superiors. If the index starts to move, they better make darn well sure they own enough stocks and the right stocks to not get left behind. And it doesn't take a lot of cash at less than 2% yield in your portfolio to get left behind when the S&P500 goes up almost 20%. Many live in fear or losing their job if they "miss the boat", so they hop on - even if they think the market is fundamentally weak.

Then there are those who have short positions in stocks (have sold stocks they do not own in hopes of buying them back at a cheaper price later in the future). Such investing is dangerous if stocks take off. (If you think buying a stock for $10 and watching it fall to $1 hurts, imagine borrowing a stock that is $10, selling it, and watching it go to $40. You've just lost three times your original investment. Scary stuff.) Many with these outstanding short positions will panic and buy back the stocks they have sold to "cover' their positions. Such buying creates more demand for stocks, sending prices higher.

There are many more types of "non-fundamental" stock trading. Such activity should support stocks prices for a while, if not send them higher. We'd much rather see real improvement in the economy and corporate America, but frankly, after this many bad months, we'll take what we can get.

As an investor, there is really not much you should "do" with such bizarre volatility running rampant to "play" the market, although almost everyone on financial TV will try to give you strategies to profit from all the excitement. You should just keep doing what really works - owning a diversified portfolio of good investments. When stocks really fall, you shift a little more money in, when they go up into the stratosphere with little reality to back the gains, you shift a little money out. Leave all the excitement for the professionally nervous. Remember, there is a lot of excitement on casino floors in Las Vegas. That doesn't mean you can win.