6/9/2014 7:30 PM ET|
Staying in stocks? Be smart about it
For those who can't stop riding this breakneck market bull, there is one way, at least, to mitigate the risk: Think 'fundamentally.'
For U.S. stocks, the fresh records just keep coming. Last Tuesday, the S&P 500 ($INX) reached an all-time high, closing at 1,912. On Thursday, it hit another one, rising to 1,920. And on Friday, it set yet another one, stretching on its tippy toes to 1,924. That, as it happens, was the 14th time it hit a new record . . . in 2014.
The tone in market chatter is as unmistakable as it is, well, unrealistic: We are in an age of unstoppable ascents -- and how could it be otherwise?
With bargain interest rates, phenomenal corporate profitability, a gradually improving economy, and "reasonable" valuations, it's no wonder that share prices keep climbing and climbing and climbing. In that wonderful circularity of logic that is Wall Street forecasting, the serial records merely validate the optimists, invalidate the doubters, and justify still another round of cheerful predictions.
Even the legends are getting into the act: Jeremy Siegel, a highly respected expert on the equity markets at the University of Pennsylvania's Wharton School, now forecasts that the Dow Jones Industrial Average ($INDU) will close the year at 18,000. That would hand investors a handsome gain of nearly 8 percent from where it stands today.
But serene, carefree optimism can be a dangerous thing in the markets. By viewing stocks as a reasonably safe haven, investors have actually driven prices to dangerously lofty levels. Remember, profits are at virtually all-time highs by any measure -- as a ratio of sales, GDP or wages. Yet price-to-earnings multiples still hover at a pricey 18 on the S&P 500 on top of those gigantic profits.
Even cockeyed bulls have to admit that this is slippery territory.
So how can those investors determined to "stay in" make sure they aren't left flat on their backs when the ground ultimately gives way? (And it will.) The best strategy is to load up on cheap, reviled stocks and dump the super-expensive high-flyers that are largely responsible for the market's elastic valuation.
Sure, you can protect yourself with an index fund. But there can be a major problem with this broad strategy: Most index funds are "cap weighted," meaning the higher the market value of a company, the bigger its share, or weight, in the fund. In purchasing an S&P 500 index fund, for instance, investors -- many without realizing it -- are allocating a disproportionate, and growing, share of their dollars to the likes of Google (GOOG), Facebook (FB), Twitter (TWTR), Amazon (AMZN), Apple (AAPL) and many other tech and biotech companies that have top valuations but relatively small or non-existent earnings. (The exception is Apple, which carries a P/E of only 15, but gigantic margins that are a magnet for competitors, and may not be sustainable.)
The "buy what's hated, dump what's hot" approach that works best is called "fundamental indexing," and this is a great time to profit from its crowd-defying stance. The pioneer and leader in fundamental indexing is Research Affiliates, a firm that designs strategies for $169 billion in investment funds.
Its FTSE RAFI US 1000 (PRF) chooses and weights 1,000 U.S. stocks not by their market cap, but by their overall size in the economy as measured by four factors: total sales, book value, dividends and profits. Price isn't included. Hence, the fund will put a much bigger weight on a manufacturer or utility with a beaten-down price and big sales than it will on a Facebook or a Twitter. That protects investors against a potential collapse in the high-flyers, and capitalizes on the tendency of unloved stocks to reward investors far better than those that are all the rage.
"For the past seven years, growth stocks have fared better than value stocks," says Rob Arnott, co-founder and CEO of Research Affiliates, who is perhaps the foremost champion of fundamental indexing. "The current market vaguely resembles the tech bubble, though not as extravagant," he adds. "We're seeing bubble behavior."
That's where fundamental funds come in. They have a strong "value tilt" -- which is to say, they give far more weight to "cheap" (low P/E or low price-to-book) stocks than cap-weighted funds do. "Since value has underperformed for so long," says Arnott, "it's likely to snap back and beat growth."
The fundamental investing methodology, indeed, is even more likely to favor the downtrodden than traditional value funds are. That's just what investors should want in these perilous times. The P/E multiple on the Russell 1000 and S&P stands at 18; the FTSE RAFI US 1000 multiple is 16, or 11 percent lower.
The gap is far more pronounced in the other metrics, notably in terms of sales and book value. "For every $100 invested in the RAFI US 1000, you're buying more than $100 in sales," says Arnott. "For the S&P it's $60 in sales. In price-to-book, we're at 2 times versus 2.6 times. So you're buying in at a 20 to 40 percent discount on key metrics."
Given the differential in sales, for example, if profit margins on pricey stocks converge towards those of cheap stocks -- a strong possibility, frankly -- the latter will jump and the former will suffer.
"The higher the flyer, the more significantly we bet against it," says Arnott. "It's called contra-trading. Some high-flyers deserve their valuations, some don't. They're either fully priced or overpriced. The fully priced ones will do no better than perform with the market because they started out so expensive. The overpriced ones will fare badly."
For Arnott, the market is largely a popularity contest in the short-run, and investors should not only resist the urge to join in, but benefit from the excesses. "Cap-weighted indexes chase momentum, growth and popularity. Those popular stocks are perceived as not risky when they're really very risky," he argues. "In a fundamental fund, whatever is most newly beloved is what you are selling, and whatever is newly feared and loathed is what you're buying."
So how well has defying the crowd worked for investors? As it turns out, fundamental indexing has far outperformed not just the overall indexes, but also value stocks -- even in the recent, lackluster period for unloved companies. Over the past decade, the RAFI US 1000 has delivered 9.35 percent annualized gains, versus 7.4 percent for the S&P. The strategy also appears to work in global markets. The ten-year return on the FTSE RAFI All World 3000 is 10 percent, 2.3 percentage points better than the MSCI All Country World fund.
Arnott acknowledges that it takes a strong stomach to sustain the contrarian philosophy. "You need to accept discomfort," he says. "What is comfortable is rarely profitable. True bargains don't exist without fear."
Even in these complacent times, the markets feature turf where investors fear to tread. Those are the places to be. Today's contra-trading, fad-defying contrarians will be tomorrow's winners. It just takes guts to stay the course.
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This is awful advice and it is not "thinking fundamentally." If you're thinking fundamentally the companies you invest in have durable competitive advantages - or what Warren Buffett calls a "moat." You're also looking for a decade or more of mostly steady growth and using the past results to estimate the future. You're looking for manageable debt and a stable or growing Return On Equity. You don't want to pay or hold on to such a high P/E that, in Peter Lynch's words, you're no longer discounting the future, you're discounting the Hereafter.
But cheap and reviled stocks are so for a reason: bad management, poor competitive environment, saddled with debt, etc. Even if they didn't fall as much as the avg. stock during a bear market, you're not going to get as much of a rebound as the stocks people want to be in when the market recovers. And, since no one can time the market, if the market keeps going up (the "pros" said the bull market was showing it's age at the end of 2012) do you want to be in good or cheap, reviled stocks?
With the call for "WAR" echoing through the halls of Russia
The Crisis of Crimea and its Black Sea Port
The Arctic Ocean being the next site of Dominance
on the pages of the NATO Alliance
And "War Games" taking place in Greenland, Denmark..
The DOW never looked stronger..
"For those who can't stop riding this breakneck market bull...."
The last two words say it all; definitely 'bull'
Yep, anything built on a Sloppy Foundation eventually fails, many times in Epic Fashion. The longer it takes, the Bigger the FALL.
Don't you people see through this phony article - It is written with one purpose in mind and that is to sell FTSE RAFI US 1000 Fund ! Stocks may crash tomorrow , I don't know, but what I do know is that they will recover at some point and when they do I will have even more money in my portfolio. Trading in and out of the market and panicking and buying some fly by night "Contrarian Fund" will get you nowhere and meanwhile this clown will retire off all the commissions he made from selling you dopes on it.
Serene, carefree optimism is a warning sign of a bubble in the market.
The only recipe for long term success in the market is to focus on the fundamentals of a company and to compare those fundamentals to the performance of its peer companies. If that is too much work, stick with a broad basket of passively managed index ETFs and mutual funds and avoid individual stocks altogether.
I hate that they use "fundamental" in this - that's the first indication it's a scam to make people think it's based on traditional Graham-type thinking.
Buying what's hated usually results in the buyer eventually learning the hard way why the stock is hated.
Fundamental investing means buy what a tried-and-true-most-of-the-time evaluation method says is a good long-term stock. It doesn't tell you to dump what's hot unless it's become too overpriced. And you don't buy what's hated unless your evaluation indicates it's a good turnaround candidate.
"Arnott acknowledges that it takes a strong stomach to sustain the contrarian philosophy. "You need to accept discomfort," he says. "What is comfortable is rarely profitable. True bargains don't exist without fear." Even in these complacent times, the markets feature turf where investors fear to tread. Those are the places to be. Today's contra-trading, fad-defying contrarians will be tomorrow's winners. It just takes guts to stay the course."
When markets appear unstoppable, it takes very little Guts to stay the course. Let see what happens if we see a sustain correction of 10% or more and Pockets of the massive Debt Bubble begin to expose themselves. What we have now, the move back to Amateur Hour where everyone can claim to be a stock picking Genius.
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[BRIEFING.COM] The stock market finished a down week on a cautious note with small caps leading the retreat. The Russell 2000 lost 0.5%, widening its weekly decline to 2.6%, while the S&P 500 shed 0.3%. The benchmark index ended the week lower by 2.7%.
This morning, the market was provided a basis to rebound with the July employment report, which was just right for the policy doves (209K versus Briefing.com consensus 220K). It showed payroll growth that was weaker than expected, ... More
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