Tuesday, November 19, 2013

Ignoring the Pundits

Financial blogger Barry Ritholtz wrote a good column for the Washington Post that appeared last weekend.

Ritholtz  noted that too often investors are buried in media commentary on the markets and the economy.

The constant news flow makes it difficult for investors to make calm, rational decisions based on longer term trends and outlooks.

Worse yet, Ritholtz notes that too often the media plays up commentary from "wise men" that usually foretell dire gloom and ruin scenarios. 

Problem is, Ritholtz writes, there is no accountability to these pundits. Prophecies of ruin make headlines, but usually they are wildly wrong - but no one seems to remember.

Here's an excerpt from what he wrote:

One thing I detest most about the financial press is the lack of accountability. All sorts of nonsense is said without penalty. On TV, guests are rarely called out for terrible calls or stock picks. Columnists can say anything without worry of anyone remembering their really dumb statements. 

I use a simple calendar trick to hold talking heads accountable. Whenever someone makes some wild claim or rolls out yet another set of predictions, I diary them. Any calendar or even your Outlook will work, but I especially like to use a simple app called FollowUpThen.com

As an example, have a look at this letter published exactly three years ago, signed by a long list of economic wise men and politically connected policy wonks. It warns of “currency debasement and inflation.” My esteem for these folks’ economic judgment is now significantly diminished; each of the list’s signatories now get assessed as incompetent forecasters. 


Here's a recent example.

Jeremy Grantham of the investment firm GMO is widely respected in the industry, and correctly so.  His work on developing sound investment strategies has been used by a variety of institutions in setting investment policy.  His most notable call was in the latter part of the 1990's, when he identified the wildly overvalued stock market as being vulnerable to a fall.

So it was with some interest that I read in Grantham's most recent newsletter that he believes the stock market is currently 75% overvalued:

"the U.S. stock market is trading at levels that do not seem capable of supporting the type of returns that investors have gotten used to receiving from equities. Our additional work does nothing but confirm our prior beliefs about the current attractiveness – or rather lack of attractiveness – of the U.S. stock market.... On the old model, fair value for the S&P 500 was about 1020 and the expected return for the next seven years was -2.0% after inflation. On the new model, fair value for the S&P 500 is about 1100 and the expected return is -1.3% per year for the next seven years after inflation. Combining the current P/E of over 19 for the S&P 500 and a return on sales about 42% over the historical average, we would get an estimate that the S&P 500 is approximately 75% overvalued."

Now, it could be right that Grantham is right, despite the fact that numerous other indicators would suggest that current market valuations are roughly in-line with historic averages.

On the other hand, if he is wrong, few will remember.  Moreover, I doubt that GMO - which manages billions for institutional investors - has truly left the stock market.

Here, for example, is an New York Times columnist Jeff Sommers quoting Matt Paschke of the investment firm Leuthold Weeden Capital Management:

“There are two schools of thought on stock valuation,” {Paschke} said. “One says you should only buy stocks when they’re cheap. The other says I need to put my money somewhere, so where should I put it? If you look at it that way, stocks are the only game in town, and that thought will probably make us and some other market participants stick around a little longer than we might like because there’s nowhere else to go.”

In my opinion, the longer the current rally continues, the higher the likelihood that we will see a "correction" at some point, and stock prices will move lower for a while, at least.

However, with interest rates likely to remain low for the foreseeable future, I would agree with strategist Paschke:  stocks remain the only game in town.