Why Q-4 should have investors very concerned…
- Oct 30, 2006
- admin
- Investing
DR. PHIL WOULD PROBABLY REFER TO IT AS HAVING A NEGATIVE PRE-DISPOSITION.
Others have suggested it’s the result of several hard-fought (and ultimately scarring) investment experiences from my early professional life.
Regardless of on the psychological analysis, one thing is certain: at this point of my life, my habit of first looking at everything that can wrong with an investment is ingrained in my DNA.
As I’ve said in these pages more often then I care to admit, I’m not a stock analyst or a security analyst: I’m an “insecurity” analyst.
And believe me when I tell you that my investment “insecurity” runs very deep.
How else can you explain my lukewarm response to our decidedly strong performance at Fallen Angel Stocks these days: As of this writing, 80% of the stocks in our model portfolio traded higher then our recommended price.
Even the two long positions we own that are flat or in slightly negative territory don’t concern me in the least: it’s just a matter of time before Wall Street recognizes the shareholder value these companies have by the truckloads.
Even Mr. Market’s tried to do his best to imprint a carefree attitude on this perpetually paranoid brain of mine: a quick calculation I did revealed that excessive optimism on his part is responsible for at least 5% of the profits you’ve made during the past 30 days!
So here we are, heading into the 4th quarter and our stocks are performing well, Mr. Market is in a jovial mood and even GATX Corp., my one longer-then-I-expected, borderline pain-in-the-buttocks-to-watch, short sale idea, decided to finally join the party and begin trading lower.
If everything is going so darn dandy for us here at Fallen Angel Stocks then why is it that this has been one of the hardest issues of the Tycoon Report that I’ve ever had to write?
At least it’s the usual culprit that haunts my nightly investing dreams: we’re faced with some big, unanswered questions as we move into the 4th quarter whose answers may have serious ramifications for us as we begin to wind down the year.
Is the FED finished raising interest rates? What effect will the recent drop in commodity prices have on global economic growth? Which group of political hacks will be in power when the mid-term election dust settles? Has Katie Holmes become brainwashed? Will Suri be forced into a life of Scientology?
These and many other questions should give us pause as we enter Q4. And while I’ll never bet against the amazing resiliency of the US economy, there’s a real chance that U.S. equities will have a rough go of it during the next three months.
If you exclude the two painful years that followed the collapse of the Roaring 90’s, it’s fair to say that for the vast majority of the past 20 years, investors have had it very easy.
That’s because during this time, total annual total returns (including reinvested income) of U.S. stocks have averaged 13%. That compares to the 9.7% stocks have earned each year for the past century!
Just think about that for a moment: for the past 20 years, average returns on U.S. equities have been 34% higher then the 100-year American average.
What does that mean in real dollars and cents?
- If you invested $10,000 at the abnormally high return of 13% annually (which is what we’ve witnessed for the past 20 years), your money would have grown to $115,230.
- In contrast, the same $10,000 invested at the historical annual rate of return of 9.7% over 20 years, your money would have grown to almost half of that, $63,698.
Does that mean that over the past 20 years investors have made $51,532 more then they “should” have?
Well, yes and no.
Financial history has proven that periods of abnormally high rates of return are always followed by a reversion back to the mean.
Following this thinking to its logical conclusion, one of two things has to happen for stocks to get back to their long-term rate of return of 9.7%:
- Stocks have to drop by 34% quickly; or
- Stocks have to trade in a tight sideways range for a decade or two until time catches up amount of money created until the average return of 9.7% is reached.
What does that mean for you?
If centuries of international financial statistics are true, it means that, at the very least, stocks will likely trade sideways for some time.
But now, it is a different era then it was back then. Things are very different due to all the new investors in the marketplace and with stocks being so widely held. Even technology has made the old rules antiquated.
You are certainly forgiven for thinking this way. In fact, if you read market histories going back hundreds of years (in different countries) you’ll see that investors have always believed that this time is different.
But it never is. Why? Because stocks, like all things financial, are governed by the laws of economics.
And that means:
- In the long-term stocks,, P/E’s will always trade in relation to what a businessman could pay for earnings in a private market transaction; and
- Over the long-term, stocks return on average 75 – 80% of their historic returns-on-invested capital. Everything else being equal, investors’ return on stocks should approximate the companies own return (ROIC).
What to Expect in the 4th Quarter
For one thing, history suggests that it’s a waste of time to join in the silly debate of whether we’ll see a new bull market or a new bear market: over the next 3 months stock may trade higher or may trade lower, but just understand where we are in the context of history.
But as always, “caution” is the watchword for U.S. stocks. Regardless of historical context, finding cheap stocks to buy always presents different challenges.
Ultimately though, you and I will make our money together the way that we’ve made it through good markets and bad: finding great companies selling for discounted prices.
This does not mean that investing in Q4 will be easy – far from it. But with a careful eye on the markets, and a solid understanding of historical precedent, , readers of the Tycoon Report can rest assured that we will work our hardest to help you avoid the pitfalls – and identify the opportunities – on the investing road ahead!
Have a Great Week,
Dylan Jovine