Wall Street or Las Vegas?
Playing the market. Taking a gamble. Blue chips. This is how many people refer to their investments. But are they investing or are they gambling?
If you believe you are investing, then you need to be able to answer a question.
How do you justify the valuation of the market over the last few years, relative to the meager earnings growth? (Deny it if you want, but earnings and revenues have not kept pace with the past 4 years of market growth and no one expects earnings to catch up in the next few years.)
Answer: A) I don't know; B) It is a new era, values don't matter; C) I don't know what you mean; D) I can't, but I'm hanging on as long as possible.
If you answered "I don't know," you don't belong in the market. You have not educated yourself enough about the market and the potential risks inherent in the market.
If you answered "it is a new era…," you need to study history closer. Every major market peak in the past was accompanied by claims of a "new era".
The current "new era" is propelled by great innovations such as the internet. Too bad history shows that previous innovations were even grander, yet the natural cycle of the markets and economy could not be derailed. Electricity, the assembly line and the radio were much greater influences on the economy of the 1920's, but they didn't prevent the market from becoming excessively overvalued and then falling.
Other "new era" characteristics are low inflation and the strong dollar. Unfortunately, these are also evidence of deflation. In fact, the strong dollar is a major cause of deflation. As foreign goods get cheaper and cheaper, domestic companies have to compete, so prices drop. The ironic thing is that a "new era" innovation, the internet, is also ushering in deflation. As more and more people shop on-line, the competition for their dollars intensifies and prices drop. The only "new era" we are ushering in is deflation.
If you answered "I don't know what you mean", you need to figure out why you are investing, what investing is, and what the difference between a good investment and a bad investment is. (Hint: it isn't based on track record)
If you answered "I can't, but I'm hanging on…", you are honest, at least. You are the true 1990's investor. You recognize that the market is the most overvalued in history, but are willing to risk everything to go along for the ride.
What all of these answers have in common is one thing, the people responding are not investing. No, they are gambling. And if you are going to gamble, that's fine, but there are some things you need to know.
First, the house always wins.
Who is the house? The brokerage firms, the banks and even the no-loads. They make money whether you do or not. They make it from commissions, annual fees and internal fees. It is in their best interest to keep you investing, and to keep as much of your money in the market as possible.
Second, good gamblers play the odds.
Professional gamblers don't hang around the slot machines with the old ladies and their buckets of nickels. They play the games they have the most control over and where the odds are the best.
What are the odds in the market today? As of the end of March, 1999, with the market near an all-time high, less than 5% of stocks were within 5% of their highs. In fact, a full 75% of stocks were down 20% or more from their highs and amazingly 50% of stocks were down 33% or more. Some odds.
So you play it smart and invest with the pros - you buy mutual funds. The odds actually get worse. As of June 1, 1999, only 11% of funds had a return of 15% or better for the previous 12 months. 32% had returns of zero or less. The odds were three times more likely you would have a fund that lost money over the past year than made 15%.
How about the past 5 years? Only 1,592 funds in a universe of 10,400 funds made more than 10% for the past five years. That's only 15% of the funds. In fact, only 4,187 funds have a positive return over the past 5 years. (If you are thinking, but I only need to pick a couple of those 4,000 positive funds. Positive includes funds that only made 1%.) *
Third, good gamblers know when to fold'em.
Let's look at the cards the gamblers are being dealt. The p/e ratio of the market is 30-something, the highest ever. The dividend yield is about 1.2%, the lowest ever. The market capitalization to GDP ratio is about 150%, the highest ever. Previous market tops were, on average 25 to 50% below the current levels. These were market tops, not bottoms. What are the odds the market will or has peaked? Well, the odds have been 100% that whenever the market was dealt these cards in the past, a long bear market followed. Those odds were 100%. Never in the past has a market had valuation numbers like today without being followed by a bear. This is a losing hand and the smart move is to fold, not up the ante.
Fourth, good gamblers know that a hot streak doesn't last forever.
What about the long-term investor? They are certainly not gambling, right? Wrong. They are possibly gambling the most. In recent years, returns have been fantastic, about 15% average per year, on the trailing ten years. But, the market has had returns similar to these in the past. In fact, the 10 year average annual return has always gone negative after returns similar to the recent performance. Further, over the past 120 years, the market had negative ten (10) year returns 23% of the time, while it returned 15% or more per year only 17% of the time. You are more likely to lose money over ten years than make 15%. Not what Wall Street would have you believe, is it?
This market is being pumped up higher and higher on nothing more than air. Smart investors have seen the overvaluation and left the game. All that are left are gamblers, and as we have pointed out above, even gamblers don't belong in this market.
So, why you are investing? Can you give a good answer to why the market is as overvalued as it is today? Do you know the average p/e multiple on your mutual funds? On your stocks? Or are you just gambling? Hoping that the funds will keep going up forever. Hoping that you will be one of the fortunate few to get out, just seconds before the market peaks. Hoping that history won't repeat itself, again.
Did you invest because of an enticing track record? Or because the salesman said it would be good? Or you don't want to be left behind? Or because "everybody else" is making money in the market? Is it really worth risking your retirement on a gamble?
If you don't want to be left out, Vegas has lots of people winning every day, and at least they serve drinks and have cheap buffets to feed you. The market is only going to lure you to thinking you are investing when you are really gambling. You are gambling that the overvaluation won't be corrected. You are gambling that this time really is different. You are gambling that you are smarter than Alan Greenspan, who warned of "irrational exuberance." You are gambling that you are going to get your share of the profits before it all goes south.
If you are in the market and don't have good answers to these questions, don't kid yourself anymore, you are not investing, you are gambling. It's your deal. |
