Multi-Unit Franchisee Magazine Issue II, 2014 | Page 72
InvestmentInsights BY CAROL M. SCHLEIF
A Balanced Approach
Fundamentals and feelings can co-exist
I
f the nation hadn’t been in the midst
of a government shutdown and debt
ceiling debate, last year’s Nobel Prize
winners in economics probably would
have received more attention and commentary. Two of the three winners—Eugene Fama of the University of Chicago
and Yale’s Robert Shiller—are as different
as Tea Party Republicans and Democrats
in their theories about the rise and fall of
stock prices and other assets. Investors can
learn a lot from both.
To Fama, markets are efficient systems
where relevant information is immediately
and rationally reflected in stock prices. So,
for the most widely researched portions
of the market, such as domestic U.S. large
cap stocks, that means active management
is nearly impossible.
Numerous studies show just how difficult it is for active managers to consistently
outperform the market when operating in
the most efficient and liquid asset classes,
since thousands of other individuals are
able to simultaneously adjust to each bit
of information just as quickly. This inability to gain an edge amid a well-informed
crowd has helped popularize such investment vehicles as index and exchange traded
funds (ETFs).
In Shiller’s behavioral finance theory,
markets and prices are considered as emotional and irrational as the people making
the investments—a version of the “fight
or flight” response that allows people to
survive danger.
After 30 years on the front lines of the
investment business, my experience aligns
more closely with Shiller’s. I can cite hundreds of examples.
Take U.S. equity markets. As we closed
out 2012, the sequestration cuts, budget
impasse, and increases in payroll and marginal tax rates seemingly would have led
you to believe that U.S. equity markets
would swoon in late 2012 and into 2013.
Remember that the tax and budget deal
70
MULTI-UNIT FRANCHISEE IS S UE II, 2014
Some of the best
long-term tactical
opportunities often
come when the
herd is running hard
in one direction,
but fundamentals
indicate a
different course.
didn’t get signed until early January. However, the opposite happened. The S&P
500 actually rallied more than 10 percent
by the end of first quarter and ended the
year more than 30 percent higher!
Last summer, when the Fed said the
U.S. economy seemed to be recovering
well enough to be taken off monetary life
support (quantitative easing), the markets plunged, instead of rising to applaud
an economy healthy enough to stand on
its own.
Now, some investors are cheering the
notion that the Fed is moving slowly in
retracting its monetary stimulus. It is likely
that the Fed will not raise short-term interest rates until well into 2015 or beyond,
given the still tenuous state of developed
economy fundamentals and balance sheets.
Longer term, flooding the globe with cheap
dollars is bound to have consequences. I
discuss much more on this topic in “The
End of the Bond Bull,” a white paper you
can read on abbotdowning.com.
Think this applies just to the stock market? What about in 2011 when Standard &
Poor’s downgraded the AAA credit r ating
of U.S. government debt? U.S. Treasury
securities actually rallied on the day of
the downgrade! Global equity markets in
general were roiled as investors prized the
perceived security of treasuries more than
the effects of the downgrade.
Fundamentals and feelings can co-exist. Both schools of Nobel Prize-winning
thought can complement each other in a
well-thought-out portfolio or investment
program. For example, investors who want
participation in the many corners of the
markets that are increasingly well covered
and efficient would theoretically look for
investment vehicles that allow broad and
cheap participation (ETFs, for example).
Those wanting to invest in parts of
the globe or in asset classes that are less
efficient (fewer analysts covering, fewer
investment choices, less market depth,
etc.) should be willing to pay a premium
price to active managers with strong track
records in those segments.
Meanwhile, behavioral finance reminds
us to consciously and actively seek to test
the implied wisdom of current market
prices against a solid evaluation of intrinsic
value. Some of the best long-term tactical
opportunities often come when the herd
is running hard in one direction, but fundamentals indicate a different course.
Carol M. Schleif, CFA,
is regional chief investment
officer at Abbot Downing, a
Wells Fargo business that
provides products and services through Wells Fargo
Bank, N.A. and its affiliates and subsidiaries.
She welcomes questions and comments at
[email protected].