Our 220-year-old stock market is a powerful assemblage of companies, strategies, directors, flacks, hucksters, and heroes joined by a spirit of capitalism that can marry Taco Bell with Doritos.
But why stop at that if you’re the financial services industry? What’s especially great about the market is how nicely it lends itself to marketing razzle-dazzle: “value-add,” as they call it on the Street. How else would a mutual fund industry whose active managers generally lag their market benchmarks still be worth nearly $12 trillion?
In his provocative post this week, “Everything You Know About Investing is Wrong,” blogging asset manager Barry Ritholtz shows us how metrics such as dividend yields, economic growth, the Fed Model, profit margins, and past stock returns—what he calls “the assumed truths of Wall Street”—“fail to withstand close scrutiny as having forecasting value.”
While sipping my annual pre-prandial Thanksgiving Courvoisier, I stumbled on a great piece of similarly demystifying research from Birinyi Associates entitled “Six Myths of the Market.” The firm, which was founded by ex-Salomon Brothers trader Laslzo Birinyi, called the market’s generational bottom in March 2009. Authors Jeffrey Yale Rubin and Kevin Pleines penned the note to take on some generally accepted half-truths of investing.
“With the S&P 500 down 5 percent from its mid-September high,” they write, “the chorus of investors and strategists suggesting that this is the start of something bigger has grown louder. With the decline, some new and some not new ideas are being bounced around in support of the negative case. We thought we would take this opportunity to review the accuracy of some of the arguments for the negative thesis.”
That intro is accompanied by a series of charts that show that the 10 U.S. bull markets since 1962 have experienced no fewer than 95 “corrections” of 5 percent or greater.
The current bull run alone has had 17, so you can understand why investors have bolted the market en masse. Or have they? Let’s start with the most eye-opening Birinyi finding:
Myth: The individual is selling.
Haven’t you heard? Investors, wherever they may be, want no part of this three-and-a-half-year bull market. They got burned in the dot-bomb and in 2008; three times would just be too suckerish. And so money continues to storm out of equity mutual funds—to the tune of $97 billion in just the first 10 months of the year, and multiples of that over the past four years.
“However,” notes the Birinyi report, “what most research is missing is the offsetting net inflows into equity ETFs over the same period.” Since March 2009, the authors write, there has been a cumulative net outflow from equity mutual funds of $242 billion, but an inflow of $270 billion to equity ETFs: “In other words, [investors] have increased their exposure to equities.”
For the first 10 months of 2012, the report says, the offset results in a $6 billion net outflow—“a far cry from the figures that are most often cited.” This comes as Vanguard index funds have had a net 2012 inflow of $88 billion, and while ETF providers slug it out on fees. So much for “Death of Equities Redux.” Rubin and Pleines accordingly “wonder if investors are not necessarily saying that they disliked stocks as much as they are suggesting they disliked actively managed mutual funds.”
Myth: Tax increases are negative for stocks.
The fiscal cliff is supposed to be Armageddon for the market. There have been no shortage of notes from Wall Street and Washington reminding us of how suddenly increased taxes on dividends and capital gains, paired with investing surcharges and the GDP body-blow of automatic budget cuts, will kill equities.
And yet markets are up nicely year-to-date, and actually not far off their record high. How can traders be so maladroit in their anticipation?
Rubin and Pleines note that while there’s never been such a large one-two punch of spending cuts and tax increases, there have been other instances where capital-gains taxes have increased, and significantly more so than they are set to rise this go-around. “We would caution that this time may be different given the combination of tax increases and spending cuts,” they write, “but in the previous two increases since 1942 in the capital-gains tax rate, the record for stocks is mixed, having rallied once and declined once.” In 1976, markets swooned after the top rate increased from 25 percent to 35 percent; a decade later, they went up after the top bracket increased from 20 percent to 33 percent.
Myth: The market is expensive.
Says the report: “Bears have argued almost since day one that the market is not attractive, and if we look at the ten-year trailing normalized earnings approach (usually associated with Robert Shiller), we should be concerned. First, we are always suspicious of contrived or artificial measures. Why ten years, why not a normal economic growth recession cycle (approximately 61 months) or ‘usual’ bull-bear cycle? Or why ten and not five?”
When Rubin and Pleines use “the conventional approach of market multiples (trailing 12 month earnings),” they calculate the S&P 500 trades at 14.8 times earnings, compared with an 85-year average of 16 times.
“Mr. Shiller’s record,” they add, “is less than compelling. In the March 30, 2009, issue of Forbes he said that his P/E calculation would have to drop another two points before he would buy. Given that the magazine has at least a two-week lead time, it was probably made around the second week of March 15, exactly when the market was hitting its low. Since then the market is up 110 percent.”
Myth: Corporate profits will disappoint.
“This mantra has been a hallmark of the bears for the past three years,” Rubin and Pleines note, “yet each quarter earnings have exceeded forecasts.” They point out how this past quarter’s overly curbed enthusiasm was no different, as analysts were looking for a 2 percent earnings contraction, “but when all was said and done earnings grew at a 4.7 percent pace.”
Rubin and Pleines do concede that earnings estimates for the fourth quarter and next year have been declining, “but given analysts’ track record of forecasting earnings, we are skeptical that this time will be any different.”
Myth: Technology is a canary in the coal mine.
“The 11 percent decline in technology stocks since mid-September has led some to suggest that a steeper decline is imminent for the S&P,” write Rubin and Pleines. After all, Apple, the market’s biggest weighting—and (probably) consensus indicator species—recently lost as much as a quarter of its peak value. The reality: The relationship between technology corrections and the broader market is “hardly a strong one.” The report notes that since 1982, technology stocks have had 39 declines of at least 10 percent, while the S&P 500 experienced a 10 percent correction just eight of those 39 times.
For those keeping score at home, the tech-laden Nasdaq would have to rally 70 percent to revisit the bubblicious high it set in early 2000.
Myth: Corporations have been building cash reserves.
A grain of salt for an otherwise bullish research note: The notion that corporations “have excessively high cash positions which will be spent once the fiscal cliff is resolved is not supported by the data.”
There goes one fine meme for us financial journos: record corporate cash, itching for a place to go.
The report’s authors explain that excluding financial companies, balance-sheet cash of the S&P 500 stands at $787 billion, which is just below the record $819 billion set at the end of last year. But they then present a chart that shows corporations have actually lugged record cash during nearly every quarter since 1990. “Why now,” they ask, “will this be spent after 20+ years of record readings?”
When they adjust cash holdings by company market value, Rubin and Pleines find that cash is in fact not at a record, and has not been for more than three years.
Not that this scuppers Birinyi Associates’ view that the S&P 500 is headed to highs unseen since the mythical era when Lehman and Bear roamed the earth.