By DAVID MOON, Moon Capital Management, LLC
July 1, 2012
Will Rogers suggested that investors should buy good stocks and hold them until they go up, then sell them. “If they don’t go up,” the humorist extolled, “don’t buy them.” That sounds great in theory – and plenty of people try – but there is no evidence to suggest that investors can successfully follow Rogers’ market-timing advice.
There is plenty of evidence, however, that investors fail miserably when they try.
Invariably, investors buy high and sell low, causing most stock investors to earn returns woefully less than the returns of the stocks and funds in which they invest. In a sort of reverse Lake Wobegon, Wall Street is a place where most people are below average.
In the fourth quarter of 1999, investors moved a record $60 billion into stock mutual funds. The US market peaked the very next quarter, beginning a 34 percent, two-and-half-year decline.
That 34 percent market decline bottomed in March 2002 – the same quarter in which investors withdrew $40 billion from stock funds, a multi-year record at the time.
Investors were pouring money into stocks when the Dow was at 11,000; they ran screaming from stocks 30 months later when the Dow was at 8,000.
The pattern repeated itself as the Dow increased 80 percent from 2002 to 2007, with investors eagerly buying stocks when the Dow reached its late 2007 peak of almost 14,000.
Predictably, withdrawals peaked in the first quarter of 2009, about the same time the Dow reached a bottom of 6,600.
In the third quarter of 2011, flows out of US equity funds totaled $75 billion, while the market dropped 11 percent. This was a time in which investors should have considered buying stocks, not selling them.
Some investors falsely assume that by accurately forecasting what other investors are going to do, they will know where new investment money is headed, and can therefore predict changes in prices. While it may sound tempting, this is another fallacy. A May 2012 paper from the Investment Company Institute (ICI) found that fundamentals, not money flow, drive commodity prices. If any asset class should lend itself to predictable price moves on the basis of fund flows, it ought to be commodities. After all, products such as corn, oil, wheat and soy beans don’t actually produce anything on their own; their value derives from their demand.
Yet the ICI found that the supply and demand relationship for the underlying commodities are responsible for the price movement of those commodities – not the money flow into or out of financial instruments representing ownership or derivative interests in those asset classes.
In other words, long-term commodity prices, like those of stocks, are a function of the underlying fundamentals of the assets, not the short-term money flow in and out of those asset classes.
With most purchases in our lives, we tend to equate lower prices with buying opportunities. Few of us rush to buy a car once we learn that General Motors has increased the price ten percent.
Why do the same with your IRA?
David Moon is president of Moon Capital Management, a
Knoxville-based investment management firm. This article
originally appeared in the News Sentinel (Knoxville, TN).