Investors Can Have Cheap Stocks or Good News...Not Both

From this MarketWatch article:

One study by John Bogle, the founder of mutual-fund firm Vanguard Group, found that for the 20 years ending 2003, the S&P 500 Index SPX returned 13% per year, while the average mutual fund returned 10.3% and the average investor achieved just a 7.9% annualized return.

American Association of Individual Investors (AAII) has surveyed its members since 1988. It revealed...

The highest weight to cash — and lowest weight to equities — in the history of the survey was in March 2009, right at the bottom of the worst bear market since the 1930s. When was the highest weight to equities? January 2000, near the absolute top of the stock market's 20 year bull run.

Clearly, panic and greed lead people to do the wrong thing at the wrong time — and to do so consistently.

It's not just the individual investor.

I've referenced previously that, in the early 1970s when Nifty Fifty stocks were sporting 50x to 100x price to earnings ratios, pension fund managers were putting 90% of their cash flow into stocks. From this Fortune article written by Warren Buffett in 2001:

...this was Nifty Fifty time--pension managers, feeling great about the market, put more than 90% of their net cash flow into stocks, a record commitment at the time. And then, in a couple of years, the roof fell in and stocks got way cheaper. So what did the pension fund managers do? They quit buying because stocks got cheaper!

Here's what private pension funds looked like as  % of cash flow put into equities:

- In 1971, it was 91%, a record high.
- In 1974, it was 13%.

Later in the article Buffett added...

That sort of behavior is especially puzzling when engaged in by pension fund managers, who by all rights should have the longest time horizon of any investors. 

and...

Yet they behave just like rank amateurs (getting paid, though, as if they had special expertise).

In 1979, when I felt stocks were a screaming buy, I wrote in an article, "Pension fund managers continue to make investment decisions with their eyes firmly fixed on the rear-view mirror. This generals-fighting-the-last-war approach has proved costly in the past and will likely prove equally costly this time around." That's true, I said, because "stocks now sell at levels that should produce long-term returns far superior to bonds."

So in 1972 pensions fund managers were aggressively buying stocks:

Six years later, the Dow was 20% cheaper, its book value had gained nearly 40%, and it had earned 13% on book. Or as I wrote then, "Stocks were demonstrably cheaper in 1978 when pension fund managers wouldn't buy them than they were in 1972, when they bought them at record rates." - Warren Buffett in Fortune, 2001

Is a similar mistake being made now?

Some of the highest weightings to equities occurred in the early 1970s and around the year 2000. Both were times when equity valuations had reached extremes. Now, at least for many high quality large capitalization stocks, valuations these days seem not rich at all.

You can have cheap equity prices or good news, but you can't have both at the same time. - Joe Rosenberg in this recent Barron's interview

The Best Opportunities in a Half-Century

Jeff Saut added in this recent Minyanville article that institutional investors (hedge funds, pensions, endowments) are, once again, very underinvested in equities:

Verily, hedge funds are having a terrible year, having been caught "short," as well as underinvested with only a 43.8% net long investment position. Or how about the endowment funds that are only ~12% net long US stocks? How can those endowment funds achieve their mandates of roughly 8% per year using 2%-yielding 10-year Treasury Notes? The answer is they can't! - Jeff Saut

There's plenty of evidence, and this article provides just one example, that the small investor is doing the same.

If the recent wild leaps and plunges in financial markets have prompted you to cash out your stocks, you're not alone. Individual investors are bolting for the exits.

It's not that stocks can't still go down a whole bunch over the next year or two but the evidence strongly suggests that many market participants, professional or not, have a great tendency to get it wrong.

Well, at least more so than some might otherwise expect.

Adam

Related post:
Rear-view Mirror Investing

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