Much has been made recently of the flattening yield curve. But Mark Hulbert says the data indicates the flattening isn’t a major trouble sign.
MarketWatch’s Mark Hulbert says that stock market sentiment has recently reached “dangerous proportions”, but also says that means little for longer term market performance.
In a recent column, Hulbert said that the average level of equity exposure among a group of market-timing newsletters he monitors through Hulbert Financial Digest was at nearly 94%, a level that, when reached, has been accompanied almost every time by a short term peak or near-peak in the Nasdaq Composite Index in recent years. “But notice also that, after each of those recent pullbacks, the market’s uptrend resumed,” Hulbert added. “It would have been a bad idea for someone on any of those prior occasions to have declared the bull market over and gone completely to cash.”
Hulbert analyzed historical data and found that up until about ten years ago, sentiment data “had its greatest explanatory power at the three-month horizon. That’s a short enough horizon already, but it has shrunk in recent years — and is now little longer than one month.”
Hulbert says the recent overly bullish mood “now tells us little more than that the market is vulnerable to a short-term decline lasting little more than a month — maybe three.” Sentiment won’t cause a new bear market, he says.
Earnings often dominate the investing headlines, but according to a growing body of research, a better indicator of future stock returns may be gross profitability.
The research focuses on gross profits because “a company’s earnings reflect myriad factors having nothing to do with how profitable it is likely to be in future years, says Robert Novy-Marx, a finance professor at the University of Rochester,” Mark Hulbert writes in a MarketWatch column. He says Novy-Marx divides gross profits by total assets in order to compare companies of different size. Research has found that historically, firms in the top 20% percent of the market on that basis have outperformed those in the bottom 20% by 3.5 percentage points annually over the next year.
Hulbert warns not to put all your eggs in one basket, however, noting that valuation is always important. In fact, Novy-Marx has found that the most-profitable companies with the cheapest valuations have outperformed the least-profitable companies with the highest valuations by an average of 7.4 percentage points a year.
While stock correlations have been declining, several researchers say that doesn’t make the current environment any better for stick pickers — whose odds of success remain exceptionally low.
“One factor that has a big effect on stocks’ sensitivity to movements in the overall market: changes in the market’s overall volatility, as measured by benchmarks like the Chicago Board Options Exchange’s Volatility Index,” Mark Hulbert writes in a recent MarketWatch column. ” Yet those fluctuations don’t mean there has been any real change in stocks’ relationships to the overall market, according to Kristin Forbes, professor of management and global economics at MIT’s Sloan School of Management. ‘It’s an artifact of the statistics that any time volatility decreases, correlations decrease automatically as well,’ she says.”
Hulbert adds that, “in addition to low market volatility recently, another reason why stocks have been acting more independently of late is that the pendulum has swung so far away from the fear end of the spectrum.” As fear increases, stocks tend to move more in sync with each other, he says. “The investment implication: Stocks — at any time and with no warning — could once again begin moving in lock step with the overall market. As a result, stock selection has no greater odds of success now than at any other time.”
Unfortunately, those odds are quite poor, he says. One researcher tells Hulbert that “less than 1% of individuals who trade frequently can consistently outperform the market through skill. Over the long run, the rest would be better off investing in low-cost index funds benchmarked to the broad market.”
Stocks have been bouncing back strong from their August troubles, but Mark Hulbert says the tone of the rally isn’t a good one.
“Nothing so well illustrates Wall Street’s dangerously exuberant state of mind as its triple-digit rally in the wake of Larry Summers withdrawing from consideration to be the next Federal Reserve chairman,” Hulbert writes in a MarketWatch column. “Do you really believe the outlook for corporate earnings suddenly became much brighter just because Summers is no longer in the running to succeed Ben Bernanke?”
Hulbert says the Summers bounce is just one example of the stock market shrugging off bad news with little or no losses — and then “bouncing back” as though there actually had been a big decline. “According to contrarian analysis, this sentiment situation is at the opposite end of the spectrum from the wall of worry that bull markets like to climb,” he says. “It’s more akin to the slope of hope that bear markets like to descend.”
Hulbert notes that the average recommended equity exposure among the short term market timing newsletters he tracks is 56.6%, according to the Hulbert Stock Newsletter Sentiment Index — 45 percentage points higher than it was in late August. Such a big jump in such a short period is a concern, he says. He thinks the market is being driven more by mood than fundamentals, and says investors could be in for a rude awakening when the collective mood sours.
Should you be worried about all the headlines saying that the Syrian crisis will pound stocks? Not if history is any guide, says MarketWatch’s Mark Hulbert.
Hulbert says that historically, the market has suffered only minor losses because of geopolitical crises, and has rebounded quite quickly in many cases. He references a 1989 study performed by economics professors David Cutler of Harvard, James Poterba of MIT, and Larry Summers, who is now in the running to be the next Federal Reserve chief. In it, the professors examined how the stock market fared on 49 days in history when major geopolitical events occurred, such as the Kennedy assassination and Pearl Harbor bombing.
“They came up with little evidence that non-economics events had a big effect on the stock market,” Hulbert writes. “On average, across all 49 events on their list, the S&P 500 moved just 1.46%, less than one percentage point more than the 0.56% that prevailed on all other days. Because of this small difference, the professors concluded that there’s ‘a surprisingly small effect of non-economic news’ on the stock market.”
Hulbert says that doesn’t mean wars have little or no impact on economies and markets. “Rather,” he says, “this conclusion is testament to the stock market’s much-vaunted ability to discount the future. The market takes into account what investors see coming down the pike, not just months in advance but sometimes even years. And the Syria quagmire is hardly something that just erupted onto the world scene.”
If you’ve spent time lately trying to figure out when the four-plus-year bull market will come to an end, Mark Hulbert has a message for you: Stop kidding yourself.
“The vast majority of professional advisers who try to get in and out of the stock market at the right time end up doing worse than those who simply buy and hold through bull and bear markets alike,” Hulbert writes in his MarketWatch column. “Even those few who beat a buy-and-hold strategy during one period rarely beat it in the next one. What makes you so confident you can do better?”
Hulbert says that the 20 market-timing strategies monitored by his Hulbert Financial Digest with the best records through the 2000-02 bear market and the subsequent bull market fared no better during the 2007-09 bear than the average of dozens of other advisers he monitors, losing an average of 26%. “In fact,” he adds, “the 20 worst timers from the 2000-07 market cycle actually made money in the subsequent bear market. Their portfolios gained an average of 3.2%, while the average market timer lost 26%.”
Hulbert says that by employing simple buy-and-hold strategies with index funds, you can beat the market timers. “Consider a portfolio that, over the past two market cycles, was divided equally among U.S. stocks and bonds, international stocks and bonds, gold and a money-market fund,” he says. “Such a portfolio would have produced a 5.2% annualized return since the 2000 market top, nearly double the return of the U.S. stock market itself — and this superior return would have been produced with less than half the volatility of U.S. stocks.”
Investors are very often drawn to flashy, exciting stocks — those that exhibit the most volatility. But, says Mark Hulbert, they should be doing the exact opposite.
“That is because ‘boring’ stocks — those that have exhibited the least historical volatility — on average outperform the most ‘exciting’ issues — those that have been the most volatile,” Hulbert writes in The Wall Street Journal. “And not by just a small margin, either.”
Citing research performed by Nardin Baker of Guggenheim Partners, Hulbert says that a portfolio invested in the 10% of lowest volatility U.S. stocks would have outperformed a portfolio invested in the 10% of stocks with the highest volatility by 19 percentage points per year from 1990-2012. Baker found very similar results in 20 other developed markets and a dozen emerging markets, Hulbert says.
A few reasons may be behind the low-volatility effect, Hulbert says. University of California, Berkeley Finance Professor Terrance Odean offered one: “Individual investors don’t systematically search for stocks to buy. They buy the stocks that catch their attention,” Odean said. “These tend to be volatile stocks, with big price moves, about which exciting stories can be told. Investor buying can drive up prices, volume, and volatility. … And that, in turn, often leads to even more attention getting paid to these companies, more overpricing in the short run and underperformance in the long run.”
Baker, meanwhile, says analysts are drawn to high-volatility stocks because they want stocks with the highest upsides, adding that high-volatility stocks tend to turn over more often, so those stocks generate more trading revenue for brokerages. Peter Hafez, director of quantitative research at RavenPack, also tells Hulbert that his research shows low-volatility stocks tend to respond better to both good and bad breaking news than high-volatility stocks do.
The bottom line, according to Hulbert: “The clear investment implication is to load up your portfolio with boring stocks and shun the most volatile ones.”
Professional and individual investors have long had a hard time beating the broader market. And, says Mark Hulbert, the rise of computer trading programs may be making it harder than ever.
Hulbert writes in The Wall Street Journal that it’s been “nearly impossible lately” for investors to consistently beat index funds, and just as difficult to predict which managers will be able to do so. “Consider the 51 advisers out of more than 200 on the Hulbert Financial Digest’s list who beat the market in the decade-long period that ended April 30, 2012, as measured by the Wilshire 5000 Total Market index, including reinvested dividends,” he says. “Of that group, just 11 — or 22% — have outperformed the overall market since then.”
Hulbert says that computerized trading has been winning out over traditional advisers in large part because computers can process vast amounts of financial data very quickly, which most people cannot do. He also says that investors “unwittingly let their emotions dominate their intellect”, something that is not a problem for computers. He references the work of behavioral finance pioneer Daniel Kahneman, who, in his 2011 book “Thinking, Fast and Slow,” reviewed more than 200 academic studies that analyzed competitions between human beings and mechanical algorithms. Whether the subject was medicine, economics, business, psychology, sports predictions, or the quality of Bordeaux wine, “the accuracy of experts was matched or exceeded by a simple algorithm,” Kahneman said.
Hulbert says all this means that investors should trade as infrequently as possible. Computer trading now dominates Wall Street so much that even professional managers “will lose out to them over time”. He recommends low-cost buy-and-hold index funds.
Hulbert does say that there may well be a place for human investors amid an increasingly computerized Wall Street. Brad Barber, a finance professor from the University of California, told him that computers cannot do some things, like determining whether a pattern makes sense. “If you don’t understand the reason for a pattern, you’re vulnerable to following a mindless algorithm that is quite likely to perform poorly,” Barber said.
While stocks have been climbing higher, fundamental indexing guru Rob Arnott of Research Affiliates hasn’t changed his outlook for the coming decade — and it’s not an optimistic one.
In a recent column for MarketWatch, Mark Hulbert looks at a forecasting model Arnott uses that has been highly accurate over the past century-plus. The model forecasts stock market returns by adding together just two factors: dividend yield and real growth in earnings and dividends. “Even if we generously assume that this latter growth rate will be just as high as in the past, despite the anemic economy, we only get a projected nominal return of between 5% and 6% annualized over the next decade [using the model] — about half stocks’ long-term average,” Hulbert writes.
According to the model, for stocks to post “anything close to [their] long-term average return, earnings and dividends will have to grow at more than double their historical average,” Hulbert says.
But Arnott actually thinks growth will be lower in the future than in the past, because of “demographic headwinds.” He thinks that could reduce GDP by 2% annually. Hulbert writes.