Stock Picking: Confident Assertion or Financial Folly

Have you ever personally experienced a Confident Assertion within yourself or while observing others? I think it’s interesting in the area finance, how many Confident Assertions are made about the stock market. Then with hindsight become a bitter punch line, more so than a reality. We see this with recommendations from bullies on Wall Street; the Guru, the Prognosticator, the Conman. These assertions often lead to massive amounts of trading (as well trading cost) on a daily basis that siphoned off real gains and profits for the average investor. They propagate an age-old idea that stock picking or chasing the market is the key to beating the market?

Benjamin Graham, an economist, author, and professor, was famous in the 1930s and 1940s. He originally introduced the idea of fundamental analysis to substantiate company stock picks which may be undervalued. This certainly sounds plausible on the surface, “buy low…sell high”. However, the reality is that constant searching for tidbits of information often triggers emotional responses which lead to excessive stock buying and selling. The unintended consequences are often a lack of diversification, as well, associated costs of trading and chasing short term economic indicators.

Graham, known as one of the greatest stock pickers of all time, the man who wrote two classics on investing; Security Analysis and The Intelligent Investor. Shortly before his death in 1976, he told the Journal of Finance the following:

–I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when Security Analysis was first published; but the situation has changed. I doubt whether such extensive efforts will generate sufficiently superior selections to justify their cost.—

Apparently, many managers did not get the memo on Benjamin Graham’s revelation of hindsight. Perhaps they missed that class or decided to play hooky that day. The point is that many of these so-called financial Confident Assertions fly in the face of the empirical scientific realities of finance. Allow me to demonstrate by looking at the current trend of many fund managers today, as of May 2017. We see many managers migrating to international from US equities rather than owning them all along. Once again by chasing the market they’re coming to the party a little late.

Let’s look at some of the returns that have taken place in the last 45 plus years. Leading up to 2017, the five-year period ending in 2016 saw the S&P 500 (US Large companies) gain 98% while the EAFE (International large companies) was up only 40%. Many advisors fell into the trap of thinking that this was the new normal, that it was prudent to invest in all U.S. stocks and ignore international. They continue to violate the three simple investing rules:

1.  Own equities (stocks)
2.  Diversify (dissimilar price movement, umbrellas and sun screen)
3.  Rebalance (asset classes not sensational sound bites)

Without a crystal ball making Confident Assertions to which asset classes will perform better over any short-term period can lead to a bitter punch line. Consider the following examples of varying five-year periods of U.S. equity (S&P 500) performances as compared with international (EAFE):

1971-1975  EAFE outperformed the S&P by 48%

1979-1983  S&P outperformed the EAFE by 60%

1984-1988  EAFE outperformed the S&P by 257%

1989-1993  S&P outperformed the EAFE by 85%

1995-1999  S&P outperformed the EAFE by 166%

2002-2006  EAFE outperformed the S&P by 70%

2012-2016  S&P outperformed the EAFE by 58%

What is truly extraordinary is that during this entire period (1971-2016), both asset classes had an average annualized return of 10% per year – these returns just occurred unpredictably at different times.

The Portfolio MRI is a tool used to identify the way a portfolio is built; it shows the actual percentage breakdown of where ones money is allocated. Do returns come from managers or the market? How are you invested?