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Harry's Notes
(11/20/11)
David Edwards, president of Heron
Financial Group, who is one of my favorite money managers, produces a
monthly market commentary. His latest, published November 18, was
especially insightful. Here's a condensed version. Visit Heron's website
to download the complete commentary.
Comments?
Behavioral Finance: Why
watching CNBC won't make you rich.
by David Edwards
Heron Financial Group (www.heronfinancialgroup.com)
Investors withdrew $6.8 billion from US stock funds in September, $15.5
billion in August and $22.9 billion in July... Warren Buffet, meanwhile,
invested $23.9 billion in US markets in Q3 - his fastest pace of investment
in 15 years. As of March 2011, Buffet was worth about $50 billion, so who do
you think is making the correct assessment of the investing climate?
We believe that the current confluence of strong and rising earnings, low
stock price valuations and exceptionally low interest rates presents one of
the best stock buying opportunities in 50 years. We also believe that most
Americans will not take advantage of that opportunity because most invest
with their hearts, not with their heads, and right now their hearts are
filled with fear! To help our clients invest with their heads, we present:
Behavioral Finance (why watching CNBC won't make you rich)
Since the 1950's, academic researchers postulated the existence of Homo
Economicus who coolly and calmly evaluates investment decisions based on a
careful measurement of risk and return. The problem is that this model
doesn't adequately explain boom and busts, whether in dot.com companies,
real estate, emerging market shares, or, as we saw in the 17th century,
tulips.
In recent decades, researchers explored why investors often make decisions
that are contrary to their long term financial health. The answer, we
believe, is that our decision making has not evolved much beyond that of our
caveman ancestors, even though the world we live in today is unbelievably
complex. Faced with complexity, we take short cuts. For example, if you
stood in a hotel lobby and all of a sudden two dozen people ran past you out
the door, would you stay put to understand what the danger was, or would you
run just as briskly? 15,000 years ago, the caveman who stood around
wondering most likely fed a saber tooth tiger.
Warren Buffet buying large when others sell is a classic example of
contrarian investing, an investment style that goes against prevailing
market trends by buying assets that are performing poorly and then selling
when they perform well. Humans, alas, are herd animals who become distressed
when acting contrary to the group. Think about the distress you feel when
your investment advisor maintains or even adds to your stock allocations,
when clearly "a depression is eminent." We track monthly and quarterly cash
flows into stock mutual funds and we've found that most investors buy when
the market has already moved up and sell after it has dropped, in other
words, they buy high and sell low.
Why CNBC is not your friend
CNBC is available in practically every bar, gym, airport departure lounge,
shoe shine stand and elevator in America. CNBC's primary editorial line is
"what should you trade today?" When markets get particularly hairy, CNBC
flags "danger" by putting up to ten talking heads on the screen. Three
people are talking, two are shouting and the rest are shaking their heads.
The image conveys plenty of emotion, but the informational content is zero.
We believe that most people have no business "trading" because mostly they
are chum for the high frequency trading sharks. The producers and on-air
talent at CNBC are not maliciously misleading small investors; they truly
believe they are delivering a quality service. However, CNBC is in the
business of delivering ratings to advertisers who are primarily brokers
whose income is trading commissions. Earnest Sam Waterston of "Law & Order"
pitches TDAmeritrade's "trading tools" to sexy, skinny clients living in
architecturally perfect homes. We have never met anyone like those "traders"
in real life!
The biggest offender is Jim Cramer and his edutainment "Mad Money" show. We
think Cramer is a very smart, talented person. His thesis is that the
average American can do their job, take care of their family, and day-trade
their 401K. Perhaps two people in a thousand can achieve that skill after
years of practice. Like a Pied Piper of investment gurus, Cramer is leading
Mr. & Mrs. America off a cliff!
What bugs us the most about CNBC is that their daily focus on whether "the
risk trade is off or on," which distracts investors from the really
interesting news that not only or S&P 500 earnings at record highs, but also
the next several years look pretty good for earnings. As we have said time,
US companies are an investment in the world economy, not just the US
economy.
Fighting the last war - fears of the "European contagion"
Like the mythological Hydra, as fast as one problem gets solved in Europe,
two more spring up in its place. In July, we wrote, "If Greece in fact
defaults, some European banks will lose some money but will not lose all
their capital as we saw in 2008 among Bear Stearns, Lehman Brothers, AIG and
certain European banks!" Greek debt was written down by 50%, but a technical
default was avoided.
Strategy
Since the last week of October, US stocks have traded in a tight range on
either side of unchanged on the year, but daily swings of over 1.5% are
common. Bears say "Europe will crush the banking system again." Bulls say
"Stocks are cheap, earnings are strong, interest rates are very low." We are
bulls and are fully invested.
Yours sincerely,
David Edwards
Heron Financial Group, LLC
The HERON FINANCIAL GROUP Financial Markets Commentary is
published following month end and whenever market conditions require
comment. The views expressed in this letter represent HFG opinion and
strategy as of the date published and can change at any time upon receipt of
new information. Data quoted in this letter are from sources deemed
reliable, but no guarantee of such data is implied.
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