Exposing
Bogus Investment Claims
By Kenneth Coleman
The Investment Tracker
This is Part 2 of a 2-Part article. In the previous Bull & Bear issue Ken Coleman dispelled some of the market "truisms." In this month's issue, Mr. Coleman will dispel two more market truisms. To read Part I click here.
In the early days of stock investing, winning investors had only Dow Theory to determine if the stock market was bullish or bearish. These investors used fundamental analysis to choose their stocks. More sophisticated investors used the ticker tape machine to alert them to stocks that were under accumulation and distribution.
This investing strategy represented a very early ability to utilize money flow analysis. The best ticker tape readers could keep track of the up and down ticks of more than one stock as they viewed the tape. In the 1920s and 1930s, stocks had a much lower trading volume than today. The Dow reached a high of about 320 in 1929. Today, it trades in the 10,000 range.
The ticker tape has become the streamers you see on your television or computer when viewing financial stations or websites. As Main Street started to pay more attention to Wall Street, stocks became a favored choice for investments by the average investor. As their savings moved out of banks and into stocks, the demand for market investment knowledge skyrocketed.
Too often, those who interpreted market research for investors were self-serving and not objective. Eventually, market "gurus" developed some market "truisms" that many investors still take as gospel to this day. In Part 1 of my Exposing Bogus Investment Claims article, I dispelled some of the market "truisms."
Now, we'll dispel two more market truisms: (1) Value stocks earn more than growth stocks; and (2) Asset allocation accounts for more than 90% of your returns (profits).
Before we examine these truisms, let's digress for a moment. In the 1980s and 1990s, I became livid as I watched the mutual fund industry become rich beyond its wildest dreams, advising mutual fund investors to buy and hold because it was the best way to invest in stocks. The mutual fund industry neglected to tell investors that it took from 1929 until 1966, when taking dollar value loss into consideration, to regain losses from the 1929 crash. And, that only got investors even, not ahead.
Dispelling "Value Stocks Earn
More Than Growth Stocks"
I have been using the work of Walter Updegrave, the author of "Everything You Think You Know About Investing is Wrong" (Money Magazine, May 1999) as the basis for my research. To quote Updegrave,"...few strategies can boast a more distinguished lineage than value investing. In the 1930s, the legendary Columbia University finance professors Benjamin Graham and David Dodd laid out the analytical framework for investing in stocks that are cheap on the basis of their underlying assets or earnings power, and they passed that knowledge on to a protégé who has managed to do pretty well following value's precepts. That would be Warren Buffett..."
Buffett has managed to find value in stocks since 1967 and has been at the helm of Berkshire Hathaway Company for about 37 years. During that time, the company's stock price skyrocketed from $12 a share to its recent 52-week high of over $95,000.
When University of Chicago professors Eugene Fama and Kenneth French published their 1992 study that unequivocally supported the value school by showing that between 1963 and 1990, "undervalued stocks (those whose prices were low relative to the value of their net assets) outgained growth stocks (those whose prices were high relative to the value of their net assets)."
No one questioned their findings because it appeared to support what most investors had been observing - Buffett's stock picks going up like clockwork, year after year.
Unfortunately, few investors were able to get the same results when attempting to use Buffett's value strategy. It appeared that value investing depended almost entirely on the skill of the investor, rather than the strategy.
To quote Updegrave, "Intrigued by this disconnect between conventional wisdom and real-world results, University of Iowa finance professor Tom Loughran decided to re-examine the evidence on value stocks." What Loughran's research produced when he compared returns on growth and value stocks between 1963 and 1995, was "...there was a value effect - but for small stocks."
Loughran found that for the largest 20% of companies which account for about 75% of the stock market's total value, there was "no statistically significant difference in the performance of value vs. growth." The evidence for value's having an edge existed for only the micro caps - stocks with around a $250 million or less market cap. That represented only about 6% of the market value of U.S. stocks as of 1999. My guess is that small percentage has shrunk even smaller since then.
Loughran warns, "exploiting any advantage small value stocks may hold in theory can be difficult at best in the real world, where investors must deal with transaction costs."
In the mutual funds industry during the period 1978 to 1998, growth funds outperformed value fund 16.9% to 15.5%. Professor Fama took exception to Loughran's findings. He claimed the poor showing of value mutual funds was tainted because mutual fund managers were "biased toward growth stocks and were unlikely to limit themselves to buying value stocks, with low prices relative to their book value, because they tend to be distressed and they look terrible."
Fama's subsequent work "confirms that both large and small value stocks outperform their growth counterparts over the long run..." Fama's work turns to a very long term outlook at this point. He contends, "it may take a very long time (30 years at least) for value's superiority to assert itself definitively."
During shorter periods of time, Fama says there's a see-saw effect with growth outperforming value for many years, then value takes the lead." When you take these professors' research together, you must ask can individual investors capture a value premium whenever it exists - is still an open question.
The fact that both value and growth stocks can have 10-year or longer periods of superior earnings makes both candidates to be placed in your investment portfolios when the time is right. Updegrave provides a caveat - "making a big bet on value stocks or value funds as if they're divinely preordained to deliver superior long-term performance at this point would be investing more on faith than on proven fact."
To be more direct, it appears Warren Buffett may retire in the not-too-distant future and whoever takes over from him will have big shoes to fill. The odds don't favor Buffett's successor as being as successful.
Dispelling "Asset Allocation accounts
for 90% of Your Returns"
Now to the truism about asset allocation accounting for 90% of your returns. According to Updegrave, this statement "is an investing truism and a marketing bonanza rolled into one. Walk into virtually any financial services firm and within minutes, you'll likely hear that the decisions you obsess about - which stocks to buy and whether to change your stock exposure based on market conditions - contribute the least to your portfolio's gains. Asset allocation, you'll be told, is the key, explaining more than 90% of investors' returns. The implication is clear. You're in a fix if you ain't got the right mix."
Updegrave continues to say, "The 90% figure at the heart of this supposed truth can be traced back to a 1986 study by a trio of researchers, among them, Gdry Brinson. He is fund manager of several hundred billion in assets for institutional clients and mutual funds, including Brinson Global, a Money 100 fund in the late 1990s. Brinson says that the idea "that asset allocation determines 90% of returns is wrong.' What it really is meant to have said 'is allocation explains 90% of the variation in returns."'
The way brokerage houses and mutual funds interpreted it was if you got "a return of 10%, then 9% is due to asset allocation and 1% comes from the rest. What it means is that if you looked at the ups and downs and zigs and zags of a portfolio across time, you could explain an average 90% of these zigs and zags if you know you allocation. But it can't tell you anything about the return you'll achieve." In other words, 90% of the time, asset allocations can tell you why you made gains or losses, but it can't even make an educated guess at how much money you will make or lose.
Another aspect of Brinson's research that has been misinterpreted is that "asset allocation is so important it doesn't pay to tinker with your portfolio or search within specific stocks." When the business cycle turns bearish, and it becomes more difficult to find stocks whose earnings (thus prices) are moving higher, then it's time to go to cash, according to Brinson.
During times when the market is showing signs of weakness, Brinson lowers his stock holding percentage (in 1999, it was as low as 30%). But, if you follow the advice offered by most brokerages, you would invest for the extreme long-term, buy beaten-down stocks whose shares could sink even further, and never adjust for market conditions.
Since Brinson's 1986 findings, there have been several other studies on the subject. Each study came to a different conclusion, but the more substantive of these research programs was authored by Chris Hensel and Ernie Ankrin of the investment firm Hank Russell. According to Hensel and Ankrin, "there is no right number." They argue that the influence or variation in returns depends on one thing - "what kind of investor you are."
Ankrin feels that "if you never change asset allocation and you only invest funds, then your asset allocation will dominate. (Conversely), If you're an index investor who frequently switches back and forth among the asset classes, the fiddling you do will dramatically affect your returns. And if you adhere strictly to one mix that invests in say, a few net and junk bonds, then security selection will be the dominant factor."
According to Ankrin, the real value in asset allocation is not returns or variations, but that it allows investors to find their mix of risk to reward, and that leaves investors the happiest. The lesson from this research is if your broker or mutual fund tells you how to invest, get a second opinion.
When you sort it all out, it comes down to this simple rule: You always move out of harm's way. Only a fool would buy stocks and stick around to see them lose 75% of their value. Buy and hole may have some long-term validity, but in the past, it has taken as much as 37 years for investors to break even from losses sustained during massive market drops.
In recent years, hi-tech development has moved so fast, that a beaten-down small cap stock is more likely to go belly-up rather than to recoup past losses. Bargain hunters and bottom fishers like to buy these stocks. The trick is in telling a bargain from an overvalued dog. It does work for some astute investors (such as Warren Buffett). But if you are no Warren Buffett, you may be better off investing in the growth stocks.
Growth stocks are like the scientific law that says an object in motion will remain in motion until it hits a more powerful force. Finally, the most important investing strategy - only invest that amount of money into those investments and/or stocks that will allow you to sleep well at night!
Editor's Note: Ken Coleman is editor of Kenneth Coleman's Investment Tracker, 4805 Courageous Ln., Carlsbad, CA 92008, 1 year, 12 issues, $139, which specializes in Domestic and Global Money Flow Analysis. Mr. Coleman brings to market analysis a unique perspective. Experience has taught Mr. Coleman what drives stocks, bonds and commodity markets, thus the economy. It's money. He is a featured speaker at many investment seminars around the country and can be heard on the George Gamble Radio Show, Mondays and Fridays, 11 a.m., Pacific time at www.gemradio.net.
Mr. Coleman's books and booklets include: America's Endangered Banks, U.S. Financial Institutions In Crisis, Money Flow Workbook and A Monetary Time Bomb Is Ticking, Ticking, Ticking. And Following the New Business Cycle to Increase Profits and Cut Losses.
For more information and a Special Subscription Offer visit the web site at www.TheInvestmentTracker.com.
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