5 market myths debunked

In this marketplace, stocks aren't all that's taken a beating. Conventional investing wisdom isn't holding up thus well either.

This market isn't pounding simply your portfolio. It's additionally smashing some of the biggest myths that investors have relied on for a generation.

1. We can't time the market. And so much for that. 2 metrics have done a very good job of telling you over the decades when to be in stocks and whenever to be from them. As well as both appear to be on the money when again: They were flashing red for months leading up to the summer swoon.

The first, called "Tobin's q," compares share costs to the cost of rebuilding those companies' assets from scratch. The logic is obvious: Precisely why would definitely you pay $1 billion to buy a business if you can start an identical you, with identical assets, for, say, $700 million?

The 2nd metric is the "cyclically-adjusted" price-to-earnings ratio, also known as the "Shiller PE" after Yale professor Robert "Irrational Exuberance" Shiller, who has popularized it. The measure compares stock prices to average earnings over the previous 10 many years, in contrast with a typical P/E that is a one-year snapshot.

Both measures continue to signal caution, though less than they did six months ago. The Shiller measure can be found on the professor's website. Tobin's q is trickier: It needs sifting through the Federal Reserve's quarterly Flow of Money report.

2. The cash on the sidelines will drive this marketplace higher. How often have we heard this? Definitely not long ago I met a bunch of professional investors, and this line came up again.

But it's a total myth. Take a deep breathing, please. For every buyer of a stock, a person else should be a seller. Sorry, but there it is. If somebody "on the sidelines" takes $1,000 in cash as well as uses it to buy, say, Exxon Mobil (XOM, news) stock, then somebody else should sell $1,000 of Exxon Mobil stock . . . as well as take the cash.

3. Markets are efficient. We know the line: Stock and bond prices reflect all available information. Attempts to outperform are fruitless.

Not long ago, this myth dominated Wall Street and financial theory. The Supreme Court even relied on it in rulings.

But this is nonsense. Three months ago Greek government bonds had been already trading as if a default were almost inevitable. The yield on the one-year Greek bond was 35%. At the same time, the Russell 2000 Index ($RUT.X) index of small company stocks was at 850, nearly an all-time high -- as well as a record compared with the cost of large-company stocks.

Thus back then, the "efficient" market was at the same time betting that Greece would definitely default, little companies would keep booming and investors would definitely continue to desire more risk in their portfolios. On which world?

4. Share buybacks will drive the market higher. We've been told over as well as over again that companies have "record amounts of cash on the balance sheet," as well as that this should be great for stockholders. After all, they will return that cash to investors by buying back shares. As well as that should raise the stock price by reducing the amount of shares in issue.

So much for that. Standard & Poor's 500 Index ($INX) companies spent a massive $103 billion purchasing back their stock in the second quarter, over $85 billion in the first quarter. And the results so far haven't been that impressive. InsiderScore reports that the second-quarter figure was the highest amount spent on share buybacks "because the first quarter of 2008." Hmm. How'd that exercise?

Turns out this logic was flawed in at least 3 different methods. First, the "record money on the balance sheets" is matched by record debts. 2nd, if a company spends $100 million purchasing back stock, it should, rationally, make no real difference to the share price: The market value should fall by $100 million. Third, "buybacks" are largely a fiction: Whilst the company spends stockholders' money purchasing in stock, the compensation committee quietly hands out new stock to executives.

Web result: You are really going backward. Standard & Poor's reports that from 2000 through 2010, S&P 500 members spent a massive $2.7 trillion buying in stock. Yet at the end of the decade they actually had more shares as well as options great than they did at the beginning.

5. To get higher returns you have to take on more risk. This 1 continues to be alive. But is it really so simple? Back in 2000 I had lunch in London with a very wise old portfolio manager. He told me to sell all my stocks as well as buy inflation-protected U.S. bonds. As it happens I did not own many stocks, but I was a young whippersnapper that had grown up during a two-decade bull marketplace, as well as I did not see a lot appeal in Treasury inflation-protected securities -- the "safest," supposedly dullest, investment around. After all, was not a young investor supposed to be taking on "risk"?

Because then, the Vanguard Inflation-Protected Securities (VIPSX) fund has more than doubled investors' money. That's been a spectacular result -- from the "safest" investment around. Meanwhile the dangerous S&P 500 Index has really lost revenue. (Over the same lunch, the same manager also told me to purchase gold. We keep in touch).

In early 2007, according to an analysis by fund firm GMO, the relationship between "risk" as well as return was actually upside down. At that point, they said, "risky" investments were thus overpriced that they have been almost guaranteed to make worse returns than "safe" investments. In other words, investors were not being "paid to take on risk" -- they had been instead paying for the privilege.


View the original article here