Lipper: Fix Your Focus and Avoid False Comparisons
When asked how his wife was an old comic strip responded, compared to who? While it was a laughing matter, it did point out that some important considerations aren’t well decided by quick comparisons. Unfortunately, far too many investment decisions are made largely by comparison, with extreme performance judged to be better.
As someone who has devoted a great deal of their career to making and using statistical comparisons, I am the first to suggest that historical comparisons are not good “guessing sticks” for making investment decisions. When dealing with the public, the SEC requires that a disclaimer be included, stating that past performance is not indicative of future results.
Unfortunately, this disclaimer is not included with all comparisons. For example, size, yield, book value, return on assets, equity, sales, operating profit, etc. All these metrics tell us is what happened, not why they happened or even the conditions that may have contributed to the results.
The main reasons there are favorite bets on tours, political campaigns and perhaps at entertainment rewards is that there is a belief that “smart money” knows something and is worth it. therefore worth to be followed. I have recently come into contact with some very brilliant student investors who have used a lot of statistical metrics to make investment decisions.
One of their new tools was the size of mutual funds and possibly stock trades. I felt it was an oversimplification in their search for “smart money”. I suggested separating the universe of funds into three compartments:
- Passive / index funds
- Funds with net inflows
- Funds with net outflows
I would absolutely ignore passive funds, as they do not make a thoughtful judgment on individual securities. They should pay only partial attention to funds that grow on net inflows and pay particular attention to funds in net redemption.
Portfolio managers of funds with net inflows typically use the money to buy more of what they own or to start a position under a new name. If the new name attracts additional future entry dollars, it could be worth it. The job of the portfolio manager who experiences net redemptions is quite different. He / she may like all of their holdings, but still has to raise cash.
As a result, stocks with the worst short-term prospects are likely to be sold. This could be the most interesting part of the exercise. For more information, I have found it useful to follow specific funds, especially when they invest in a new name. (This is exactly the type of SEC warning that would be appropriate, past performance does not predict future results.)
Part of the comparison error is a misperception of the relevance of the index used to compare a particular stock, fund or investor.
Currently, the largest number of investment accounts hold 10 to 30 stocks and have less than $ 5 million invested. In these cases, performance comparisons with major indices are inappropriate. The indices, in terms of the number of titles, represent a small percentage of the number of titles available.
Plus, unlike mutual funds, most stock accounts don’t face daily liquidity needs. Most pension funds have a limited need to make unplanned sales, so liquidity is not a priority in their decision-making process either.
As a young junior safety analyst, I thought comparing a steel company in Chicago with those in Pennsylvania was not helpful. The Chicago producer mainly sold to nearby customers and had an advantage in terms of transportation costs, which he used to obtain higher prices. Likewise, the degree of in-house production of critical auto parts was a major differentiation between auto manufacturers. Thus, I am a first questioner of comparisons without adjustments.
Applying comparisons to future market direction
As is often the case, smart analysts and portfolio managers see the US stock market moving in one of three directions:
- A major economic expansion
- At half-time in a continuous bull market
- At a break before a market storm
In each case, their main argument is based on a comparison with an indicator. I’ve listed their views and metrics below, allowing subscribers to form their own opinion.
“Mother of all recoveries”
This is an economic forecast based largely on a combination of government stimulus and post-lockdown recovery.
“Half-time” in a long-term uptrend, with occasional correction and change in market leadership, supported by market analysis.
Rounding off the top that could lead to a bear market
Until Thursday, the Dow Jones Industrial Average (DJIA) -1.64% and the S&P 500 -1.81% are down from their May 7 highs. The NASDAQ is down -4.77% from its April 26 high.
While the first quarter was pretty positive, the second quarter may be flat or down, with earnings per share gaining the most in the second quarter of this year.
Over the past week, Precious Metals Funds has advanced + 7.16%, with 118 new lows on NYSE and 230 new lows on NASDAQ. In the week the tax payments were due, money market funds attracted $ 25.2 billion.
What are the chances of a top in the next six months?
- Mother of All Recoveries 25%
- Half-time 35%
- Round-Top 40%
Based on these projections, I would prepare to trade parts of the account and be ready to raise 50% in cash. For five-year accounts, 20% cash to redeploy once the market has gone beyond a 10% decline makes sense. For accounts lasting more than five years, no additional amount is suggested.
A past president of the New York Society for Security Analysts, he was president of Lipper Analytical Services Inc., the home of the Lipper global line of indices, averages and performance analysis for mutual funds. His blog can be found here.