The market volatility of the past couple of weeks has inspired me to share a few thoughts on markets, investing, and trading. As many of you know, my formal educational background is economics, but my professional life has been spent as a trader of international financial and commodity markets.
I begin with a brief disclaimer: the thoughts I am sharing are the way I view the world; the point of view of one man. There are many other approaches to slice and dice these concepts, some of which may be perfectly valid, but this is how I see things.
I start at the beginning. If an individual has accumulated some money, not intended for spending, a choice must be made between savings, investing, or trading. Often these three get mixed up. I will try to unravel them.
Money can be placed in any one of a vast array of financial vehicles. I would suggest the only vehicle which truly qualifies as an investment vehicle is equity shares, i.e., stocks.
Stocks are ownership of a corporation or business activity. As such, equity shares are an investment in the activity, energy, and ingenuity of people. This is what truly grows over the long run. In so saying, I am expressing a confidence in the continuing progress of mankind, and the conviction that good triumphs over evil.
Put another way, equities are not a mean-reverting financial asset.
In other words, they do not rise or fall simply to fall or rise back to some average level. In the long run, stocks as a group gradually rise. They may go up a lot and then down a lot, but in the big picture, they rise more than they fall.
As new technologies are discovered, as improvements in worker productivity are realized, as crime and wars diminish, our economy prospers. This is most readily captured, financially speaking, through the ownership of companies; the ownership of equity shares.
In advanced economies such as the U.S., Canada, western Europe, Japan, and the like, human capital represents about 80 percent of the value of the economy. The remaining 20 percent is to be found in the “real” or tangible capital such as buildings, equipment, natural resources, and so forth.
This means the ownership of equities is, on average, an 80 percent ownership in the output of people and a 20 percent ownership in tangible assets. People are what really matter. People are at the heart of our civilization.
An alternative to investing is saving. Bank CDs, bonds and notes, property and real estate, and plain old-fashioned cash are what I would categorize as savings vehicles. Although each of these differ considerably in their specific characteristics, I find these to all be similar in that they tend to revert to a mean level. The chief difference in these relates to the time horizon one has in mind for the savings plan.
Cash is, of course, a very short-term savings vehicle. Bank CDs, and interest-bearing notes can be a short- to intermediate-term savings assets.
Real estate, in contrast, is, to me, a long term savings instrument; a place to park cash for the long haul.
The reason I lump real estate into the savings category (as opposed to an investment strategy) is that long run historical evaluations of this asset group indicate houses and land tend, on average, to rise in value at the same rate as money inflation.
When it gets ahead, it reverts back to the mean inflation rate. In the race to the top, it falls way behind equities over decades of time.
To be sure, many families have found that their house was, in retrospect, a good investment. Those, for example, who bought houses in my childhood home town of Harrington Park, N.J., made out very well, but this was coincident with a large migration into the New York Metro area.
Ask the folks in Machias or Millinocket how their housing “investment” has worked out over the past couple of decades.
Now we come to trading. Everything else in the world is meant to be traded.
When I speak of trading, I am referring to actively buying and selling, shorting and covering these instruments.
“But what about gold and silver,” you might ask? They should be traded. “What about commodities?” Traded. “What about diversification into other currencies?” Trade them.
Now this may be somewhat confusing. Wall Street spent a decade between the mid 1990s and the early part of this millennium convincing folks that commodities were an important asset class that should be a part of everyone’s investment portfolio.
They had already convinced the same folks decades earlier that precious metals had the very same investment grade qualities. However, commodities and metals are either grown or dug out of the ground. As such, they do not have the capability of growing in the same fashion as human enterprises.
In fact, human beings seem to constantly figure out ways to produce commodities more and more efficiently. Humans also seem able to discover metals, hydrocarbons, and minerals in places previously overlooked. These are therefore great trading vehicles, but lousy investment vehicles.
Just consider the past decade’s behavior of gold, silver, soybeans, wheat, oil, copper, and so forth. They flew to the moon and back again. If you traded them successfully, you made a killing. If you used them as a portfolio investment, you likely did poorly, but, in this case, your Wall Street broker did well.
This brings us to our next topic, namely, market timing. Most of you may have heard investment advisors declare, “We are not market timers. We do not believe in trying to time the markets.” What a copout! As soon as I hear this, I shake my head and think to myself, “Then what exactly do you do for your clients?”
Market timing is more important than anything else in the investment or trading world.
If any of you doubt that last bold statement, I remind you of the Japanese Nikkei 225 stock index. In April of 1989 it stood at just a whisker under 40,000. As recently as 2012, it was easily buyable at 9,000. This year it has been as high as 21,000 and as low as 17,000. Market timing is all important.
Further, look at any corporate stock you like. The trading range has been enormous this year, last year, or any year. Timing is not everything, but it sure is far ahead of whatever is in second place.
It is highly likely that a savvy investor can be perfectly correct in his or her conviction that company XYZ will experience high growth, increased profits, and a significant increase in the dividend payout. If these factors are already built into the price of the stock, if the market has priced these in as if they had already occurred, this otherwise savvy investor may actually lose money for quite some time by paying too much for these eventualities.
This naturally leads us to ask, “How does one time the market?” This is the $64,000,000 question (inflation adjusted). Unfortunately, this will have to wait until next week.
(Marcus Hutchins, MA, M. Phil, Economics, Columbia University, NYC, is a former economist, treasury bond arbitrage trader and hedge fund manager. He retired to Southport in 1997 where he resides with his wife Andrea and his youngest daughter Abbey. He welcomes feedback at coastaleconomist@me.com.)
