Investment Commentary

He Undressed the Maid Himself

May 2012 Investment Commentary by Richard W. Boyer, CFP, CFA

I just returned from back-to-back conferences featuring some of the brightest minds in the investment industry. The Strategic Investment Conference, May 2-5, was followed by the 65th annual Conference of the CFA Institute May 6-9.

At the CFA Conference, Daniel Kahneman delivered a talk he called “Psychology for Behavioral Finance” in which he attempted to explain how the human brain operates and why it can lead us into making bad investment decisions. He said the functions of our brains are divided into two systems: “System 1” is intuitive and automatic… it’s always “on” but not necessarily accurate. “System 2” kicks in when the need to be more accurate demands effort. System 1 can handle a simple arithmetic problem like adding 2+2. Multiplying 24 X 17 requires System 2. The problem is that humans can be a little lazy. We tend to let System 1 handle as much as possible and we’re not always aware when a situation requires more effort. Stopping your car when you see a red light is pretty much a System 1 task… but texting and driving… now THAT’S definitely a System 2 function! (I don’t condone texting and driving but you get the point).

The System 1 part of our brain can hear one word and automatically prepare itself to hear other words associated with that word. He called this the “priming” effect. If you hear the word “black,” your brain may automatically be primed to hear the word “white.” When you see the yellow traffic light, you automatically know a red light is soon to follow.

But System 1 can mislead you. When your brain is on auto-pilot (which it tends to be when you are watching CNBC), you can hear words that you “associate” with other words. You might associate the word “Booyah” with a good investment opportunity. This can lead to misunderstandings.

To illustrate, Mr. Kahneman told the story of being at a party with his wife. At the party, his wife pointed across the room to another man and referred to him as being “sexy.” She followed that with the phrase “He undressed the maid himself,” which wasn’t any kind of statement Mr. Kahneman would have expected to hear from his wife. Not only was it an odd piece of information but, more importantly, he wondered how his wife came to possess such information?

What she actually said was, “He underestimates himself” but, because her phrase was preceded with the word “sexy,” Mr. Kahneman’s brain associated her statement with the word “sexy.” The word “sexy” primed his brain to hear any subsequent phrase differently than he would have otherwise.

Another behavior that Mr. Kahneman described is called “anchoring.” Anchoring causes us to rely too heavily on one piece of information when making a decision… sometimes a piece of information that should not even be a part of the decision making process. Investors are frequently guilty of this, and anchoring can lead to bad investment decisions. The decision to sell a stock should be based ONLY upon your expectations of the future performance of that stock. Many investors, however, take into account the price they paid for the stock. Tax considerations aside, what you paid for a stock should have nothing to do with the decision to sell. Even though you might think a stock trading for $50 is going to decline, the fact that you paid $70 for the stock may prevent you from selling. You are “anchored” to that $70 price and feel you deserve more than $50 when you sell.

I’ve heard this frequently for the past four years when people contemplate selling their house. I’m sure you have heard at least one person say, “I can’t sell it because I will take a loss on it.”  And a year later the loss has increased. The price you paid for the house should not influence your decision to sell your house. Continue reading →

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The Supremes

April 2012 Investment Commentary by Richard W. Boyer, CFP, CFA

The United States Supreme Court recently heard arguments regarding the Patient Protection and Affordable Care Act… also known as Obamacare (you can read all 906 pages of it at http://www.gpo.gov/fdsys/pkg/BILLS-111hr3590enr/pdf/BILLS-111hr3590enr.pdf). At issue is whether it is constitutional to enact a law forcing every citizen to purchase health insurance… or pay a fine/tax/penalty if they don’t.

This is probably the most significant case to come before the Supreme Court since “Citizens United v. Federal Election Commission,” a decision handed down in early 2010. In Citizens United, the Supreme Court basically threw out years of campaign finance regulation by ruling that limiting corporate contributions to political campaigns violates the First Amendment right to free speech.

If you recall, shortly after that decision, President Obama used his State of the Union Address to verbally pistol whip the Supreme Court Justices who were sitting on the first two rows of the Senate Chamber. I happen to agree with the President that it is not healthy for billions of corporate dollars to influence elections. However, I’m pretty sure I wouldn’t trash the Supreme Court on national TV. Continue reading →

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Beware the Ides? Not this March

March 2012 Investment Commentary by Richard W. Boyer, CFP, CFA

I’m a little late posting my Investment Commentary for March. I’ve been waiting for something to write about. I have become used to disaster and excitement. The world has become eerily quiet and uneventful. No dictatorships have been overthrown lately, Syria notwithstanding (they’re working on it). Occupy Wall Street has become “Go Back Home and Occupy Mom and Dad’s House.” Everyone knows Greece is going to default. Everyone is pretty sure Italy is NOT going to default, Spain is tomorrow’s news and no one seems to care much what Portugal is doing. No tsunamis, floods or earthquakes. No disasters of any kind, natural or unnatural. No terrorist attacks. Bin Laden has been captured, tried, convicted and executed (all rather quickly) so no one is worrying about what he is planning next.

Stock markets LOVE periods like this. Stock markets HATE negative surprises, periods of uncertainty and volatility. They don’t like toga parties, they like garden parties. They don’t like Metallica, they like Enya.

One day, not a long time ago, the brain trusts on Wall Street decided they needed an indicator that would let them know whether to be nervous or not… not fully realizing that any such indicator might be “after the fact.” Wall Street created an instrument for measuring volatility. It is called the “VIX,” which stands for the Volatility Index.

Below is a 5-year Bloomberg graph of the VIX. In 2011, the Dow Jones Industrial Average was up or down more than 100 points in a day… sometimes 200 points or more? On the graph, you can see where the VIX spiked close to 50 last year, just as it did in 2010. Looking back to the economic crisis in 2008, you can see where the VIX touched 80 a couple of times.

5-YEAR GRAPH OF THE VIX INDEX

5-year graph of VIX
click image for larger view

Interestingly enough, the graph below represents the performance of the Standard & Poors 500 Index during the same 5-year period.

5-YEAR GRAPH OF THE S&P 500 INDEX

5-year S&P graph 
click image for larger view

As volatility in the stock market increased in 2008, 2010 and 2011… the prices of stocks declined. And as volatility has disappeared, stock markets all over the world have rallied. U.S. stock markets were up over 4% in February, while the EAFE Index (Europe, Australia and the Far East) increased almost 6%. Year to date they are up 9%, and over 11%, respectively. Since the end of September, they are up over 21% and 15%. It seems that uneventful global optimism is the theme. As long as everyone stays calm, we can just keep making money.

In addition to an absence of volatility, we are quietly seeing slight improvements in the economy… or at least an absence of continued deterioration. We have seen increases in auto sales, industrial production, retail sales, and housing starts, as well as continued decreases in jobless claims. This is not good news for Romney, Santorum, et al.

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Class Warfare? The Speech Obama should have Delivered

February 2012 Investment Commentary by Richard W. Boyer, CFP®, CFA

When President Obama was running for election four years ago, part of his campaign theme had to do with the unification of America. You know, bring everyone together as patriotic Americans against common enemies and for common causes. Ironically, his attempts to increase taxes on “the wealthy” have not resembled anything remotely similar to unification and have basically amounted to class warfare. I don’t recall any president being as critical about the financially successful as Obama has.

As we head into 2012, it is time to start handicapping the election. Three years ago, when Barack and Michelle hopped out of the limousine and started walking down Pennsylvania Avenue, I thought there was absolutely no way he could avoid being a two-term president. The excited crowd lined both sides of the street and cheered for a new president like we haven’t seen in a long time. The economy was absolutely in the tank and there was no way he could be blamed for the economic crisis… it occurred before he took office and would almost certainly be better four years later. America was clearly looking for someone to unite us… it was looking for a “leader”.

Three years later, it appears he will be a two-term president but not for the reasons I expected. He virtually ignored the economy the first year of his term as he pushed for his vision of health care reform. Whether Obamacare is right or wrong is a separate blog… ignoring the economy while Americans were being laid off was a presidential blunder. He spent the next two years crucifying corporate jet owners, a move which did not unify Americans nearly as much as he thought it might.

Meanwhile, the GOP has been staging its own production of Beavis and Butthead, all but ensuring that Obama will not be changing addresses next year. The Republicans seem to be a few stocks shy of an index. However, as they have demonstrated, when the campaign gets down to debates, anything can happen (how is it that Romney’s campaign advisors  hadn’t coached him how to answer the question, “are you going to reveal your tax return?” They HAD to know that question was coming. They HAD to have developed a response and rehearsed it, right? How could he be stumped for a response? What other debate questions will stump him?). Say what you will about the Republican debates (the word “embarrassing” comes to my mind), the seemingly weekly GOP version of “Survivor” should make the Republican nominee well prepared to debate Obama. Meanwhile, President Obama is not getting to practice his debating skills on anyone. If Romney ultimately becomes the nominee, debating President Obama might seem like child’s play after tangling with Newt Gingrich.

Obama’s efforts to polarize Americans have not worked in his favor as much as he might have hoped. Other than Occupy Wall Street’s protests against greedy and overpaid bankers, there has not been a groundswell against wealthy Americans. Maybe because a lot of people still aspire to be one of them. I think Obama is getting bad advice from his entourage. However, I still think Obama could get America behind him to increase taxes on the wealthy… to increase taxes on dividends and capital gains and to increase the marginal tax rate. After bashing greedy corporate jet owners for a couple of years, it may be too late but… I have the speech that Obama should have given… the one that would have made him a shoe-in for a second term… the one that unites Americans AND results in the tax increase he desires. Here is the condensed version of that speech:

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A Lot of Noise for Nothing

January 2012 Investment Commentary by Richard W. Boyer, CFP®, CFA

You’re standing at the front of the line as the previous riders come gliding back into the boarding station. You saw them depart a few minutes earlier, a look of calm hiding their anxiety. And now you see them return, wild-eyed, frightened and relieved to have the ride behind them. Some of them vow to never ride that roller coaster again, and some can’t wait to get in line to get back on.

Rich rides a roller coaster

As wild as 2011 was, it is hard to believe that the U.S. stock market finished the year almost exactly where it started… just like a roller coaster. Many investors have vowed to never ride that roller coaster again… and some just can’t get enough of it. The S&P 500 began the year at 1257 and ended the year at 1257, and it paid you a little over 2% in dividends along the way. What’s the problem? Sounds pretty boring to me.

During the year the markets, as you know, were anything but boring. In 2011:

  • The AVERAGE daily gain or loss was over 1%.
  • Of the 252 trading days, the market was up/down in excess of 1% 95 times.
  • On August 9th the market GAINED 4.74%.
  • The NEXT DAY the market LOST 6.66%… ending the previous day’s party quickly and rudely.
  • There were 14 days the market experienced gains in excess of 2%.
  • There were 21 days the market experienced losses in excess of 2%.

And then, on the last day of the year, the market calmly brought you right back into the boarding station as if nothing had ever happened. Those in line waiting to get on for the next ride are looking closely at you… looking at your eyes and checking to see if you are happy or sad, excited or frightened… to get some sort of a clue as to what they might expect. And that is where the similarities end, because you have absolutely no clue what 2012 will bring… although most of you probably expect another roller coaster. As do we. Continue reading →

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