Just because you can, doesn’t mean you should…
In August of last year, Federal Reserve Chairman Ben Bernanke made a speech at the annual Federal Reserve Economic Symposium in Jackson Hole, Wyoming where he said, “The (Federal Reserve Open Market Committee) is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly.” This comment, and the later adoption of specific easing efforts by the FOMC, triggered a stock market rally that has continued through 2011’s first quarter. Now, while our portfolio has benefitted from this market move, we didn’t aggressively increase our equity exposure on this news of aggressive monetary easing (commonly referred to as “QE2”). We could have, but we didn’t because that’s not how we invest.
Investing and trading are not synonymous. For an investor, trading is a necessary evil; it is a means to an end, the action necessary to make an investment or to unwind one. For a trader, as the old joke goes, an investment is a trade gone awry. For both an investor and a trader, forays into the other’s area of expertise tend to be fraught with peril, expensive and, preferably, kept to a minimum.
Trading has become much more prominent in financial markets over the last 40 years as the cost of trading has declined precipitously. With the end of fixed commissions in the mid-1970s, the rise of the discount brokerage firms in the 1980s and ‘90s, and the rapid adoption of ETFs in the ‘00s, the cost of trading has declined while the number of shares traded has skyrocketed. In the early 1970s it was not unusual for an investor to pay 25¢ per share to make a stock trade. Average daily volume of the New York Stock Exchange – the world’s biggest, most active exchange – was about 19.5mm shares a day in the 1970s. Today, many institutional accounts pay less than 5¢ a share (frequently less than 1¢), while “retail” traders pay less than $10 per trade regardless of how many shares are bought or sold. And a slow day on the NYSE is when there are fewer than 1 billion shares traded.
This dramatic reduction in trading costs and advances in technology to enable trading has facilitated increased speculation and pushed the marginal “investor” into the camp of the “traders”. Today the result is a market environment where “putting on a trade,” “gaining exposure,” or diversifying one’s portfolio has all become much cheaper and easier to accomplish than anyone could have imagined 40 years ago. Television caters to the trend with shows like CNBC’s “Fast Money Half Time Report” where talking heads tell retail traders what to buy and sell. If it wasn’t easy and cheap to trade, there would be no audience for the show.
So while trading is cheaper and faster than ever before, we believe investing has hardly changed over the last 40 years. In fact, from our perspective it’s moved backwards a tad, as many people have become more interested in analyzing the instruments of finance than the underlying asset. With the plethora of cheap and easy-to-buy financial instruments available – ETFs, options, futures, foreign exchange, commodities, structured products, and more – people have become befuddled and intimidated to the point of not asking the only relevant question any investor should ask before putting their money down: Why is this going to go up?
At LindeHansen, we believe stock prices rise for companies experiencing an improving trend in their Return on Equity/Return on Invested Capital. We spend our time searching for companies that we believe have catalysts in place to drive profitability higher from a lower than historical average over the next few years. We invest in the common stock of these companies believing that we will be rewarded as increasing earnings drive the stock price higher and generate excess cash flow that can be transmitted to investors via cash distributions. And cheaper trades has little to no effect on our investment strategy.
There is no guarantee that any investment will achieve its objectives, generate positive returns, or avoid losses.
When the profitability enhancing catalyst has been realized, we sell the stock. This holds whether the price is up or down from where we initiated the position. It’s our investment discipline.
So when Ben Bernanke spoke last August, we speculated stocks would likely benefit from an easier monetary policy from our central bank. And though we will never gainsay a tail-wind for the equity market, we’re keenly aware of what our forte is and have stuck with what we know: investing. Sure we could have “put on a trade” to become fully exposed on the basis of our speculation, but then when would we unwind that trade? We know what we know, and why it works. We’ll stick with that.
In other words, just because you can, doesn’t mean you should.
The material provided herein has been provided by Linde Hansen & Co. and is for informational purposes only. Linde Hansen & Co. serves as investment adviser to one or more mutual funds distributed through Northern Lights Distributors, LLC member FINRA. Northern Lights Distributors, LLC and Linde Hansen & Co. are not affiliated entities. 0359-NLD-3/9/2012This entry was posted in Contrarian Thoughts. Bookmark the permalink.