[caption id="attachment_437" align="alignleft" width="240"] John G. Finley, CFA[/caption]
In Part 1, we looked at two behavioral biases that investors commonly have when looking at the market. Here, we will look at what investors should be looking at.
Monetary policy trumps political party affiliation
Wall Street Journal columnist and legendary investor Jason Zweig recently wrote about the effect presidential elections might have on investing. He referenced a research paper published this year by Professor Robert Johnson from Creighton University entitled “What to Expect When You’re Electing”. It has been previously well documented that, contrary to popular opinion, stocks actually perform much better on average during the time that a Democrat occupies the mansion at 1600 Pennsylvania Avenue than a Republican.
What the new study reveals, however, is a significant relationship between stock performance and Federal Reserve monetary policy, especially for small stocks. It just so happens that, from January 1965 through December 2008, Federal Reserve monetary policy was, on average, more expansionary during Democratic terms while monetary policy during Republican terms tended to be more restrictive. In other words, the biggest driver of the market is whether the Fed policy is supportive of economic growth or not. The researchers concluded that there was “no significant [statistical] relationship between the president’s party affiliation” and stock returns. Thus, the person occupying the White House really doesn’t seem to have that much power over the day-to-day valuation of capital markets after all.
Another bias de-bunked!
Perhaps our time would be better spent looking at what really does drive capital markets over time: the fundamentals. Valuations come from discounted future cash flows based on such things as, expected revenue growth, operating margins, tax rates, quality of management, business and financial risk and the cost of capital, to name a few.
There are no shortcuts to doing this analysis. At Coyle Financial Counsel, we seek out and hire investment managers for our clients who focus on the fundamentals and stick to a strong investment discipline, which helps them to mitigate the potential behavioral distortions we all have from time to time.
I still like shortcuts and they certainly have their place in the created order. But, let’s do ourselves a favor and try to keep them out of the investment realm as much as possible. And, for that matter, out of road trips.
Give us a call to discuss your investment strategy:
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Posted on Mon, September 1, 2014
by John Finley