The Not So Random Walk - Part 2

The Not So Random Walk - Part 2

[caption id="attachment_437" align="alignleft" width="150"]John G. Finley, CFA John G. Finley, CFA[/caption]

See Part 1.

Investing is a little like picking which path to walk: you want to go the direction that yields the greatest return for the lowest risk of loss, but you have to make that choice without knowledge of the eventual outcome. Back when I managed bond portfolios, I used to joke that managing money would be a whole lot easier if I knew the future! The investment choices would be blatantly obvious!

Alas, as the actress Doris Day famously used to sing, the future really isn't ours to see. But that certainly hasn't stopped people from trying! History is replete with predictions about the end of the world. The explorer Christopher Columbus thought it would happen in the year 1658. The Mayan calendar is said to predict December 21st of this year as the end date (they apparently missed their own demise in the 9th century AD). Some newspapers stil print daily horoscopes and, judging by the sign in the yard, the local psychic is stil in business. I won't even mention the History Channel's obsession with Nostradamus. (Self test: how many of you read the little slip of paper found in Chinese fortune cookies?)

The investment world has seen its share of predictions as well. Near the end of the dotcom / tech stock bubble in 1999, a new book came out with the title "Dow 36,000". The authors, James Glassman and Kevin Hassett, asserted that over long periods of time stocks were just as safe as treasury bonds. They also suggested that the additional annual return over treasuries (historical y around 6%) demanded by investors to move their hard earned money into stocks, which is known as the equity risk premium, would eventualy drop to zero. This would quadruple the price/earnings multiple from 25 (at the time the book was published) to 100. In other words, a dolar of earnings would be worth 100 dolars of stock price. Since the Dow was then at 9,000, the authors expected the index to eventualy reach 36,000. (Presumably, it would take some amount of time for everyone to read the book and change their investing habits.)

A three-year bear market followed the tech bubble, with the Dow index falling 34% from 11,700 at its peak to 7,700 in September of 2002. That same month, the well known bond manager Bill Gross of PIMCO also made a prediction, but not about bonds. Referencing Glassman's book, Mr. Gross proceeded to make the case for a Dow index of 5,000 by taking the exact opposite position. He argued that investors realy do need additional returns over long term treasuries to compensate them for the additional risk of owning stocks, and that P/E multiples have historical y been too high and are likely to fal . Six years later, after yet another market bubble (real estate, this time), the Dow bottomed out at 6,600, in March of 2009. At Coyle Financial Counsel, we like investment managers who have a sound, disciplined investment process, working as a team of professionals who are informed by their years of collective investment experience, who wifl make reasonable judgments about what sectors of the global markets of er the best risk / return tradeoff. We believe that the global capital markets will continue to produce attractive long - term returns because those very returns to capital are determined by the fundamentals, the productive capacity of an economy and, ultimately, the future stream of corporate earnings. We are also firm believers in diversification, because no one consistently knows which asset classes are likely to outperform.

As I write this, the Dow is hovering around 13,000. I think the next time we take our dog for a walk, I will stop wondering if another path would have been more rewarding and just take the simple advice of Yogi Berra, the former New York Yankees manager, who said that when you see a fork in the road, take it!

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