Watching the Big Things

October 12, 2006 by  


By Bob Wood

“There are big things, and there are little things. Do not make big things out of little things, and do not make little things out of big things.”

Now that I have excavated that little piece of ancient wisdom, how can you go about applying it to your investing efforts? I think that is an appropriate application, considering how markets react to the smallest details, only to turn the other way when those details are contradicted by some other minor bit of news.

Lately, the stock market has rallied, due, in part, to falling energy prices. The thinking that fuels this rally is that with lower energy costs, consumers will have more discretionary money to spend on other things. And that is good for the economy! Of course, most companies also experience lower costs of doing business when energy prices drop; so again, this is good for the markets.

But our government no longer counts the price of energy when calculating inflation, calling it “too volatile.” So if we assume that this rationale is, in fact, rational, can we believe that lower energy prices today could possibly signal a lasting trend? For example, what happens when last month’s milder weather in most parts of the country changes with the calendar, and colder nights return? September’s lower energy prices quickly become October’s higher energy costs. Does that mean that investors who bought stocks in September should sell them in October?

Well, it could mean just that, considering what we see in today’s stock markets. Of course, not only the weather affects energy prices. A brief spell of relative calm reigns in the Middle East–for now. I emphasize the words “for now,” since, as we all know, those conditions could change at any moment. So when another flare-up of violence occurs there, should you sell stocks until the shooting stops again?

Another data point that helps build bullish sentiment is the Monthly Trade Report. Amazingly, when we hear trade deficit numbers announced at some horribly high amount, the market is as likely to rally as fall on the news, since the report may show the huge trade deficit totalling somewhat less than the market consensus expected. Forget the possibility that this deficit number may well hit a new record next month! Market players will worry about that when the time comes, but they are eager to extrapolate today’s news as the potential start of a new, upward trend.

The residential real estate market also produces data that can be taken as omens of economic good health in coming months. News about home sales, whether higher or lower than expectations, spurs buying activity with incredible speed–lest a slow-acting trader be left in the dust at the start of yet another rally. That these numbers will continue to vary in coming months is of little concern–until they do indeed change. Then Bulls run the other way!

Now, I ask you, is this any way to invest? Do you think Warren Buffett became successful this way? Does he today sit anxiously by his television set, watching as numbers for particular data points are announced? Why would he, or anyone else, react and alter his investment course based on such transitory information? The art of making big things out of little things hits new heights on Wall Street almost everyday!

Then we encounter the perverse practice of perusing new job creation numbers each month and trying to predict from them what effects they will have on interest rates and other financial matters. A disappointing number might indicate that the economy is not so strong as thought, resulting in the Fed’s being less likely to hike short-term interest rates. That possible action, in turn, would argue for higher P/Es for stocks, which would mean higher stock prices. The resulting message: Buy stocks on bad jobs news!

To me, such data spinning is beyond ridiculous! How can anyone consider a weakening economy good for the performance of stocks, which are already selling at historically high valuations? But Bulls argue that low bond yields mean that stocks deserve high valuations in comparison. So, because bond yields will remain at historically low rates, we should happily pay premium prices for stocks? That must be still another variation of the investing tenet “Buy low and sell high,” or maybe the new paradigm is “Buy high and, hopefully, sell higher, and repeat as often as possible.”

Energy prices rise and fall, as prices for all things tend to do, especially commodities like oil and gas. But more important than the rise and fall of weekly demand for these products is the long-term trend for their prices. With demand for energy consumption rising in places that have never before been significant consumers, does the falling price of oil look anything but short-lived? Why would anyone load up on stocks based on the today’s price of oil, which will soon be yesterday’s price?

If this message sounds a bit monotonous, it’s my intent to dramatize how any short-term trend is likely to fail, since it begins with the most transitory information. The only trends worth following are the long-term, secular ones. Isn’t it more rational to consider what the price of oil will be in another five or 10 years — as opposed to another five or 10 days?

Aren’t general trends in job creation, perhaps as seen over the past 10 years, much more reasonable data to consider than the week-to-week changes breathlessly announced in the media each week or month? Remember though, that even a trend solidly in place will not show data points consistently moving in the same direction. We will always see short-term, counter-trend information. But the long-term outlook for jobs and wages is firmly intact.

And doesn’t it appear that low interest rates have done about all they can to stimulate the economy? Lowering rates early next year, as thought likely by Bulls, should have much less effect now than in the past, when rates were falling from much higher levels. After all, what effect did ultra-low rates have in Japan throughout its 13-year bear market in stocks and real estate?

But as easily as these ever-changing, minor data points are escalated into bigger, more meaningful mileposts, Bulls also have an amazing ability to make little things out of very big things. And those very big things keep me very much the Bear on domestic stock markets, the current rally notwithstanding, of course.

Such big things include the structural shift with jobs moving to cheaper international locations to do business, the rising demand for energy in newly capitalistic countries with huge populations such as China and India and the rapidly rising mountains of debt on our consumer and governmental balance sheets. I also consider such big issues as the long-term effects of losing two wars, collapse of the housing bubble and falling dollar value as major reasons to remain committed to the secular trends previously reviewed in this column.

To me, these big things can’t be talked into becoming small things. They will have a much longer-lasting effect on stock prices over the next few years than all weekly changes such as the direction of oil prices, new jobs number or yield on 10-year Treasuries. The trends I follow and the information supporting them are also likely to bounce from week to week, compelling some investors to buy, then sell — and then buy back again. To me, this activity creates the investor frustration which is consistent with so many investors’ missing the best bull markets while chasing news that, in the long run, has no real meaning at all.

Focus on the big things, and let the small things come and go! Staying focused on longer-terms trends is much easier — and certainly less confusing when any given data point expectation fails to materialize, which it will do yet again!

Have a great week,
Bob

Bob Wood ChFC, CLU Yusuf Kadiwala. Registered Investment Advisors, KMA, Inc., bwood44@tampabay.rr.com.

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