2011 Quarter 3 Market Review
In September 2011, "Moneyball" premiered in movie theaters around the country. Having read the book by Michael Lewis back in 2004 and being a big baseball fan, I was quite interested in seeing the movie...and it did not disappoint! Brad Pitt plays the role of Billy Beane, the General Manager of the Oakland A's , who utilized carefully interpreted player statistics, rather than conventional baseball scouting methods, to build a team that won over 100 games in two consecutive seasons (2001-2002) despite having the lowest player payroll in the Major Leagues.
While Brad Pitt might draw ladies to the theaters, I am most interested in the economic concepts behind the process used by Billy Beane to compete successfully in an industry where the deck is stacked against the "small market" teams.
Beane and his staff compiled and analyzed mounds of player data to determine which statistics are most critical for a team to win baseball games over the course of a long (162-game) season. He concluded that certain players were "undervalued" by other baseball GMs and, considering he had relatively little money to use for payroll, those were the players that he traded for and signed to build his ballclub. The success of his team was not due to the way a player looked when he played, but rather due to the collective results of the players on the team.
There are myriads of comparisons to Billy Beane's approach to building a baseball team and the investment markets. What might appear to be a good investment to many people, based on the over-hyped investment media, is often not appropriate in a portfolio. By the time a security is revealed to the public as a great investment, its price is probably overvalued. When building a portfolio of stocks, professional money managers are typically as concerned with the price of a company's stock (value relative to earnings, cash flows, etc.) as they are with a company's stated growth expectations.
History reveals other counter-intuitive results:
- A country's GDP (Gross Domestic Product) does not correlate to its stock market returns
- A country's GDP does not correlate to its bond market returns
- Tax rates do not correlate to stock market returns
- High beta (systematic risk) stocks have underperformed low beta stocks
Ultimately, a carefully selected portfolio of complimentary stocks provides investors with the best chance of outperforming the market over time. A well-diversified portfolio comprised of stocks, bonds, and cash can reduce volatility in the short-term, while improving the odds of achieving long-term investor objectives.
Just like Billy Beane, we rely on statistical analysis to determine the appropriate investment strategies and to seek out the most reliable money managers for our clients. Media hype does not enter into our equation...things are often not as they seem!
The third quarter of 2011 was a rough one for investors in the world stock markets, but relatively good for fixed income investors, as we witnessed a "flight to safety." Here are the returns for selected market indices for Q3 2011 (as stated in U.S. dollars):
Heightened concerns about the European debt crisis, and the inability of politicians around the world to act decisively to solve problems, raised fear and doubt during the quarter. Uncertainty once again stalled business activity and consumer spending in the U.S. Consumer confidence is now near the low levels last seen in 2008. Congressional approval ratings (only 13%) are at the lowest level on record and unemployment remains stubbornly high. Housing remains in the doldrums and most developed countries currently have massive budget deficits and debt
The macro economic outlook is decidedly bleak. However, the "tug of war" continues between negative macro sentiment and positive micro factors (such as fundamental stock analysis). After-tax corporate profits are at the highest level on record (for large companies), corporate balance sheets are very strong with record levels of cash, and dividends are on the rise. The current Price/Earnings ratios for U.S. large cap stocks are 30% "cheaper" than their 20-year historical average. The S&P 500 Earnings Yield (9.5%) is significantly higher than the Moody's Baa Corporate Bond Yield (5.2%).
So, where do we go from here? In the short-term, it is always difficult to predict. Who would have thought that, after Standard & Poor's downgraded its debt ratings for the U.S. Government that investors would have poured money into U.S. Treasury Bonds (which occurred in abundance in the third quarter)? In the long-term, we will continue to emphasize well-balanced diversified portfolios to help mitigate risk, and like Billy Beane, will look for mispriced opportunities to add value.
It is a privilege to have you as a client of Falcons Rock.
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