November 9, 2013 Hats Off

Risk/Reward Vol. 194

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN

'Hats off to Larry/It may sound cruel
But you laughed at me when you
Said we were through."---lyrics from "Hats Off to Larry" sung by Del Shannon

"Is this a lasting treasure/Or just a moment's pleasure
Can I believe the magic of your sighs
Will you still love me tomorrow?"---lyrics from "Will You Still Love Me Tomorrow" sung by Ben E. King

"Why do we never get an answer
When we're knocking at the door
With a thousand million questions
About hate and death and war?"---lyrics from "Question" by the Moody Blues

"Hats off to Larry" and every other Tom, Dick and Harry who chose to invest in passive stock index funds this year. The Dow Jones Industrial Average (DJIA) is up 19% year to date and the S&P 500 (S&P) is up 22.5%. Deservedly, stock index investors can "laugh at me" because my active approach has reaped a much smaller return. And as for the really smart guys---those that run hedge funds---according to Hedgeweek, they have averaged a mere 5.7% return through the first three quarters of the year. "It may sound cruel", but those that predicted that the days of outsized stock index returns "were through" have been proven wrong.

But, is a strategy based upon stock index investing "a lasting treasure/Or just a moment's pleasure?" "Can you believe the magic ?" Lest we forget, despite both returning roughly 20% so far this year, the DJIA and S&P have averaged only a 7.5% return over the past 10 years---and with a great deal of volatitliy (remember Spring, 2009?) Moreover, in the past few weeks we have received mixed signals as to future returns---even from the same sources. Last week, Larry Fink, the CEO of BlackRock the largest asset manager in the world ($4Trillion!) warned that stock investors are exhibiting unwarranted exuberance and that the stock market in general is becoming an asset bubble (a sentiment shared by IBD in this Thursday's edition). At the same time, BlackRock published a report (www.blackrock.com/investor ) suggesting that the average investor may be overly cautious because 48% of his/her investable assets currently are in cash; inferring that considerable fuel for across the board stock price appreciation has yet to be deployed. Please, cut the double talk, just answer the question, "Will stocks still love me tomorrow?"

"Why do we never get an answer/When we're knocking at that door?" It's just one question on a single topic; not "a thousand million questions/About hate and death and war." Perhaps the best response is found in two axioms uttered by the Wizard of Omaha, Warren Buffett:


1)"Be fearful when others are greedy, and greedy when others are fearful."
2)"Interest rates are to asset prices like gravity is to the apple. When interest rates are low there is little gravitational pull on asset prices."

As shown by recent record highs in the stock indices, stockholders are greedy; so some level of fear is warranted. Thus, I keep my eye on interest rates. On Friday a better than expected jobs report resulted in the DJIA reaching another record high. But, that same report resulted in the rate on the 10 Year Treasury note jumping, to 2.75%. It is my belief that if interest rates continue to rise, their gravity will pull stock prices down. We shall see.

Index investing has been a runaway success so far this year. But, like Del Shannon, I question whether, longer term, index investing might be "A Little Town Flirt." If interest rates spike, "I wonder where she will stay/My little runaway--run, run, run, run, runaway."