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Six Myths on Stocks and a Fact

Six Myths on Stocks and a Fact. When do stocks reflect economic realities and when are stocks just plain neurotic like the Super Bowl Indicator* or the Hemline Indicator ? Richard D. Marcus. http://www.snopes.com/business/bank/superbowl.asp. Slide 1. Two January Myths.

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Six Myths on Stocks and a Fact

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  1. Six Myths on Stocks and a Fact When do stocks reflect economic realities and when are stocks just plain neurotic like the Super Bowl Indicator* or the Hemline Indicator? Richard D. Marcus • http://www.snopes.com/business/bank/superbowl.asp Slide 1 Richard D. Marcus

  2. Two January Myths • So goes January, so goes the whole year. • January 2010 was down 3%, but I expect a return of about 6% for the whole year • Note: January 2009 was down -8.54%, but the whole year was up for S&P 20%. • In the last decade, 6 of 10 years had negative January returns, but 6 out of 10 were up years. This myth worked only 6 out of 10 times in recent years. • See: http://www.moneychimp.com/features/monthly_returns.htm and http://www.moneychimp.com/features/market_cagr.htm • Most of the returns for small stocks are in the first week of January (The January Effect or Turn-of-the-Year Effect) • Investing in a disappearing phenomenon about 1989 • If high returns for first few days, then investors can purchase in late December

  3. 3. Go Away in May? Month 1950 – 2009Ave. Mo. Return • “Sell in May and go away,” is an old maxim that suggests that Summer Doldrums affects the markets, even though September is the danger month • But not true. Earn 1% on average over the Summer (May-Aug)

  4. 4. Black Mondays? • Stock market crashes have tended to be on Mondays, and some call it the Weekend Effect. • Black Thursday, October 24, 1929 through Black Monday, October 28, 1929 Stock Market Crash • Monday, October 19, 1987 508 point drop • Monday, September 15, 2008 Lehman Brothers Collapse over the weekend • But day of the week effects have been a shifting phenomenon • Monday has shifted to a Tired Thursday for lowest returns, depending on the time period. • Stock volatility has also shifted, with lowest volatility on Wednesdays and Fridays

  5. 5. Pre-Holiday Effects? • Invest before a long 3-day weekend • Like other behavioral impacts, this one appears and then disappears • Vergen, Roger C. and John McGinnis, “Revisiting the Holiday Effect: Is it on Holiday?,Applied Financial Economics, Vol. 9, October 1999, pp 477-82. • One view is that longer periods tend to have higher average returns.

  6. 6. Invest when Republicans (or Democrats) are in Power • Long history of claims about which party is better for stocks. The following is from 1909 – 2009. • However, we can measure power also by congress. Proportion of Down Years (or up years) is not significantly different, and the difference in the means is not statistically different either.

  7. But GDP Actually Drives Stock PricesOver Quarterly Periods • Stock prices do generally reflect economic conditions, though not day to day • Using Dow Jones Industrial Quarterly Index returns for 81 quarters and • Using Quarterly GDP growth rates over the previous quarter • We find that a 1% growth in GDP over the previous quarter leads to 4.3% • return in the market over that quarter. R-square = .163

  8. The Recent Financial Crisis What Happened? What Do We Do Now? Slide 8 Richard D. Marcus

  9. What caused the financial crisis and then recession? • Federal Reserve – excessively low interest rates Source: John B. Taylor, Getting Off Track, Hoover Institution Press, 2009

  10. Causes of financial crisis and recession • Housing speculative bubble • Predominantly in California, Arizona, Florida, and Nevada • No attempt to stop banks and non-bank mortgage lending at 125% of asset value • Flip This House on nearly every channel • Financial Innovations • Credit default swaps on bonds • Collateralized debt obligations • Fannie Mae and Freddie Mac pushing to underwrite more and more mortgages – congress did not oversee the risk

  11. The Business Cycle is Globally Connected • From 1985 – 2007, a period of the great moderationwith relatively continuous growth and modest inflation • Recessions in 1991 and 2001 were just hiccups compared to the 1980-1983 twin recessions and 1973-1974 recession • But downturns have not disappeared • Worldwide oil price increases and housing price decreases in several nations help start the 2007-2009 recession • US and the rest of the world felt the effect of bank failures and excessive consumer debt

  12. What did the US Government do in 2008 & 2009? • Increased taxes, especially in state and local • Exception the $400 tax rebate in the spring of 2008 • Increased regulations on businesses • Higher CAFE standards on automobiles • Restrictions on CEO compensation & on Banks • Increased business uncertainty by nationalizing selective companies • Criticized corporate travel, CEO salaries, and business leaders • Spent on social projects with little chance of improving employment

  13. Has this Recession Ended? • NBER dated this recession as starting in December 2007 and continuing still into 2009 • A recession is a significant decline in production, employment, real income, and other indicators. • I expect that the Business Cycle Dating Committeewill declare its end on October 2009, but we must await confirmation, likely in April ’10. • The 1980-81 recession was followed close by with a 1981-1982 recession, a so-called “W” recession or back-to-back recession, which may still be in 2011.

  14. Why was this recession so long? • Already 25 months into this recession. Economist Geoffrey Moore finds that the average US recession to be 11 months since 1948. • Reasons – Contradictory Policies • Unprecedented federal fiscal stimulus… • But delaysin the implementation of the spending • Stimulus undone by state and local tax increases and cut backs and “crowding out effects” of letting the federal money do what state money did before • Huge monetary expansion must reverse itself • Increased taxes are feared by many • Increased regulation – seldom a stimulus to entrepreneurial spirit and job creation

  15. When will inflation arise? • Excessive monetary growth leads to inflation • Monetary Base jumped 150% in this recession WOW! 9-11 Y2K

  16. Quantity Theory of Money M·V=P·Q • When money rises, eventually prices rise. • Prices have been slowly rising from 1.59% in 2002; to 2.64% in 2004; to 3.24% in 2006; 3.85% in 2008; and 2.7% in 2009. Food and oil price increases are volatile, but they are rising Inflation tends to lag 11 months from changes in the monetary base. We are experiencing some inflation already

  17. What should I do now? • Investing for the long run means accepting some risks. • Economic gyrations have gone on before. When problems arise, policy changes eventually adapt. • Diversification and asset allocation should consider the possibility of inflation, which may include some inflation-sensitive assets like: • Commodities that tend to out-perform financial assets in periods of rising inflation • Gold or producing-gold mining firms • Treasury inflation-protected securities (TIPS) bonds and mutual funds exist that may fit as a portion of one’s fixed income asset allocation • Even real estate tends perform well in inflationary periods. • Traditionally stock returns have provided the best long-run returns. I expect this to be true in 2010.

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