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Financial Industry Insights from Advisors Asset Management
On June 12, 2012
The Hypochondriac Investor
Yesterday epitomized the “hypochondria” that has taken root in the investing climate. An individual who believes everyday bodily functions may represent a rare and critical disease may be classified as a hypochondriac. The announcement over the weekend that Spain’s banking system would accept the $100+ billion in support for the European Central Bank (ECB) was thought to be a boon for the credit markets. This medication was short lived as concerns then rose for Italy. It seems we have finished the PIIGS (Portugal, Ireland, Italy, Greece and Spain) dilemma, and now must move on to the remaining 12 countries in the Eurozone and then on to the new countries that may request entry into this consternating governmental conglomerate.
From the introduction of the PIIGS, the plot was evident with the ending several chapters away. However, in moments of anxiety, we tend to treat current news as a current concern. Italy and Spain have always been the more significant concerns due to their size of debt and GDP as a percentage of the Eurozone as well as challenges to the banking system and their lack of adherence to mark to market. So the pill taken for the “Spanish Flu” has the hypochondriac investor seeking another pill for the Italian side effect.
This move has amplified the move to safety once again with the 10-year Treasury marking historic lows as well as the German 10-year Bund trading a current 1.20%. Yesterday also saw the S&P 500 open up fairly strong only to close near its low for the day. It had a trading range of over 2% for the day. If this were a short pit stop for another “flight to quality” by investors who were limited in time frame, this would be less concerting. However, according to the Fed Flow of Funds report, we are seeing domestic households raising purchases from the end of 2011 to the first quarter of 2012 by 13.4%. Since the official end to the recession, households and nonprofits have increased direct Treasury securities over 63%. Holding these to maturity may cause a pricing concern if the 10-year Treasury gets back to its long-term average of 3.9%.
The hypochondriac investor disregards all financial data points and believes only that they are about to suffer another one-in-a-million catastrophe. We couldn’t begin to blame investors from suffering from the “recency bias” where recent events shape immediate expectations. This exact moment when emotion clouds judgment and assets have been sold with little regard to historic value, is the opportunity where inefficient and emotionally-driven markets reveal select opportunities. As investors who are cognizant of the recent “black swan event” hunt around for a flock of black swans (infinitely unlikely by its definition), they often don’t see the golden goose that got a bit dirty in panic scrum.
Now it has been assumed most physicians are not keen on having hypochondriac clients, as their need for definitive guarantees drives physicians to an early burnout. However, we are reminded of a joke: “What does a doctor do with a hypochondriac? Ask for referrals.” Assuming a hypochondriac drives unnecessary testing, he or she also drives up revenue for the physician, though it is considered a very laborious gain of revenue. Then the question is, “Is this group-think polarization part of the majority or minority?” It appears to me in watching headlines, hearing retail questions and monitoring the markets behaviors that the pessimistic majority actually sense they are in the minority. This is another subtle ingredient in the recipe for opportunity.
With the assistance of Mike Boyle, Senior Vice President and equity portfolio manager, we looked at the proficiency of the “sell in May and go away” hypothesis that most investors are subscribing to. Since 1962, the November–April price of the S&P 500 has had 21 periods out of 50 where it outperformed the May–October period by 5% or greater. I used a 5% level as benchmark because of taking extra trading costs, capital gains and leeway in accounting for delayed re-entry back into the equity markets. This means that over 40% of the time the theory worked. The difference in outperformance was fairly large by using this, but it assumes – and we all know what assuming does – the investor was willing to get back into the market when it would have been most difficult due to pessimism’s permeation and the majority feeding the need for safety. That sounds a lot like today, in our opinion.
We continue to favor risk assets such as equities, low grade municipal and corporate debt, specific commodities like industrial metals and agriculture. If one suffers from hypochondria, emotion dominates logic. Just as a physician cannot use reason in addressing the patient’s concerns, advisors will find a stalemate in using the same approach with the risk weary investor. It is a laborious and strenuous relationship between hypochondriac and doctor; however, in the investing world’s equivalent, great opportunity may lay in waiting and we believe, well worth the effort.
This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the disclosures webpage for additional risk information. For additional commentary or financial resources, please visit www.aamlive.com/blog.
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