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Financial Industry Insights from Advisors Asset Management
On May 31, 2016
AAM Viewpoints - The Voice of Consensus is Rarely the Best Message to Listen To
Recently we have heard a spate of analysts warning investors to lessen exposure to the equity markets. Market heavyweights such as Goldman Sachs and Merrill Lynch are counseling their clients to be cautious on equity exposure. We have seen a rash of cash pulled from equity markets and stored on the sidelines. In the past five weeks, Merrill Lynch reports that $44 billion have been pulled out of domestic equities. This is the largest withdrawal since 2011 (see chart below). Uninvested cash balances in equity mutual funds is close to an all-time high. There is an unmistakable wave of pessimism that has gripped equity and bond investors.
What is the reason for this rush to the sidelines? Many are advising caution because of valuation, citing that current markets seem fully valued based on historical data. Some are alarmed because Europe and China have slowed and they believe that slowdown is headed for the United States. Others cite the U.S. presidential election uncertainty, Fed rate hikes or the “Brexit” (the move in Britain to separate from the European Union). Some simply use “sell in May” as a strategy.
What do we believe an investor should do? If history is any indicator, probably the opposite of what they are being told.
The truth is that market timers rarely get it right over the long term. They might get lucky once or twice, but getting in and out of the market is trickier than it seems. We would argue that this advice is coming a year late. In 2015, when optimism was running high, being fully invested in equities and corporate bonds was actually the wrong place to be. We saw a stealth bear show up and provide a very tough environment for investors. Historically, selling peaks usually are coincident with lows in prices. Those who held on experienced a strong recovery in March of this year.
In fact, some of the best returns over time can be derived from doing exactly the opposite of what the market advisors are telling you to do.
Merrill Lynch has maintained an index since 1985 that has been incredibly accurate. It is called the “Sell Side Indicator.” The indicator attempts to measure when equity valuations get to a buy level and when they should be sold. The primary inputs for this indicator includes the degree of optimism or pessimism that “sell side” strategists are feeling. The more pessimistic that Wall Street firms become, the more bullish the indicator gets. Conversely, the more excited and bullish Wall Street strategists get, the more bearish the indicator moves. So, you guessed it, if you would have done exactly the opposite that the “experts” were touting you generally would have done much better. As of the May 2016 reading, the indicator is flashing a buy signal (which it has done since 2012) that have become more pronounced as the experts have voiced more caution.
It is important to remember that “time in” the market is much more important than “timing” the market. Long-term investors only have to make one decision right – and that is to commit capital to the market on a regular basis. Market timers have to make at least two decisions right – when to get out and then when to get back in. Over my years in the market I cannot think of anyone who I have witnessed who could time the market effectively over long time periods. I have seen plenty of market timers who have been quite hot until they crashed.
Markets can have some very pronounced moves in some very short time periods. However, over the longer term the moves tend to smooth themselves out and longer horizon investors tend to do better. In fact, the investor’s emotions (swinging between fear and greed) can be the worst enemy of long-term results. Interestingly, it appears investors know the right thing to do, but easily get sidetracked by short-term events. The truth is that at any giving time there are ample reasons to be pessimistic. We note that in 2015, dividend strategies, high yield, energy and MLP’s (Master Limited Partnerships) got taken to the woodshed. However, they all have been winners so far this year. If you had gotten scared and sold last year you would have taken the losses without the ability to recover.
Sir John Templeton, one of the world’s most prolific investors, said that “Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria.” What stage of this bull market do you think we are in? Likely not the final stages. There is rampant skepticism and downright pessimism. There is precious little optimism and definitely no euphoria. Will the future be different this time? Templeton called those words “The most dangerous words ever.” We believe it is highly likely that we have not seen the end of higher prices.
What should you watch out for? Wall Street euphoria expressed in advice to “risk everything.” However, until we get there, we think investors should stay the course, as time tends to mitigate the pitfalls of market timing.
CRN: 2016-0502-5323R
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.
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