HOME OF "PICTURES OF A STOCK MARKET MANIA"
June 11, 2005
Samex Capital's Stock Market CROSSCURRENTS
Alan M. Newman, Editor
This excerpt from the June 6th issue has been posted
to coincide with receipt by snail-mail subscribers.
We’ve lost count of how many times we have written aboutindexing, a procedure we believe is the worst idea ever perpetrated upon investors. Like portfolio insurance in 1987, it works in theory. Trouble is, when everyone usesthe same strategy, it backfires. In 1987, the idea was to sell futures if stockswent down by a predetermined amount to protect portfolios against furtherdeclines—”insurance.” However, the more it was utilized, the moreprices went down and more sales catalyzed still more sales, and those sales catalyzedstill more sales. How the procedure could be widely adopted without doubts to itseffectiveness is a testament to professional hubris. Indexing is similarly cursed.
William Hester, CFA, recently showed us(www.hussman.net/rsi/misfitstocks.htm) how indexing penalizes investors by the strategy ofreplacing laggards with “hot” stocks. Unfortunately, the selectioncommittee for the S&P all too often replaces the bad at their worst and adds the goodat their best. According to Hester’s analysis, “The median annualizedreturns of the removed stocks outperformed the shares of companies that were added to theindex in every year going back to 1998. The median returns were positive in each year,even during the three-year bear market.” [italics ours]. If this isn’t ahuge indictment of indexing, we’ll eat this page.
As each new year begins, we always look forward to Yale Hirsch'sStock Traders Almanac, a compendium of calendar related information that can easily placeone ahead of the curve. Yale discovered the seasonal tendencies that have ruled themarket for more than five decades (see our discussion of "the Dead Zone," in theApril 25th issue of Crosscurrents) and his Almanac Investor newsletter (
Judging by the past, the inference is for lower prices withsmall odds that the remaining months could turn out to be slightly positive. But ifthat is the best stocks can do, there does not seem to be much in the way of reasoning toremain long at this juncture. In the November 1, 2004 issue we highlighted aDecennial Cycle analysis and argued that 2005 could easily break the pattern and finish onthe downside. We see no reason to change our analysis and the Almanac's revelationclearly solidifies odds that favor the downside.
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The Investment Company Institute ("ICI") recently releasedthe mutual fund inflow statistics for April, showing net inflows down 42% from March anddown 61% from February. Contrary to what we have been accustomed to expect, bothJanuary and April have now disappointed. Both months, typically excellentperformers, were down (see article, "Down January…., on page 3). IfJanuary and April are down, performance for the entire year is in doubt.
What has to be truly depressing is the consideration that sincethe end of 1999, just before the mania surged to impossible levels, more than $700 billionhas flowed into mutual funds. That's right, $700 billion net inflows over 5 yearsplus has bought essentially nothing of value for investors. The Dow Industrials havereturned only minimal dividends over this period of time, while the S&P 500 havefallen by 18% and Nasdaq has been nearly sliced in half. Clearly, this speaksvolumes about supply and demand. The 2000 highs will not be surpassed for a long,long time to come.
While price performance in January and April has consistently beensatisfactory over the years, they are no longer a guarantee that even the first fourmonths of the year will reward investors. Over the last five years as measured bythe broad based S&P 500, the first four months of the year met with a 5.4% loss in2001, a 6.2% loss in 2002, a 4.2% gain in 2004, a 0.4% loss in 2004 and a 4.5% loss thisyear.
Our featured chart compares the mutual fund cash-to-assets ratio(bold) versus the absolute cash levels of mutual funds. Note how dramatically thecash-to-assets ratio has fallen over the years. Even the peak level achieved inNovember 2000 as stocks were crushed was exceeded every month from 1984 to September1996. However, the most startling aspect is how similar the chart points are now tothe precise manic peak of March 2000. Absolute cash levels are virtuallyidentical. Cash-to-assets ratios similarly so. Was there a better example inhistory of outrageous optimism than that shown by money managers at the manic peak? Given current levels of both absolute and relative cash, we can certainly make the casethat the mania never ended and merely took a time out. Yes, prices are much lowernow but they are still too high. History is the best teacher any investor can everlearn from. It would appear that money managers are not listening.
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ABOUT ALAN M. NEWMAN
Alan M. Newman has been the Editor of CROSSCURRENTS since the firstissue was published in May of 1990. Mr. Newman is also a member of the Market Technician'sAssociation and has been widely quoted for years by the financialpress, media, and other newsletters and has written articles for BARRON'S.
The newsletter is published 20 times per year and focuses on economicand stock market commentary, often covering controversial subjects. Several proprietarytechnical indicators are usually featured in every issue accompanied by currentinterpretation. Broad samples of our work can be viewed at
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