Two Crummy Choices: Risk Another Fall in Stocks or Try Outpacing Inflation

For more than a year now, fundamental analysis of companies has been a waste of time. Stocks have traded as a block, first plummeting in tandem a year ago to March as banks froze up the financial system, then soaring in tandem as the Federal Reserve expanded the monetary supply and made cash worthless as an asset with near zero interest. The latter sent liquidity flooding into stocks, lifting all of them together.

We've seen evidence of this recently. Last week, Apple (AAPL) delivered a superb earnings report that announced its most profitable quarter ever. It sold 10.2 million iPods, 7.4 million iPhones, and 3.1 million Macintosh computers in the quarter. Reports just don't get any better.

Since the March low, Apple's stock has risen nearly 150% and the easy explanation is its phenomenal business execution. Was it that bad before, though? No. Here's how Apple CEO Peter Oppenheimer began the earnings report conference call a year ago, on Oct. 21, 2008: "We are very pleased to report our September quarter results, which were record-breaking on a number of fronts. First, we sold more Macs than we have in any other quarter in Apple's history. Second, we sold more iPhones in the September quarter than in all previous quarters combined. Third, we sold more iPods than in any prior non-holiday quarter and finally, we generated more revenue and earnings than in any previous September quarter in Apple's history." Remember, that was a year ago. During that record-breaking quarter, Apple's stock declined 40%.

All Apple's recent stock price rise has done is return the stock to where it was in December 2007 before it dropped 59% to its low last March. It was a solid company with strong fundamentals all through the drop, and it's been a solid company with strong fundamentals in this year's rise. Those fundamentals didn't matter a wit. What mattered was the macro backdrop.

Also, since the March low, stocks of other companies -- both healthy and sick alike -- have risen remarkably, too. Citigroup (C) is up 350% and Crocs (CROX) is up 500%.

Judging by correspondence I've received from book readers and subscribers to my newsletter, the latest shenanigans from government, banks, and big business may have had a lasting impact on the character of the market. I sense that many individuals have finally had it. The ruse is over, the curtain is drawn back, and what's revealed is that Wall Street is no longer about companies using public markets to raise capital in an efficient way that allocates it to those with the best prospects.

Nope, it's a fraud in which you can spend all of your free time (or work time, as the case may be) analyzing product plans, marketing plans, management history, and so on just to be laid low by a bank that levers up too far or a single pen stroke from the Federal Reserve chairman. It finally became plain as day that individual investors are up against the Goldmans (GS) of the world, and the Goldmans own the casino via their connections to government and government's connections to the Fed. When the investment banks control the Treasury and the Federal Reserve, observing their actions alone is all that matters to the performance of a stock portfolio. Enough individual investors have seen that and realized that they stand little chance against such collusion that a crowd of former market participants would rather take their chances against inflation than the casino owners.

Sadly, those are the alternatives. Deciding to walk away from the stock market is barely an option for Americans because the money supply has been constantly inflating since the Fed's creation in 1913. Americans face two crummy choices: risk another cliff dive in stocks when the powers that be speculate the whole sham into another crisis, or try outpacing inflation in non-stock investments that are less vulnerable to Washington's whimsy. Lovely.

Individuals used to take solace in looking at fundamental factors, thinking they could find an edge with the personal shopping experience as Peter Lynch taught, inside their own circle of competence as Philip Fisher taught, or culling the attributes of quality companies as Warren Buffett demonstrated. Now that even that impression has been rendered cock and bull, what's left?

About the best anybody can do is stick with broad index ETFs and try to sense the waves of pressure on the stock block. Good luck with that. Nobody can do it consistently, as has been widely demonstrated in the literature. Given the increasingly dice-like nature of stocks as the number of factors that individuals can analyze to make a difference dwindles, no wonder so many look to be placing their money elsewhere.

Trading is still alive and well. However, most stock market participants weren't in it for the slot machine aspect of speculating on stocks. They were in it for the steady average 10% per year growth they were told by the industry to expect, which is obviously not part of the bargain. It was made clear that past performance was no guarantee of future results. At last, it looks like people are paying attention to that. Instead of accepting the risk as they used to do, however, they're now concluding that they would like a few more guarantees in their financial future, and are more trusting of just about anything other than stocks.

Comments

[somecatchyp...:]

My sentiments exactly -

"Americans face two crummy choices: risk another cliff dive in stocks when the powers that be speculate the whole sham into another crisis, or try outpacing inflation in non-stock investments that are less vulnerable to Washington's whimsy. Lovely."

It's extremely risky to be in the market, it's extremely risky to be out of the market.

Oct 30 08:18 AM

[untrusting ...:]

Well stated. Could not agree more with you basic points. The flood of money into bonds vs a small trickle into stocks in 2009 is pretty clear evidence of the disgust of average investors with the casino culture of the stock markets. Unfortunately bonds, given the low interest rate environment, are just as risky as stocks. When interest rates rise, as surely they must, bonds will also suffer some serious declines in principle value. Then when one considers the large declines in the the US dollar and the loss of purchasing power, it further harms the average investor. Let alone the spector of serious inflation somewhere out in the coming years.

In short the grossly irresponsible behavior of our governments, our regulators, Wall Street, our large public company executives, and the related interconnected vested interests of these groups has very seriously damaged the average American and the average investor over the past decade or two.

The grossly irresponsible behavior of the interconnected vested interests has truly turned investing into the largest casino operation in the world. Average investors have litttle choice but to either exit the game altogether (who knows where anyone can safely put any savings now) or attempt to become traders and play the game at serious disadvantages to the vested interests that run the casino.

Oct 30 08:29 AM

[Mad Hedge F...:]

pls Those of you who heeded my GLOBAL RISK ALERT on October 13(click here for report at www.madhedgefundtrader...) missed the top of the market by six trading days and 10 S&P points. I’m sorry; I’ll ring the bell more precisely next time, with a more accurate date and time. Since then, technical sell recommendations have been breaking out like acne at a junior year prom dance. You are all now out of your positions or love them so much that you are willing to carry them through another crash. At the risk of hubris, even PIMCO’s Bill Gross has jumped on the bandwagon, although I doubt he needs my help ascertaining the direction of stocks and bonds. The way everything turned tail and ran at exactly the same time was a complete vindication of my theory that a tsunami of liquidity was raising all boats, completely unjustified by the underlying fundamentals. Long time readers of this letter know the only short I have advocated this year was in long dated Treasury bonds through the TBT. But the better than expected Q3 GDP of 3.5%, obviously fueled by temporary government programs like “cash for clunkers” and the first time homebuyers tax credit, may be presenting one of those pristine, “sell on the news” moments. Will this data finally give us our long awaited double top? Fading rallies in stocks is looking more enticing by the day.

Oct 30 08:48 AM

[Roger Knights:]

Regarding Apple, it's not quite true that, "It was a solid company with strong fundamentals all through the drop, and it's been a solid company with strong fundamentals in this year's rise. Those fundamentals didn't matter a wit. What mattered was the macro backdrop."

Apple had some special negatives (on a superficial view):

Worry about Steve Jobs's health;
Worry that competitors could catch up quickly to the iPhone;
Worry that the recession would more sharply impact Apple's premium priced products;
Apple's high beta, indicating vulnerability during a market drop.

Those were somewhat reasonable. less reasonable were:

Worry that Apple's P/E was too high (because of a failure to correct for Apple's subscription-based accounting for iPhone revenues);
A smug/superficial belief that Apple's success was based on mere hipness, marketing, and cosmetics.

So only about half (??) of AAPL's decline could be attributed the trend of the overall market. There must be better examples of companies that were irrationally tossed overboard.

Oct 30 10:25 AM

[David Van K...:]

Strong market-wide trends have always swept along stocks that "deserve it" with stocks that "don't deserve it." This is nothing new, it has happened as long as there have been stock markets, and it will continue to happen as long as there are stock markets. It is inherent in the nature of markets, it is a function of crowd psychology, and it is not unique to the past year or two. This is not the first time that "average investors" have become disenchanted with the stock market, and it won't be the last.

Investors who want a safe haven for inflation-beating returns are doomed to look forever. It does not exist, and it never has. The 10% average returns of the stock market over the past 100 years are a mere statistical summary. In fact, annual average returns have wandered all over the place, rarely falling at or near 10% in any given year. If you want to beat inflation, you have to assume some risk.

Fundamental analysis is not dead. The better stocks, over the long run, will still prevail. If you don't want to trade blocks of stocks (via ETFs) to beat inflation, then head for dividend-paying stocks. The best ones among them (and finding them takes actual work, not just throwing a dart at the Dividend Aristocrats list) will yield growing, inflation-beating returns for as long as you need them. Their principal value will vary (that is the risk you must assume), but the dividends will keep flowing. And don't worry about the S&P reports about dividends being cut all over the place. If you do your homework, you won't own many or any of those stocks--you'll own the ones that quietly, year after year, increase their dividends.

Oct 30 10:51 AM

[Innocex:]

I think it is also important to note that the macro backdrop relationship with individuals stocks has gotten more intertangled via:

1. the end of pensions and a bigger emphasis on 401k mutual funds for retirement
2. the rise of the ETF as a liquid block

All good individual stocks are in these packages and when the boat is rocked, fundamental analysis will go out the window as people panic, change allocations, or just do poorly thought out trades. The key to succeeding in this new phase of investing is to anticipate mass trader mentality in relation to the machinations of gov't/corporate greed or ineptitude.

Oct 30 11:17 AM

[mbkelly75:]

David Van Knapp has it exactly right and clearly said. I do not think I can say it better. Stocks that have paid a RISING dividend for more than 5 years have beaten the S&P pretty much every year and kept you ahead of inflation while, at the same time, protected you from deflation at the same time. They are always at least 50% of my Core Portfolio for that reason. Think about it.

Oct 30 04:55 PM

[ryanclarke:]

It's not just two crummy choices. It's a few hundred of them ... but all the crummy choices have something in common ... they all come from HARVARD. It's precisely because we have an economy where the current Fed chief, Bernake, and the current CEO of Goldman Sachs, the "premier" bank of America, namely Lloyd Blankfein, (BOTH OF WHOM GRADUATED FROM HARVARD TOGETHER IN 1975), have such power that they control the economy with entire dominion, that the rest of us 300 million citizens have been reduced to serfdomship. Harvard has a law school (OBAMA by the way) and a medical school and a business school ... and if you don't have such a rubber stamp on your resume you are NOBODY in this economy! Too bad Harvard doesn't have a tech school ( ya I know about MIT ) because the Harvard bubble heads and their centralized command and control of Wall Street are going to have to figure out how to move goods and people around the country without cheap oil ... someone with a business degree or a law degree or a medical degree doesn't have the knowledge base OR EVEN THE PROBLEM SOLVING SKILLS required to solve such a problem ... and that's the problem. The people presently in charge of the U.S. economy ... who should be making the structural changes in the U.S. economy ... lack the skills and background to successfully navigate the economic storm which is rapidly approaching the U.S.

Oct 30 05:23 PM