Finance and Stuff

Thoughts on finance and other stuff by Johan Lindén

Month: April 2012

Cash Better than Stocks?

monkey picking stock marketIn my search to provide you with more evidence that stock investments are bad placement for most investors/traders, I found an article about the e-book “Monkey With a Pin.” It’s free so go ahead and read it.

According to the book there is a 6% annual cost for the average stock investor trying to make money. Compare that to the long-term gains in the average stock market which is around 5 percent.

From the article about the book on the Sci-Fi blog:

Comley starts with the fairly undisputed fact that 85% of fund managers fail to beat the market each year.

Most stockmarket growth in the last century was generated not by capital returns – which were more or less flat, adjusted for inflation – but from reinvesting dividends.

Looking at the average investor’s return, which is biased by our overoptimistic need to buy high and sell low, Comley’s estimate comes in at between minus one or two percent.  That is, investor “skill” generally reduces returns by one or two percent. […] Roughly fund investors appear to lose 2.2% a year, stock investors about 1.3% per year.  Those costs add up as well: they depend critically on your investment size, and the bid-offer spreads, but the Dalbar figure is roughly 3.8%.

The book also tried to give some answers to way people are so willing to keep investing in the stock market.

People do not want to put their capital in money market accounts since they are almost certain to give a negative yield when adjusted for inflation. However, as the article says:

Losing small amounts of money to inflation is far, far better than losing large amounts investing in overhyped stocks. The odds are against the investor, but loss aversion dictates that people will often prefer to take the gamble of a possible large loss, but a possible large gain, over a certain loss.

That is called the loss aversion bias, which is well documented in psychology.

Another fact is that people’s memories are anchored to the huge stock market gains of the 90’s and they still live on the hope to re-live that time once again.

Source: The Sci-Fi Blog

Stock Market Analysis Follow-up

In my previous stock market analysis I thought the market would make a down turn before reaching multi-year highs and then make a false break up before a big downward trend.

What happened was, as you can see in the chart below, that the S&P500 index only made a minor move down (A), before it broke up (B) and giving a false buy signal so that people would buy, then continue down (C) tricking people it was a false buy signal so that they would sell. After shaking of some weak hands of their positions the years strongest rally started (D), which was followed by the years biggest correction (E) which again landed below the previous multi-year high.

The S&P 500 was trading at 1357 at the previous analysis, while todays futures indicate and opening at 1361 (+0,29% change) in over two months time. So although a lot has happened in volatility, nothing much has shifted when it comes to valuation.

So what can be learned from this? Well, we still see that the market trying to make the most amount of people to become losers. We also see that contrarian sentiment has been reliable. It showed us the bottoms at (C) and (E), when people quickly panicked and started talking about a bigger correction down. It also showed us that the tops at (B) and (D) were not likely to give stronger long-term trend changes since people had become skeptic about the market trend.

That is obviously the reason why the market did not continue down but instead made new multi-year highs.

S&P500 technical analysis stock market

What can we expect next?

Most statistical signals are indicating that the market will be higher in the coming months. The risk-averse person should be out of the market while the speculative person should be buying on short-term oversold conditions and selling on overbought conditions.

What we should look for before expecting a longer change of the trend is that sentiment gets increasingly bullish while hitting new highs or that it gets stubbornly bullish while making the next correction down.

Most People Should Rely on Passive Investment

The intelligence of the average stockholder is probably above the population average. Still they cannot bet the index. That is to say they cannot even beat random guessing, a coin flip, or similar, as the chart below shows.

Active vs passive investment decision-making

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