Monthly Commentaries

Now What? – March, 2009

During the first week of March, equity markets across the globe continued lower. Investors quickly moved to cash to hopefully wait out the decline. By the end of the month, however, equity markets rallied by almost 20% from the lows of the month and ended up 8%. The turnaround was quick and unanticipated; it appeared that all that was required was a small bit of good news. For traders who moved to cash to "wait out the storm", they have now missed out on one of the best 3-week periods in almost a quarter century. This short period rally highlights the dangers of market timing. For traders who went to cash during that period, they must ask themselves "Now what do I do"?

For Toron, the terms "trader" and "investor" are not synonyms. Traders have a very short-term view of the market and jump in and out of stocks attempting to profit from fluctuations in share prices. In contrast, investors are interested in the long-term prospects of the businesses to produce cash flow. Stock prices vary hourly and daily but the long-term prospects of a company do not change that rapidly. For market timing to be successful over a long period, the trader must make two decisions successfully: First, their decision when to sell must be correct and, second, their decision when to buy must also be correct. All too often traders sell their positions, watch the market go up and rally beyond their original sale. Then the weaker traders face a difficult decision as to whether or not to buy into a rising market. All the studies on market timing indicate that it is a losing proposition.

However, this is what passes for investing today. The average institutional portfolio manager has a holding period of 10 months, meaning their annual portfolio turnover is about 120% per year. While it's an attempt to outsmart the market from quarter to quarter, it's usually in vain. Brokers are the big beneficiaries of such rapid turnover. Each time a portfolio manager trades a position, they pay the bid/offer spread and the commission. These transaction costs add up to a large penalty for clients of these portfolio managers and become bonuses for the brokers executing the trades. The sales effort by all institutions is to get a trade, not because it makes sense for the clients but because it makes money for the broker. By being a diligent and astute investor, it's important not to jump in and out of the markets and make the brokers rich. Instead, focus on the company and its core business and the cash flows that the company generates. Over time, higher dividends and a more profitable company reward the investor. The investor is never left to wonder "Now what do I do?" Arthur Heinmaa, CFA Managing Partner