Rational Investing

by Clark Davis

The market has become troublesome at least the market in terms of that oft-quoted measurement, the Dow Jones Industrial Average (DJIA). In my last column, I discussed my concerns about the extreme overvaluations of almost all of the 30 stocks which comprise that venerable average. Now I am seeing more of the anecdotal evidence that occurs before a meaningful correction.

I am not saying that we are about to enter a bear-market phase, but I do see signs that are flashing a caution light. CNBC spent the better part of a week promoting a three-hour special for the day the market crossed over 9,000.

Two weeks ago, a client called to tell me that he predicted the market would go over 9,000 "tomorrow." Money is flowing into aggressive mutual funds with near abandon. I hear people talking about the "new market" that should be bought on any dips. There is much too much focus on Dow 10,000.

The stocks of many large companies have been bid up to irrational levels, as managers of large pools of assets (mutual funds, large money management firms, major trust companies, etc.) have had to put to work the large inflows of cash they have received. Because of their size, it is easier for them to invest in the "big names" that have a lot of stock outstanding the type of names such as those in the DJIA.

That has created an interesting situation in which they buy the "big names," which drives prices higher, which causes the market to go higher, which increases investor enthusiasm (read "greed"), which causes investors to throw more money at the money managers, which causes the money managers to buy more of the "big names," which ... and so on.

This phenomenon is most obvious in the area of index funds that are designed to match the performance of various indices most often the Standard & Poor's 500. It is almost a feeding frenzy at times.

When the euphoria that fosters greed turns into worry that generates fear, this greatest of all bull markets will stumble, hesitate, and then teach many inexperienced investors that the old saying is true, "In a bear market, money returns to its rightful owners."

Will every investor's portfolio decline in value? Yes, but not at the same rate or in similar magnitude. Those investors who are experienced and who limit their investments to high-quality issues with strong underlying fundamentals and reasonable valuations will see the best returns. Those who have been caught up in the euphoria of trading over-valued stocks on the basis of their price momentum, and have "confused brains with a bull market" will see the worst.

This is a time for extreme caution, and the very careful selecting and monitoring of investments.

Perhaps I will be proven overly cautious, but 30 years in this business, through bull and bear markets, has taught me that in periods of uncertainty, it is better to err on the side of conservatism.

Every year about this time, after the first quarter ends and the Masters has been played, I am overwhelmed with the conviction that this year I really will consistently shoot in the mid-80s. It takes but a couple of outings to remind me that, in spite of succumbing to the siren's call of the Alien wedge ("guaranteed to get you out of the sand and deep rough, or your money back"), and the Lee Trevino claim that the Magna ball will eliminate hooks and slices, I will once again learn the lesson that, as my Dad said years ago, "You can't buy a game. You have to swing from the inside."

Erratic performance on the course is tolerated by most golfers because the gods of golf will always give us one or two shots that were so good we can't wait to play again.

In spite of knowing that lessons and practice are more likely to produce positive results than rushing out to the first tee every chance we get, most of us have thought to ourselves, "I know what I did wrong. Next time I will ... (fill in the blank) and I will have it right."

So, instead of doing our homework of lessons and practice, out we go, only to have those same gods of golf wink at each other and insinuate shanks, skimmers and foozles into our round.

What does this have to do with investing? Not much, but hey, there's more to life than just making money.

(Clark Davis is a 30-year investment veteran and CEO of Saint Louis Investment Advisors, a specialized money management company. Questions or comments can be directed to him by mail via The Springfield Business Journal, 313 Park Central West, 65806 or e-mail at clark@slia.com.)

[[In-content Ad]]