Newsletter
November 4, 2006
It's Not Necessary to Understand Everything
Market & Sector Review
The Election, What Does It Mean for The Markets?
Largest Changes In Raw Numbers (21 Days)
This Week's Economic Reports
It's Not Necessary to Understand Everything
Many successful people live by a very useful belief. They do not believe they have to know everything about something in order to use it. They know how to use what's essential without feeling a need to get bogged down in every detail. A very simple example: I am sure all of you own a TV and a remote control device. How many know exactly how they work? What you do know is how to use it. Simply press the power button and the TV is on, press the channel button and it changes channels. It is not necessary to know the inner workings in order to use it.
Time is one of those things none of us can create. Achievers invariably manage to be time misers. They extract the essence from a situation, take out what they need, and do not dwell on the rest. In the markets, it is not necessary to be able to understand every aspect of a company's financial statement, or to understand every aspect of economic prospects to trade the markets. It is also not necessary to understand every technical indicator. There is a balance between understanding everything and picking what you need to know.
In order to effectively use all that you are in this life, you should discover that there is a balance between use and knowledge. "You can spend all your time studying the roots, or you can learn to pick the fruit". - Anthony Robbins. There were probably plenty of scientists and engineers at major universities who knew more about computer circuitry than Steve Jobs and Steve Wozniak (founders of Apple Computer), but they were so effective at using what they had.
If you follow the markets every day, in time you will become proficient at extracting the information you need to make a decision. Whether it is looking through hundreds of charts, or the use of market scans looking for stocks fitting your personal criteria, or breaking down the marketplace into sectors and groups to determine what's hot and what's not. As you gain experience you will become very proficient at extracting the information you require. Then merely include these stocks, sectors, or groups you have found into a watch list where you will keep extensive notes on such things as: buy point, sell point, and your perceived risk and potential gain.
Market & Sector Review
The Election, What Does It Mean for The Markets?
I'm sure most of you, like myself, are tired of all the political ads and all the talk of how the election will mean this or that for the stock market. There is the longstanding Wall Street belief that the stock market performs better when the government is paralyzed by gridlock. For example in 2001 when Senator Jim Jeffords of Vermont switched his party affiliation from Republican to independent; Tom McManus, chief equity strategist for Banc of America Securities stated "The stock market loves gridlock. Now the Republicans no longer have the majority in both houses, gridlock is back." Prior to the 2000 election Edward Yardeni, chief investment strategist at Deutcshe Bank Securities was quoted in U.S. News and World report as opining, "Gridlock has been very good for the stock market."
The theory underlying this belief is that gridlock makes it less likely that the federal government will do something radical, and the markets crave the stability of knowing that the status quo is not likely to change very much. Conclusion: Wall Street must be wishing for a Democratic take over of at least the House of Representatives in order to return to gridlock. However, this begs the question: is this supposed Wall Street wish, myth or fact? While doing some research on the subject I came across an article in the current issue of the Financial Analysts Journal which calls this longstanding Wall Street belief into serious question. The article was written by Scott B. Beyer, an assistant professor of finance at the University of Wisconsin-Oshkosh; Gerald R. Jensen, a professor of finance at Northern Illinois University; and Robert R. Johnson, a managing director at the CFA Institute. They evaluated monthly returns from 1949 through 2004 for ten (10) equity indices, four (4) fixed-income indices, and an inflation index.
A link to the full article appears at the bottom of this section of the newsletter. Might I suggest you click on that link and read the full report!
The study consisted of separating each month from 1949 through the present into two classifications as follows:
- A divided government equals gridlock;
- A united government equals harmony; a united government is when the White House, the House of Representatives, and the Senate are all controlled by the same party.
The researchers found no evidence that the stock market performed better during periods of gridlock. In fact, they found limited evidence to the contrary: The stock market actually performs slightly better during periods of harmony. However, in an interview, Jensen stressed that this finding in favor of harmony is of limited statistical significance. The most important takeaway from their research, according to Jensen, is not that harmony is particularly good for stocks; instead, the important lesson to draw is about gridlock: The markets do not perform any better when it exists than when there is harmony. This research therefore suggests that the stock market's recent strength has little if anything to do with the likely outcome of this election.
Taking a look at the above data in a chart:
A quick overview of some of their findings for equities:
- “...Reveals a couple of interesting relationships between equity size deciles and political environments. During gridlock periods, the small-company premium is absent; the return to the largest companies exceeds the return to the smallest companies by more than three (3) percentage points.”
- “During periods of political gridlock, equity returns have been more consistent across the size deciles than during periods of harmony when small companies return 27% vs. 8.78% for the largest companies.”
- “The standard deviations indicate that equity returns were generally more volatile in gridlock periods than in harmony periods.”
- “The findings are consistent with the view that the increased incidence of legislative action during periods of political harmony is advantageous to equities – particularly small-cap stocks.”
I think what I found most interesting is that fixed-income or bond indices do act differently depending upon whether there is political gridlock or harmony.
- “The bond returns tell a much different story about the relative attractiveness of political harmony. Fixed-income returns were much higher in periods of political gridlock than in periods of harmony. The return differences are economically large and statistically significant at the one percent level. The largest return difference is for long-term government bonds…This finding indicates that the return difference between political environments can be attributed primarily to changes in the general level of interest rates rather than to changes in credit spreads.”
- “Surprisingly, even though bond returns were significantly different in the two political environments, the inflation rate was very similar. Therefore, the differences in bond returns are probably driven largely by changes in inflation expectations rather than the differences in the actual rate of inflation.”
- “The higher fixed-income returns reported during gridlock periods result primarily from a general reduction of interest rates during gridlock…Separating the return on long-term government bonds into its two components, income and capital appreciation. Table 4 indicates that significant difference in total returns can be attributed to both components; that is, interest income and capital appreciation are both significantly higher in gridlock periods.”
Largest Changes In Raw Numbers (21 Days)
This Week's Economic Reports
Have A Great Week!
Bill
Disclaimer: Trading in securities, of any type, may not be suitable for all individuals. The contents of this newsletter are not a solicitation to buy or sell securities. The opinions expressed are solely that of the author. You must do your own research, contact your own financial advisor for suitability of any investments. Data gathered is from sources believed to be reliable, but NO guarantee as to their accuracy is made.
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