I once suggested what I thought was a great idea to my attorney who countered with, "Steve, that's not a good idea. You don't understand. You're in the system now, and the system defies logical thinking." To twist the knife, he added, "It's always dangerous when the client begins to think."
I'm reminded of that interchange when I pull a dusty copy of "Stock Market Logic" by Norm Fosback off the shelf. I subscribe to his newsletter, which he initiated in 1975, and have found his "Fosback's Fund Forecaster" to serve up a modicum of logical thinking with respect to financial markets. Could it be dangerous when the investor begins to think?
I wrote about Norm back in June of 2004, and at the time he predicted that the market would rise by 36 percent over the coming five years. Former Treasury Secretary George Shultz was famous for saying that you can make a prediction of how much the market is going to rise and when it will rise, but you should never offer both pieces of information at the same time. Norm ignores that advice.
A 36 percent rise in value over five years represents a 6.3 percent annual compound rate of return. Back in 2004, Warren Buffett was saying that he expected market returns to be about 6 percent for the next 10 years. Adding reinvested dividends of 1.5 percent to Norm's number brings us to about 8 percent. In fact, the market rose 40 percent in just 3-1/2 years from the time of that 2004 prediction, but we all know what happened after October of 2007. What Norm failed to anticipate, of course, was the black swan event of a major collapse of the financial markets, but hey, nobody's perfect.
So, what does Norm predict now? In his latest May 25th letter, he suggests that the market will rise by 37 percent over the next 12 months and 121 percent in the next five years. That 37 percent increase will have put him almost at where he originally estimated, but about one year later, in six years instead of five. If he turns out to be right from this point forward, the stock market will have turned out a decent return with the bonus of immediate gratification, especially when considering the alternatives of cash and real estate.
The Fosback Fund Forecaster places heavy influence on the amount of excess cash in the hands of money managers that they don't need to meet routine liquidity needs. In this case, that amount of cash is off the charts by any historical measurement, and what is more astounding is that this is true even when cash is essentially earning nothing. If history means anything, this amount of cash will flood the market to fuel that 37 percent rise (on top of what we've recently enjoyed) that we can look forward to in the coming 12 months.
In terms of where in the market to be, it looks as if foreign stocks are some of the best contenders, with international stocks outperforming domestic stocks over the past few months. Of those foreign funds, the emerging markets sector has proved to have offered the best results this year, but only because they lost less in the earlier months.
The Pacific Stock Index and European Index lost more in the year's earlier downturn, but all three are now enjoying a strong recovery. These international funds have also shown no hesitation and have continued to rise during the time our domestic stocks have paused to absorb the astounding gains of March and April and May.
It's a good bet that markets will return to a pattern that will allow some productive rebalancing from year to year. Different fund types and investment styles tend to be inversely correlated to some extent with small company funds typically leading a stock market advance. This time it was different.
The downdraft in the market took everything with it. Going forward, stay diversified for now with a number of different fund types, but be prepared a year from now to take some chips off the table from a few funds that will have shot beyond their portfolio mates. Add those chips to your losers for the year, and the net effect of this practice over time is one of buying low and selling high.
Analysts like Norm Fosback can help us adopt the long view which, in turn, contributes to a healthy dose of optimism. This heady mix of the long view coupled with optimism amount to an investor's equivalent of Prozac.
The soothing result relieves the investor of having to think; and thinking, we should recall, is dangerous because what may seem like logic can lead to panic.