Signals and Noise.

November 16, 2015

Successful investing? Equal parts history, psychology and math.
To achieve a modicum of long-term success, an investor must have historical perspective. An understanding of how the market traditionally responds to events and circumstances.
Additionally, investors must be aware that success often involves activities that run counter to everything with which an investor is comfortable. We are not hardwired for investing. So, one must learn the traits inherent to doing so effectively.
Finally, one must be able to crunch a few numbers in order to validate one's thesis.

The rest? All signal and noise.
Historically, two contrarian indicators have provided reliable signs as to when investors should buy and sell stocks. These are Wall Street and Main Street.
The equity strategists of the major Wall Street brokerage firms have been as accurate as the Mayan Calendar when it comes to forecasting. When they were most bullish, telling investors that stocks were positioned for future returns in 2000 and 2007, the market cremated anyone who listened.
In 1997 and 2009, when equities were primed to begin huge runs, Wall Street's strategists were soundly bearish. Counseling clients to overweight bonds. Again, dead wrong.
Which brings us to today. As of November 2015, Wall Street's equity strategists remain bearish on equities. Warning of tough sledding ahead.
And yet, Main Street does not concur.
Traditionally, Main Street has been nearly as inaccurate as Wall Street in regards to its forecasting efforts. When the stock market is shooting upwards, mutual fund flows shows investors pouring into bonds. When the market is gearing up for a correction, fund flows show investors pouring into stocks.
For six years, the S&P 500 has rebounded from the March 2009 lows like John Travolta's career after Pulp Fiction. America loves a comeback. Yet, American investors did not love this one. Never buying into the bull market. Still allocating capital to bonds, even as equities climbed higher.
Recently, however, something changed. Electrical engineers call it a "signal." Something that conveys specific information to those seeking it.
Conversely, electrical engineers, attempting to find such signals, endeavor to tune out "the noise." Those unwanted, non-meaningful, random distractions posing as signals.
The election? Budget deficit? Europe's migration crisis? Iran? Noise. All of it.
Typically, Main Street's enthusiasm might scare us. For we would no sooner invest with Main Street that we might attend a movie with Pee Wee Herman.
But being contrarian does not always involve being bearish.
So, let's look at the two existing camps.
One insists that the market's positive performance is overextended, unjustified, and due for a big correction.
The other claims that the last six years were an unorganized, garbage rally in which the average investor did not even participate. So, as Main Street begins to laggardly enter the market, and corporate profits remain decent, the market has room to run.
Such investor confidence typically makes us squeamish. But, consider the context.
This remains the most hated of bull markets. The last few years have seen a herky-jerky trend line dominated by crisis conditions, and the residual fear and apathy of the Credit Crisis. Everyone detests stocks. Preferring bonds and zero-yielding money markets.
Which is why recent signals are so interesting. For the first time in years, investors appear to be flocking towards risk. Even as Wall Street's finest caution against it.
At 2,062, the S&P 500 sits just below all-time highs. Yet, Main Street is putting capital to work. The Fed and other global central banks continue to support markets with record-low interest rates and easy liquidity. Corporate profits, ex-energy, continue to surprise. And energy will turn at some point.
Growth rates for employment, retail, durable goods and service orders all continue to accelerate. The home building revival continues.
True, manufacturing remains weak. Recent tax increases will degrade household incomes, and likely lower GDP growth. But, GDP growth should accelerate as 2016 begins. Especially if the eurozone sees a concurrent jump in productivity.
The wonderful aspect to our system of free-market capitalism is that ambitious, determined individuals, toiling in their self-interest, can propagate their visions upon the world stage. If consumers like what they see, then these forces of nature can create comfort, enjoyment and wealth for all. Regardless of increasing amounts of government intervention and politically manufactured volatility, energetic visionaries will always create opportunity.
Focus on the signals. Forget about the noise. For when you least expect it, equities could provide continuing upside surprises.

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