Investors Look at the Wrong Information! Why?
It is difficult to beat the market. Individual investors who try to do so have, on average, results that are decidedly inferior. And not just by a little. It is more like half of the market return. They try to time the market using all of the wrong methods. They are afraid when they should be active. They are "all-in" when they should be cautious.
We are developing some general themes — common mistakes — but our effort is one of building the case a step at a time.
An Example
Before departing on a long weekend of pure relaxation, we tried to leave investors with an insight that we felt was particularly valuable. Our experience shows why getting perspective is important.
Earth to OldProf: They do not get it! We posted an article on why accounting rules may be misleading investors. We know that this is important for several reasons:
- It affects all of the financial stocks, an important key to the market;
- General understanding of the issues is poor and reflected in the prices of many stocks:
- The financial write-downs get plenty of daily play, with each new story changing analyst estimates.
- The crucial element of understanding requires knowledge of accounting rules, the immediate effect, and the longer-term implications.
- The big mainstream media sources report each fact, but often do not provide an analytic framework.
With this in mind, we wrote about how the rules affected a key company, AIG, and the market impact. Quite frankly, we hoped and expected that this would generate some interest and comment. Wrong! What were we thinking?
We checked this with our own small focus group and got a big yawn. No one wants to think about FAS 157. It is over the barrier of complexity. If things get too technical, everyone tunes out, no matter how important the topic.
The focus group was correct. We pay little attention to daily traffic at "A Dash" since we are not doing advertising, but we do periodic checks to see what resonates. FAS 157 causes eyes to glaze over. No one cares.
This myopia is empowering for those who take each issue to the lowest common denominator. FAS 157 was a big story when the bearish bloggers saw last November 15th as a doomsday date like Y2K. When it did not happen, the powerful writers in mainstream media did not point this out. There is no accountability. It is easy to make big predictions of write-downs. And it is newsworthy, picked up by all of the popular media sources and financial television.
Conclusion
There is always a way to appeal to an audience without providing understanding. Realizing this is the biggest challenge and the biggest opportunity for investors.
The credit market issues are difficult to understand. Investors and traders are not really capable of making independent decisions. Even if they work to get the facts, it also requires a solid analytical framework.
We shall pursue this with some other examples. Meanwhile, we need to work on article titles! Maybe if we had called the article DOW 15000 and included the Sports Illustrated swimsuit indicator, with a picture or two, it would have gotten more attention.
Understanding why FAS 157 is important is both more important and more challenging.
“Quite frankly, we hoped and expected that this would generate some interest and comment. Wrong! What were we thinking?
We checked this with our own small focus group and got a big yawn. No one wants to think about FAS 157. It is over the barrier of complexity. If things get too technical, everyone tunes out, no matter how important the topic.
The focus group was correct. We pay little attention to daily traffic at “A Dash” since we are not doing advertising, but we do periodic checks to see what resonates. FAS 157 causes eyes to glaze over. No one cares.”
****************************************
In my opinion, there is ***SO MUCH*** that can be learned from Warren Buffett and his investment career, and he freely shares his wisdom with investors.
He has a concept of “circle of competence”. In my opinion, most investors either vastly overestimate their circle of competence, or routinely stray well beyond it in the investment decisions they make. Furthermore, I think this is one of the reasons for many investors underperformance. They do not know what they do not know nor have any hope of truly understanding.
Buffett also has a concept he calls his “too hard pile”. These are potential investment opportunities that are simply “too hard” to ascertain what if any edge exists. For Buffett, the “opportunity” of tech stocks in general fall into this pile. That is OK, because he can go make a ton of money elsewhere, and has done so.
For me, Level 3 assets, FAS 157, mark to market versus mark to model, and whether AIG is a compelling opportunity or sitting on a time bomb of potentially worthless assets is well beyond my “circle of competence” and something I immediately throw in the too hard pile.
For me, thats OK, because as an example, I can stick to my natural gas E&P stock I completely understand (Chesapeake Energy-10% allocation) which once again closed at an all-time high and is still substantially undervalued.
I did not comment on the post because I had absolutely nothing of value to add. I thought your post provided an alternative perspective which again serves the purpose of bringing balance to the discussion. Any comment on my part would have been noise.
I think more then any other principle, investors (especially amateur individuals) would be best served to figure out and stick to their “circle of competence” which might be something like a pure lazy ETF diversified asset allocation portfolio.
Two notes on accounting:
1) When a standard becomes so complex that most professionals have a hard time with it, typically companies in that industry tend to see earnings and book multiples sag. Opaqueness gets a discount, except during manias.
2) On average, new accounting rules typically don’t affect the prices of stocks much because free cash flows are typically unaffected by accounting rules.
Finally, an aside — I didn’t like FAS 157 or FAS 159 much because they lessen comparability across companies… an argument that Marty Whitman made as well.
But, that’s been the consistent direction of FASB over the last 20 years, so maybe we should just scrap the whole thing and move to the international standards, even though it will give us a new set of flaws — no accounting standard is ever perfectly complete or consistent, and angels are not applying the rules or principles.
How do you think fair value was calculated before FAS 157?
Fair value isn’t new. You are just hearing about it more because of the wider disclosure required by the standard.
If anything it has increased consistency because of the focus of regulators. The first part of FAS157 says it all, the standard does not require any new fair value measurements.
If you want to get to the accounting standard that matters, it is the accounting standard that allows a company to fair value complex investments… FAS157 just tells you how much BS is mixed in the pot. Did you like it better when that was just hidden behind the scenes? Maybe FAS157 has just woken everyone up to the fact that they’ve leveraged up on BS equity for the last 5 years. I’d stop trading too.
To point in the correct direction: FAS140 allows gain on sale for asset transfers (securitizations) and generated most of the originators profits. FAS115 allows you to mark to market securities. Somehow we all bought off on the idea that a securitization locks in a profit (gain on sale) and transforms a loan into a security (and hence mark to market accounting).
For what it is worth, IFRS has a similar framework.
I think the problem lies less with the failure to understand the complexities of FAS157 than with the broader market willingness to unquestioningly accept explanations of directional risk – ESPECIALLY when it is presented in the context of complex valuation issues. The Y2K bug and the introduction of FAS157 into market parlance both served a common purpose – to “rationalise” a commonly presented view as soundly researched and therefore unchallengable as fact. Level 3 assets were regarded as trash precisely because their precise definition was too complex and it happened to fit the zeitgeist of the time – that the banks and Hedge Funds were in an EVEN BIGGER HOLE than we thought. Yet when, 3 months or so later you highlight that they told you no such thing and that the issue is interesting in the sense of what opportunities that may provide – well the ship had moved on. We no longer regard ourselves as on the edge of the abyss so – no interest. The real frustration is for those of us who pointed it out at the time – to a greater or lesser degree – but had to sit back and watch the Charlie Gasparino’s of this world hector the investment community with their “certainties” of fact and see markets selling off further on the basis of little more than scaremongering and rumour. I guess they are doing their jobs – never letting the truth get in the way of a good story – but it is irksome none the less.
Chris –
Thanks for a very thoughtful comment. It helped to inspire today’s article.
It would be nice if some of those who highlighted the bad predictions of the past revisited those stories, but I am not holding my breath!
Jeff