On his August 3rd, 2013 radio program, “The Investor Coaching Show,” financial adviser Paul Winkler discussed why stock market decisions can often be driven by history, rather than by a long-term future outlook. “One of the questions that investors often ask: ‘Is it a good time to be investing in stocks?'” states Paul. He said that investors “want to make sure that they aren’t hopping into a market that is ripe for a downturn.”
No one likes “showing up too late to the party, paying inflated prices for companies just before a [market] bubble pops,” Winkler said. “Stocks have been on an extended bull run since March of 2009, so this question is increasingly being raised on financial pages everywhere.”
An investor doesn’t need to go far to find opinions on where the stock market is headed. Analysts may compare the current market trend (in today’s case, a bull market), returns and stock prices to the past to shape their opinion. Winkler said that the opinions of analysts “are often backed up with convincing data. They will look at stock prices compared to earnings, and they [may] compare the length of the bull market to past market runs.”
However, Winkler said that the “problem with this method of analysis is that stocks don’t have a memory. In other words, stock prices aren’t based on what has happened in the past, but what is likely to happen in the future.”
As a challenge to putting too much attention on history, Winkler began by explaining the basic activity of the stock market: “When a stock is bought or sold, we must always remember that there are two willing parties to the transaction: a buyer and a seller. The seller wants to know what price they should demand based on what future earnings they will miss out on. The buyer is trying to determine what they might be willing to pay for the right to receive those earnings.”
“Looking at past or even future earnings, while helpful, does not provide a complete picture of what is at stake,” Winkler continued, introducing the complexity around basic buyer and seller activity. “Earnings may be depressed [now, because] current expenses may come down significantly in the future. What if new energy sources are developed that reduce a company’s expenditures? Or, what if new technology is around the corner that will increase productivity for years to come? That can have a major impact on earnings growth.”
“What about demand for products? Well-run companies will focus on the needs they can meet for future generations which may, or may not, look like their past product and service mixes. Furthermore, the buying public will often delay purchases of bigger ticket items when they lack confidence in the economy, only to suddenly reverse course when that confidence returns.”
It is not only product lines or the operational costs of a company that change, affecting investment decisions. “Another factor that can cause rapid changes in stock prices is risk,” Winkler said. “If there is tremendous uncertainty about the future, stock prices will stay depressed until that uncertainty abates.”
Winkler presented one example of how risk affects investor decisions, and how it can pay off: “If, as a buyer of a company’s stock – and therefore its owner – I am uncertain about how much of the company’s future revenues will be needed to abide by new regulatory requirements, I will protect myself by paying less for that stock now. In effect, I am protecting myself from a possible overpayment for earnings that may not come to pass. If those earning do show up,” Winkler concluded, then the investor is “rewarded for the risk taken.”
While it may seem wise to avoid investing in the stock market while it seems overheated, Winkler warned against relying on a bad word in the financial lexicon: “timing.”
“All of the major studies that have been done on market timing show that this behavior almost always results in reduced returns and greater risk,” Winkler cautioned. “If the pros can’t do it, then it is unlikely that the rank-and-file investor will have better luck.”
About Paul Winkler of Paul Winkler, Inc.:
Paul Winkler, QFP, ChFC(R), RFC, CLU, LUTCF, CASL, AAMS, is president and founder of Paul Winkler, Inc., a registered investment advisory firm located in Goodlettsville, Tennessee. Paul has been in the financial services industry since 1989, and has been published extensively in industry and mass media publications. In addition to being the host of the long-running radio program, “Investor Coaching Show,” on WWTN-FM, often Paul has been a guest on nationwide radio and television programs.
Paul’s unique approach to the world of investing and financial planning stems from his strong belief that the traditional approach to the discipline is often driven by promoting financial products rather than by sound investment philosophies. Paul is the author of the book, Above the Maddening Crowd, which is endorsed by many financial teachers and university professors around the country.