Where is the Edge in Today’s Market?
Before my article from yesterday travels too far, I want to take a moment and dig into what I believe to be the most important conclusion to draw from it. Here is the relevant clip:
Over the past ten years, trading was wildly successful relative to buy and hold investing. The pronouncement that this relationship will continue into the future seems to be coming from those who are now trying to train more than trade, or those who missed the boat and are attempting to play catchup.
The evidence proves computers now own the short-term, but humans still own the long-term. Getting back to my conversation with Justin Fox, over the past decade “price efficiency” ruled in creating a substantial opportunity for traders. In today’s market, earnings multiples are so compressed that “value efficiency” creates an equally great opportunity for buy and hold investors.
For the most part, I take pronouncements with regard to the market in relative terms, not absolutes. No one statement in and of itself should be interpreted as a black or white pronouncement where only A or B can and will be true. The past decade, which many have labeled the “end of buy and hold” saw plenty of investors succeed with buy and hold. Meanwhile, watching CNBC or reading a wide variety of financial and trading-centric bloggers would have one believe that neither the S&P nor Dow went up over the last 10 years therefore buy and hold unilaterally did not work. The truth is not so simple. While many struggled with buy and hold there were some who succeeded.
Now with day trading, over the past decade, the industry enjoyed fairly widespread success. While yesterday’s article pronounced the end to “day trading” I am still fully aware that there are some in the industry who continue to produce results, but the opportunities are fewer and farther between and the edge is both overcrowded by those looking for an easy living and eroded by the prevalence and speed of high frequency trading (HFT). Ultimately, there is a finite amount of dollars available intraday in each and everyday, and day traders now must compete with other day traders and highly profitable computers for that money. The edge has diminished substantially.
My larger point–which tends to get lost in the comments from what I’ve seen–is that market participants are all looking for an edge. People are in the market to generate a return on capital, and it requires thinking as to how best to attain that return. Today, the real opportunity is over the long run and in the most basic sense, my reasoning is two fold.
First, for the past thirty years bonds have rallied aggressively to the point where there is little room for interest rates to go lower. In terms of asset allocation, the preference has shifted extremely in the direction of equities right now for the long-run and that has serious implications for money managers. The people who still own equities following the double-bubbles in the last decade, and the recent shakeout move in the second quarter of this year are committed owners of stocks at this time.
Second, the disdain for equities as a long-run asset class over the past ten years has led to the dramatic compression of earnings multiples. At the end of the day, taking a bottoms up approach, stocks are now cheap. To make matters even better, there has been such equal opportunity selling of equities to the point where the good was sold with the bad. This leads to once-in-a-lifetime opportunities for those who can dig down and do their research on company fundamentals. There are many stocks that fit the criterion for both “value” and “growth” investors.
So with all that being said, if someone were to take a pool of “sideline cash” and ask, how best would I deploy this cash? Should I day trade? Leave it as cash? Or invest for the long term? The answer, in my opinion, is unequivocally to invest for the long term. Day traders had their time to earn market-beating returns but those days are in the past.
I’ll end today’s column again quoting yesterday’s:
Often times when something becomes conventional wisdom in the market is exactly when that something quickly loses its prestige. For the past few years we have heard over and again that “buy and hold investing is dead” and that “trading” is the way of the future. Personally, I believe we are in the midst of the classic example of reversion to the mean.