As investors, and we all are investors these days, it is important that we understand the specifics of stock market price data that help us make decisions. On Wall Street, investing can be a minefield for those who don't take the time to appreciate why stock prices are at the levels that appear on quarterly statements. At least four times a year, stock prices are a function of institutional marketing practices rather than a reflection of the economic forces we like to think are their primary determinants. Not even close… At about the end of each calendar quarter, we hear the financial media matter-of-factly report that “Institutional Window Adding Activities” are in full swing. But that's as far and as deep as it ever goes. What is it talking about and what does it mean for you as an investor?
There are at least three forms of Window Dressing, none of which should make you particularly happy and all of which should make you question the integrity of the organizations that either permit, implement, or condone their use. A more familiar option involves removing stocks with significant losses from portfolios and replacing them with shares of companies whose shares have been the most popular in recent months. Not only does this practice make managers look smarter in messages sent to major clients, it also makes mutual fund performance numbers appear significantly more attractive to potential "fund switchers". On the sell side of the ledger, the prices of the weakest stocks are pushed down even more. Obviously, if they choose to survive, all fund managers will participate in the ritual. This form of window dressing is neither investing nor speculation by most definitions. But no one seems to care about ethics, legality, or the fact that this "Buy High, Sell Low" picture is being painted with your mutual fund palette.
A more subtle form of Window Dressing takes place during the calendar quarter, but is "unrolled" before the quarterly portfolio reports reach their glosses. In this less widespread (but even more fraudulent) variant, managers invest in securities that are clearly out of sync with the fund's published investment policy at a time when their particular specialty has fallen from favor with the gurus. For example, adding commodity ETFs or popular emerging country issues to a Large Cap Value Fund, etc. Profits are taken before the end of the quarter, so the fund's holding report remains uncompromised, but with better quarterly results. A third form of Window Dressing is called "survival," but it only affects mutual fund investors, while others undermine the information used by individual security investors (and their market performance). You might want to look into it.
I don't understand why the media is so superficial about these "common" practices. Perhaps ninety percent of price movements in stock markets are the result of institutional trading, and institutional money managers seem to be more concerned with politics and marketing than investing. He tries to impress his major clients with his brilliance by reporting ownership of all the hot tickets and none of the major losers. At the same time, they manipulate the performance statistics contained in their promotional materials. They have made "Buy High, Sell Low" an accepted investment strategy in the mutual fund industry. Meanwhile, individual security investors receive inaccurate signals and suffer hedging losses by moving in the wrong direction.
From an analytical perspective, this quarterly market value of reality (artificial demand for some stocks and unwarranted weakness for others) completely throws almost any individual security or market sector statistic out of line with the company's underlying fundamentals. But it gets even more blurry, and not in a nice way. Just for fun, consider the impact of the "demand" impact of an ever-growing list of ETFs. I don't think I'm alone in thinking that the real meaning of stock prices has less and less to do with corporate economics than with the morning line of bets on ETF ponies… the dot-coms of the new millennium. [Remember “Circle of Gold” from the 1970s? Isn't GLD or IAU about the same thing?]
As if all these institutional forces weren't enough, you also have to consider the impact of tax-driven transactions during the always fun final quarter of the year. One would never suspect (after watching millions of CPA driven taxpayers gleefully lose billions of dollars) that the purpose of investing is to make money! The net impact of these (euphemistically labeled) "year-end tax saving strategies" is essentially the same as the Type 1 Window Dressing described above. But here's an off-quarter buying opportunity you really shouldn't miss. Simply put, go out and buy the November 52-week lows, wait for the periodic and mysterious "January Effect" that will be the media wide-eyed in amazement, and make some easy profits.
There may be no method to actually decipher the true value of a share of common stock. Is market price a function of company fundamentals, artificial demand for "derivative" securities, or various forms of institutional window dressing? But this is a condition that can be used for great financial benefit. Since security prices are less closely related to those old-fashioned fundamental questions like dividends, expected earnings and unfunded pension liabilities, and perhaps more related to artificial demand factors, it appears that the only operational alternative is trading! Buy distressed issues (but still basically investment grade) and take your profits on those that have risen to unreasonably high levels based on fundamental quality measures…and try to do it before the big players do. To put it simply, the recipe for success would involve buying investment-grade stocks at bargain prices that would allow them to cook until a reasonable, pre-defined profit target is reached, and seasoning the portfolio with the discipline to actually realize the profit-taking. plan.
Yes, I miss the days when there were only stocks and bonds, but maybe I'm too old fashioned. An interesting place on Wall Street…
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