3/21/14 – Seeing the Forest Through the Trees

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Mar 21, 2014 9:27:01 AM

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One of the biggest problems most investors have—heck, that most people have—is seeing the big picture. A key finding of behavioral finance is that we weight more recent, more personal experience much more heavily than we should, and it costs us.

I’m thinking of this as I head out to speak in Columbus, Ohio. I give talks around the country for Commonwealth advisors and their clients, and it is invariably a great experience. The advisors are wonderful, the clients are interested and interesting, and I always learn a great deal talking with people.

Another common denominator, beyond being nice people, is that the audience asks questions on the differences between national trends and their own experience. I’m usually not an expert in the local area, so I can only say, “I understand things may be different here, but this is what the numbers are saying nationally.”

Both points of view are valid, of course. People in any area—including me in Massachusetts—live in and react to their own reality. Housing prices in my town matter much more to me than national trends. Friends who are unemployed matter more than the aggregate numbers. Children I know with college or credit card debt matter far more than the national stats.

As true as that is, we can’t make decisions based on our own experience. One of the key failings of many investors is that they focus too much on how they feel about things, or on what they know personally. For instance, knowing that a friend works at a company, and likes it, can trump information about declining earnings and market share.

How can we apply this today? I would point to three particular areas where the forest looks quite different from the trees:

  • According to Bloomberg, American business has record-high profit margins, generated by low wage increases over the past several years and very low interest rates.
  • Because of this, earnings are at very high levels, affecting P/E levels. Current P/E ratios, even if close to normal, are not based on normal Es. We forget this at our peril.
  • On a more positive note, none of the effective indicators of a recession is even flashing yellow. The current slowdown is easing, and it’s unlikely to be more than a passing phase in the recovery.

What does this mean? I’d say that it calls for intelligent caution about the stock market, per my recent post on warning signs, but intelligent optimism about the economy. Plan for the things that worry you, but know what’s worth worrying about. The cure for tree-ism is more data, and an intelligent analysis of which data actually works.

You can make it through a forest, even taking time to admire the trees, if you have a good map. That’s what research is all about.

Upcoming Appearances

Tune in to Bloomberg Radio's Bloomberg Businessweek on Friday, February 28, at 3:45 P.M. ET to hear Brad talk about the market. Stream the show live at https://www.bloombergradio.com/, listen through SiriusXM 119, or download Bloomberg's app, Bloomberg Radio+.

Tune into Yahoo Finance's The Final Round on Thursday, March 12, between 2:50 and 4:00 P.M. ET to hear Brad talk about the market. Exact interview time will be updated once confirmed. Watch at finance.yahoo.com

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