What You Shouldn't Buy in the Investment Market: The Pundits' Advice

Investing is a jungle, and most of the so-called experts who get quoted in the media are on the prowl with a simple purpose -- to give you a reason to trade more often. Frequent trading isn't good for you, but it's the life blood of the brokerage industry. Without trades, there are no commissions, and without commissions, there are no brokers' yachts. However, the fact remains that if you keep all your money in a savings account, you'll be treading water financially.

There are plenty of different ways that self-styled market gurus frame their arguments. Here are the three most common:

  1. The stream of daily economic reports and rumors of government responses to them provides a meaningful guide to whether you should buy stocks. For example, CNNMoney reports today that stocks went up Monday because a disappointing labor market report now means that the Fed will pump more money into the economy at its next meeting through so-called quantitative easing measures. I am not sure why stocks should go up because of this -- after all, bad news on the labor market means that economic growth is not in the near-term cards. More likely, the fetish over these market smoke signals masks a deeper inability to explain the hourly fluctuations in prices.
  2. The government is printing money too rapidly and debt is out of control, so stocks are worthless -- therefore, buy commodities. As I wrote in an article for DailyFinance back in August, hedge funds are using this argument to justify owning gold, which some people think will replace paper currency as a means of exchange. I am not sure whether anyone credible actually believes this, but as long as more cash is flowing into gold than flowing out, its price will keep rising. This makes it a great investment -- as long as you know when everyone is going to sell so you can get out at the peak. (But you don't, do you?)
  3. Stocks are expensive -- or cheap -- based on some special measure of their value compared to their earnings forecast and you should sell -- or buy -- them accordingly. For instance, Fortune reports that Yale economics professor Robert Shiller -- who developed a 10-year inflation adjusted Price/Earnings ratio called Cyclically Adjusted Price/Earnings ratio (CAPE) -- has concluded that stocks are expensive. Although they trade at a historically cheap P/E of 14.5, their CAPE is 21. And even though earnings grew 39% to a near record in 2010, he expects stocks will fall in value because companies can't cut costs anymore, so earnings won't grow as much in 2011. But Monday on CNBC, Ned Riley argued the opposite -- that in 2011 growth would accelerate and more of that growth would go to the bottom line due to the cost cuts. They both seem smart -- but can they both be right at the same time?
Numbers Can Be Found to Support Any Investment Theory

All these arguments ignore a basic reality: The market is now controlled by short-term traders, rather than the long-term investors for whom these arguments might have some relevance. Specifically, 70% of trading volume on the major exchanges is conducted by high-frequency traders who hold a stock for an average of 11 seconds. Only a handful of market players have the real-time data needed to make these short-term trades. If you're not one of them, you are vulnerable.

Professors like Wharton's Jeremy Siegel argue that stocks outperform all other investments -- generating annual returns averaging around 7%. He came to that conclusion after analyzing hundreds of years of history. Over the last decade, though, stocks have lost value -- the S&P 500 is down 17.3%. One key point is that the stock market provides enough numbers for pundits to prove whatever point they want.

The more important point -- as prospectuses often say -- is that past returns do not guarantee future performance. This is just as true for a mutual fund as it is for stocks in general. The bad news is if past performance has been good, it might be bad in the future. Whereas, the good news is that if past performance has been bad, the future might be brighter. Nobody knows.

The punch line here is the smartest money -- the hedge funds -- pay their portfolio managers as much as $4 billion a year to turn their money into more money. David Tepper, for example, personally pulled in $4 billion in 2009 with $12 billion under management in funds that have returned an average of 40% a year for the last 10 years. These hedge fund managers do know things that you don't. But unless you're a millionaire, you can't get them to invest your money.

You're welcome to read everything that the pundits say you ought to do to get rich in the market, but it's worth what you paid for it -- nothing.

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