Streetwise for Friday, July 7, 2017

The major equity indexes have swung wildly of late. So how do you navigate your portfolio in this turbulent sea of uncertainty? Instead of participating in Wall Street’s game of, “guess what will happen next,” ask is whether there is a secret to winning on Wall Street without relying on tea leaves and tarot cards?

Of course, there is. Start by ignoring the deafening din emanating from the naysayers and prognosticators that are continuously courted by the media. They only produce a flourishing contagion of economic and financial hysteria.

While there are strong indications that the future looks promising, you can never be sure. However, investing is not about deciding what the markets are going to do. Market direction will always be unpredictable. What can be ascertained is a company’s prior accomplishments, its prior earnings and its dividend policy.

Then the problem is relatively straightforward. You simply need to find those corporations with superior records of accomplishment, whose product lines you understand and then forecast future performance. However, before making any investment decision ask yourself, do you really understand the path a company is taking and why? If you cannot answer yes in a minute or two, move on.

What about trying to mimic investors known to be successful in the past? Robert Shiller, an economist at Yale University, recently pointed out many people have tried to mirror the strategies of investors such as Warren Buffett. The problem is that by not understanding exactly how someone makes decisions, you cannot fully duplicate the process.

For example, a 2008 study by Gerald S. Martin of American University and John Puthenpurackal of the University of Nevada, Las Vegas, published an academic paper that showed when Securities and Exchange Commission filings reveal changes in the Berkshire Hathaway portfolio, the stock prices of newly acquired companies had an abnormal one-day increase, averaging 4 percent.

And there were even some potentially long long-lasting effects. A simulated replication strategy from 1976 through 2006 based on the S.E.C. filings outperformed the market by over 10 percent a year.

Now I know you are thinking, why not simply mirror Buffett’s moves. Not so fast. Copying Buffett in recent years has been considerably less successful than in earlier years, meaning that no one can excel all the time. And by not knowing the strategy in detail you cannot judge the timeliness of a specific move or the motive behind it. You are better off doing your own research.

A much-talked-about paper by R. David McLean of Georgetown University and Jeffrey Pontiff of Boston College pointed out that the effectiveness of stock market investing strategies seems to diminish, but not disappear, after their publication.

The paper, which won the American Finance Association’s 2016 Amundi Smith Breeden Award, examined 97 financial patterns that appeared to predict investing returns, and had been published in reputable scholarly journals and supported by tests that found statistical significance.

Such strategies relied on factors like price-earnings ratios, changes in analyst recommendations, credit rating downgrades, stock price momentum, industry momentum and failure to pay dividends.

What the researchers discovered was that while the strategies outperformed the market, their success decreased by more than 50 percent after publication.

In a follow-up paper, the two authors, along with Joseph Engelberg of the University of California, San Diego, showed that the one-day positive surprises on firms’ earnings announcements accounted for virtually all the ongoing outperformance. Why? Most likely because going forward the market consistently makes erroneous valuations of corporate earnings.

I would agree that the investment efforts of knowledgeable people are worth considering. However, please do not follow the strategies of others blindly, including mine. You must insert your own analysis and judgment when deciding on your investment selections.

Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com. Phone calls accepted between 9 AM and 3 PM at (941) 706-3449. For back columns please go to www.RuddReport.com.

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