As investors, and we are all investors these days, it is important to understand the quirks of the Stock Market pricing data we use to help us make decisions. Investing on Wall Street can be dangerous for people who don't take the time to understand why the prices of securities are where they are on their quarterly account statements. At least four times a year, the prices of securities are more of a result of how institutions market them than of the economic forces that we would like to think are the most important ones. Not even close... Around the end of every calendar quarter, the financial news tells us that "Institutional Window Dressing Activities" are in full swing. But it only goes that far and that deep. What do they mean, and what does that mean for you as an investor?
There are at least three kinds of Window Dressing. None of them should make you very happy, and all of them should make you wonder about the honesty of organisations that approve, use, or allow them. The better-known type is when stocks with big losses are taken out of a portfolio and replaced with shares of companies whose stocks have been the most popular over the past few months. Not only does this make the managers look smarter in the reports they send to their biggest clients, but it also makes the performance numbers of mutual funds look a lot better to people who might want to switch funds. On the sell side of the ledger, the prices of the stocks that are doing the worst get even lower. All fund managers will have to take part in the ritual if they want to stay in business. Most definitions of investing and speculating say that this is neither investing nor speculating. But no one seems to care about what's right or wrong or that this "Buy High, Sell Low" picture is being made with your Mutual Fund paints.
A more subtle form of Window Dressing happens over the course of a calendar quarter, but it is "unwound" before the Quarterly Reports for the portfolio get to the glossy magazines. In this type, which is less common but even more dishonest, the managers buy securities that have nothing to do with the fund's written investment policy at a time when their specialty has fallen out of favour with the gurus. For example, adding commodity ETFs or popular stocks from emerging countries to a Large Cap Value Fund, etc., would be an example. Profits are taken out before the end of the quarter so that the fund's holdings report stays the same, but quarterly results are better. A third type of Window Dressing is called "survivorship." It only affects investors in mutual funds, while the other two hurt 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 cover these "business as usual" practises with so little depth. Maybe 90% of the price changes in the stock market are caused by institutional trading, and institutional money managers don't seem to care as much about investing as they do about politics and marketing. They want to show how smart they are to their big clients by saying they own all the hot tickets and none of the big losers. At the same time, they change the performance statistics in their marketing materials to make them look better. They have made "Buy high, sell low" the most popular way to invest in mutual funds. Individual investors in securities, on the other hand, get bad information and lose money because they move in the wrong direction.
From an analytical point of view, this quarterly market value reality (artificially created demand for some stocks and unwarranted weakness in others) throws almost any individual security or market sector statistic completely out of sync with the underlying company fundamentals. But things get even messier, and not in a cute way. Just for fun, think about how a list of ETFs that keeps growing affects "demand pull." I don't think I'm the only one who thinks that the real meaning of security prices has less and less to do with corporate economics and more to do with the morning betting line on ETF ponies, the dot-coms of the new millennium. [Do you remember the 1970s song "Circle of Gold?" Isn't the same thing meant by GLD and IAU?
As if all of these institutional forces weren't enough, you also need to think about how the tax code affects transactions in the last quarter of the year, which is always interesting. After seeing millions of CPA-advised taxpayers lose billions of dollars with glee, no one would think that the point of investing is to make money. The net effect of these (euphemistically called) "year-end tax saving strategies" is pretty much the same as Type One Window Dressing. But here's a chance to buy outside of the quarter that you shouldn't miss. Simply put, go out and buy the November 52-week lows, wait for the media to talk about the mysterious "January Effect" with wide-eyed wonder, and make some easy money.
There may not be a way to figure out what a share of common stock is really worth. Is the price on the market based on the fundamentals of a company, on the artificial demand for "derivative" securities, or on different kinds of institutional window dressing? But this is something that can be used to make a lot of money. Since the prices of securities seem to have less to do with old-fashioned fundamentals like dividends, projected profits, and unfunded pension liabilities and more to do with artificial demand factors, trading seems to be the only way to get things done! Buy the ones that aren't doing well but are still good investments, and sell the ones that have gone up too much based on basic measures of quality. Try to do this before the big players do. To oversimplify, a recipe for success would be to look for investment-grade stocks that are on sale, let them cook until a reasonable, pre-set profit goal is reached, and add the discipline to follow through with the plan to take profits.
Yes, I do miss the days when there were only stocks and bonds, but maybe I'm just too old-fashioned. Wall Street is an interesting place...
