7th Graders Say the Darndest Things

My 13-year old came to me this past Wednesday night to ask for help with a new social studies project that she was assigned earlier that day. 

Her teacher had split their classroom into teams and each team had to allocate $100,000 to a stock portfolio.  She wanted to know which stocks I thought her team should invest in. 

At this point, I’m trying not to let her see me drool. 

At last!  This was my opportunityto show my daughter just how smart I am and in the process help her crush the other teams! Within a matter of seconds, I knew exactly how she should make the initial allocation, both long and short; because that’s how we roll.

And I’m imagining quality father–daughter time spent together poring over stock charts and discussing the latest edition of The Whaley Report.  However, my bubble was soon burst. 

The project entailed picking only the stocks that trade on the New York Stock Exchange, which, while it’s consists of approximately 61% of the world’s market capitalization, is basically a basket of large cap stocks. 

The kids’ stock picks would be made at Friday’s closing price and then left alone for 3 months.  At the end of the 3 months, whichever team had the highest rate of return would win the competition. 

I resisted the urge to call the social studies teacher and say, “Let me make sure I understand.  You’re asking kids to allocate $100,000 to large cap stocks and to sit on those investments for 3 months after a 194% move in the S&P 500, right at a time when US economic growth is slowing and the S&P just broke a 15-month trend line that had previously been tested 3 times?  It doesn’t sound like you’re teaching them about the stock market, it sounds more like you’re teaching them how to lose their asses.” 

After a deep breath, she and I spent the next hour discussing why I would allocate to utilities, REITs and other defensive stocks rather than Apple or Whole Foods.  And while I understood her deep desire to own Apple, buying a stock that has just rallied 50% over the preceeding 6 months and yet still failed to retake its uptrend line that starts at Crisis lows, wasn’t smart investment management.  To which she said to me, “I don’t know what that means but everyone I know loves their iPhones and iPads.”  Well, she had me there. 

How Do You Invest Your Money?

I’d like you to think about something for a minute…do you invest money like a 7th grade social studies project?  If you’re reading this report on a routine basis the answer to that is probably “no.” 

But if you have a 401k account, you probably do.  And I would say most Americans invest their non-401k accounts in a manner similar to the school project. Whenever they have money to invest, they invest it. Some people may look at Barron’s or a similar publication to figure out “what’s hot” and then invest the following Monday morning in whatever basket of stocks or mutual funds they think will go up from that day forward.  Doesn’t matter if its February 10, June 3, or Christmas Eve. And certainly most people don’t give any thought to where the world (or specific countries) are in their economic cycle and the potential impact that could have on any forward investments. 

So is it any surprise that last week, after a 2-week, 5% correction in the S&P, saw the largest outflows from equity mutual funds, EVER? 

I’m not surprised at all.  Is it any wonder that fund flows out of emerging market equity funds has only now just begun to pick up?  I mean most emerging market equities peaked only 5 short months ago.  But this is how most investors haphazardly manage their money getting in and out of investments after the moves have been made and without any understanding of the underpinning fundamentals, which currently are deteriorating both domestically and abroad.

The World Is Getting Shaky...Again

China continues to slow both in terms of manufacturing as well as services.  China reported this past week that manufacturing has hit a new 6-month low and services grew at the slowest rate in 2.5 years. And while the ECB chose to keep rates unchanged this past week, economic data out of Germany slowed month-over-month in December.

After posting 2% growth in November in both factory orders and industrial production, both numbers slowed on a month-over-month basis and decelerated (grew at a slower pace) year over year than what was reported in November. 

On their own, these numbers aren't necessarily troublesome.  But the global picture that is being painted is fairly clear. 

Domestically, this past week was more of the same slowing data that we’ve been getting all year.  The ISM factory index declined 10% month-over-month in January while the prices paid index increased 13%.  Inflation anyone? 

However, the biggest development in the ISM index was on the margins, in the new orders subindex, which declined by 20% from December. This decline was the largest month-over-month decline since 1980, that’s 34 years! Anything that's happening for the first time in 34 years is worth paying attention to. 

We also received 3 jobs numbers last week that show that the labor market continues to cool off.  The ADP employment report as well as the non-farm payroll numbers both declined on a monthly basis from December but year-over-year growth in bothremain steady around 2%.  Last week’s initial unemployment claims showed slight improvement from the previous week and held steady around the trailing 8 month average. 

However, what matters most happens at the margin.  The year-over-year growth rate for the last 4 weeks of unemployment claims have been -8.5%, -7.9%, -7.2% and this past week’s growth rate was -5.5%.  Notice a trend?  The year-over-year decline in unemployment claims has been decelerating for the last month. 

This deceleration isn’t flashing any warning signs, yet.  But I point it out because these are the types of things you should be aware of and won’t hear about on CNBC or in the latest blog posting.  Everyone else is going to focus on the headline number and whether that number is higher or lower than last week or last month.  The real value in any data series like unemployment claims is the trend and its outliers. 

And if slowing world data isn’t enough, very quietly, oil is now busting a move to the upside, rallying 10% over the last month. 

Do you think rising oil prices will help or hurt the global economy? Do you think they can keep up their consumption while being “taxed” with higher and higher prices on everything from milk to corn to coffee?  I doubt it.  I will continue to be defensively positioned or on the sidelines until the data and the price movement dictate otherwise. 

There are a lot of great qualities to emulate from 7th graders, like curiosity, mental elasticity, and the realization (for guys) that girls do not, in fact, have cooties.  But managing money like a 7th grade social studies project is not a skill that should be replicated. 

If you're a regular reader of TWR, then I’m preaching to the choir.  But do your children a favor and when the opportunities present themselves, begin to teach them a better way to make sound investment decisions.  They’ll thank you for it later.