Ten stock market myths that bedevil investors

by John Dorfman
TodayOnline. Oct 29, 2009.

Misinformation can be costly. Here are 10 notions that lead investors astray.


1: BEST FIRMS = BEST STOCKS
Stocks advance when a company exceeds prevailing expectations. The best companies usually generate lofty hopes among investors, which are hard to exceed.

Example: Companies such as IBM, McDonald's and Xerox were so loved that investors paid 60 times earnings to own them. These were good companies: Their earnings climbed strongly for a decade or more. Yet they were bad stocks, because people overpaid for their anticipated success. Today's equivalent in my opinion is Apple. The maker of iMacs, iPhones and iPods is highly profitable, debt-free, and held in universal awe. That's why shares sell for 32 times earnings, more than six times book value and almost five times revenue. Apple is a great company. But I predict over the next two years it will be only an average stock.

2: ONE MUST BE AN ACTIVE TRADER
Do consider commissions and taxes.

3: ANALYSTS PICK GOOD STOCKS
Most believe that analysts are intelligent, know a company's manager better than you ever will, work long hours, and have a staff of young, hard-charging assistants. However, none of that necessarily makes them standouts at picking stocks. In my ongoing study, now at 10 years and counting, analysts' most-favoured stocks underperform the Standard and Poor's 500 Index. I think analysts tend to fall for Myth No 1.

4: BEWARE OF OCTOBER
The worst month for the markets is September, not October. According to Ned Davis Research, the average monthly price change for the Dow in September since 1900 has been a loss of 1.1 per cent.

February and May also show small losses, on average. October, with an average gain of 0.1 per cent, is the fourth-worst month. The best months, incidentally, are December (average gain: 1.5 per cent), July (1.3 per cent) and April (1.2 per cent).

5: COUNT ON THE PRESIDENTIAL CYCLE
In general, the first year of a president's term is the weakest for stocks, and the third year is strongest. The second and fourth years tend to be average.

6: P/E RATIOS ARE THE PERFECT MEASURE OF A STOCK'S VALUE
They are neither a perfect measure nor a magic shortcut to stock picking.

Example: Ford earned US$1.20 a share in 2005. At the end of that year the stock was selling for about US$8 a share, so the P/E ratio was attractive at about six. But this didn't stop Ford from losing money in each of the next three years. And it didn't stop the stock from falling to $2.29 at the end of last year.

7: BUY STOCKS WITH MOMENTUM
Many respected market participants believe this. Perhaps foremost is William O'Neil, publisher of Investors Business Daily.

I tend to side with Burton Malkiel, a Princeton economics professor who argues that the benefits of relative strength are cancelled by the increased trading costs with this strategy. Momentum investing works some of the time, but in my judgement it doesn't work consistently.

8: WAR IS GOOD FOR STOCKS
Because spending on World War II helped pull the US out of the Great Depression, many think rising military spending correlates with a rising market.

It's often untrue. The market gained little in the 1970s, during the Vietnam War. It boomed during the 1980s, a time of relative peace.

9: MARKETS PREFER REPUBLICANS
According to Ned Davis Research, the annual gain in the Dow average was 7.2 per cent under Democratic presidents from March 4, 1901, through July 8, 2008.

It was only 3.6 per cent under Republicans during the same period. The best stock-market performance on record so far was under Mr Bill Clinton, a Democrat.

10: TIMING CAN BOOST RETURNS
Successful market timers are rarer than scrawny sumo wrestlers. Most people who try to time the market end up being on the sidelines during the unexpected sudden upturns that account for a significant part of the market's long-term gains - this spring's rally, for example.


My Comments:

1. I share the view that most analyst do not outperform the benchmark index. To make things worse, they charge a professional fee which requires the fund to perform even better to only match the index performance.
2. It is also difficult to select the best stocks as the best firms determine through the fundamental analysis of PE ratios, financial raios, etc, the stocks do not necessarily perform as expected. Therefore, a good strategy is to diversify into an ETF.
3. Actively trading and timing the market mostly results in missing the strongest ralliest and getting caught in the worst crashes. Therefore, dollar cost averaging is a good strategy for passive management.