|
|
|
|
Extra!
Don't scream over the extremes
Interest rates aren't likely to go lower, I say. We simply have to remember through these occasional aberrational periods that reversion to the mean -- 'normal' -- is almost assured.
By James B. Stewart
We seem to be living in a period of extremes. Not only has the Northeast had more rain this June than any other on record, but we also have the federal funds rate sitting at 1%, the lowest level in 45 years. This comes in the wake of the longest, worst bear market since the Great Depression. What ever happened to the notion of "normal"?
Markets pose unusual problems for economists and statisticians. There are the so-called random-walk theorists, who believe the market's movements are governed solely by random probability; there are the fundamental analysts, who believe they reflect underlying economic and psychological realities; and there are those, like me, who suspect market movements result from a hybrid of the two. Come to think of it, markets are a little like the weather, which has tied scientists in knots for centuries.
Whatever the explanation, markets have shown a historical tendency called "reversion to the mean." This is simply the tendency for events over time to conform to the statistical norm. This means that the lower interest rates go, the less likely they will go still lower; the same was true for the likelihood of the soaring stock market in the late 1990s to go still higher. This doesn't mean interest rates won't go lower; just that it would be statistically anomalous. This is often difficult for investors to grasp, since human intuition tends to make all of us trend investors.
I say lower rates aren't likely
Can interest rates go still lower? Yes, they can, at least until rates hit zero. Are they likely to go still lower? I don't think so. Probability suggests that they won't. Reversion-to-the-mean theory suggests that they'll begin to revert to higher, more normal levels at some point. So I remain underweighted in bonds.
Our tendency to think in trends was on my mind recently, after a friend sought my advice about Merck (MRK, news, msgs), the big pharmaceutical concern. He was overweighted in the stock. This month alone, Merck has jumped nearly 20%, hitting a new 52-week high last week. We're well into territory where, as I've said repeatedly of late, it's fine to take some profits. I own some Merck myself, and am not looking to sell anything just now, but I said it seemed like a great time for my friend to reduce his position. He did, and the next day Merck rose a few more cents. "It's still going up!" he lamented to me, castigating himself (and thus me) for not waiting longer. I could only shrug.
Today it's below his selling point, but that isn't the issue -- he made a rational, statistically sound decision at the time, no matter what the stock does now. We simply can't plan for the aberrational and expect to beat the odds. As during the past three years, we simply have to live through these occasional aberrational periods and wait for reversion to the mean -- which will almost assuredly happen at some point. Both the technology bubble and the bear market ended eventually, and so, too, will the bond-market rally.
The Cablevision saga
For those of you following the saga of my Cablevision Systems (CVC, news, msgs) calls, I can report that my June $17.50 options expired last Friday at $4.20. Cablevision shares closed at $21.17. I have no idea why anyone would have paid $4.20 to buy CVC at the equivalent price of $21.70, but my guess is that the options traded when CVC shares were higher, sometime before the close. In any event, my shares were sold for $17.50. Added to the $3.50 I sold the calls for several months ago, my proceeds were $21-- just 17 cents below the closing price.
Was this a smart trade? I think so, since I had the use of the call proceeds for those months, a time when the market was rising strongly. I'm sure I made more than 17 cents on that money.
But as I've already said, you can't measure the wisdom of a trade with benefit of hindsight. By selling the calls when I did, locking in a sale price of $21, I was able to realize a much better return than had I simply sold the shares back then. Meanwhile, I bid fond farewell to my Cablevision position, which paid off handsomely. Now I don't have to worry if the company will bid for Vivendi Universal's (V, news, msgs) entertainment assets, or any of the other hair-brained rumors that had those options gyrating wildly.
|
|
|
|
