Week of June 18, 2007

The Markets
 
It usually doesn’t pay to be a pessimist—especially in the stock market.

If you open up the newspaper or turn on the news, there’s no shortage of depressing things going on in our world. From war in the Middle East to less than 30% approval ratings for the President and Congress, you might think our country would be in a collective depression. Even the business arena is not immune. Ten-year Treasury rates are near a five-year high, the dollar is depreciating, housing prices are declining, and mortgage foreclosures are up nearly 90% from May 2006, according to RealtyTrac. 

Yet despite these troubling headlines, the Dow Jones Industrial Average closed within 50 points of its all-time high last week. So what’s the story? Well, there is plenty of good news too and that’s what investors seem to be focusing on. For example, core inflation rates remain under control based on data released by the Labor Department last week. U.S. household net worth reached an all-time high in the first quarter, according to data from the Federal Reserve. Moving overseas, foreign economic growth is strong while in the U.S., we’re holding our own. 

Our economy is so diverse that when one part starts tanking (e.g., housing), it seems like there’s another one ready to pick up the slack (e.g., energy). On balance, the growing sectors seem to be beating the tankers and the net result is many Americans are wealthier than ever. And some of that wealth is driving up stock prices.

Source: Yahoo! Finance, Barrons Past performance is no guarantee of future results.  Indices are unmanaged and cannot be invested into directly. Three-, 5-, and 10-year returns are annualized.  Assumes dividends are not reinvested.

Maybe There is Such a Thing as Bad Publicity
You don’t read every newsletter that crosses your desk, so why are you reading this one? It’s probably because it provides information that catches your attention. Experts in behavioral finance, the study of how emotions influence our investment decisions, suggest that individual investors act in a similar way when it comes to buying equities.

In “All that Glitters: The Effect of Attention and News on the Buying Behavior of Individual and Institutional Investors,” forthcoming in The Review of Financial Studies, Brad M. Barber and Terrance Odean test and confirm the hypothesis that individual investors, because they have limited time and resources, are net buyers of attention-grabbing stocks. As a group, we prefer stocks in the news, stocks experiencing abnormally high trading volume, and stocks with extreme one-day returns, i.e., the glitter stocks.

Of course, our personal preferences still determine which attention-grabbing stocks we buy. Contrarian investors seem to choose out-of-favor stocks that catch their eye, while momentum investors chase recent top performing stocks.

Researchers initially set out to document investor behavior, not the pricing impact of the behavior. However, they found that although stocks heavily favored by individual investors one week tend to outperform other stocks for the following two weeks, those same stocks tend to under perform in subsequent months and over the next year.

Bottom line? Individuals’ attention-driven buying doesn’t generate superior long-term returns. Interestingly, the study also found that institutional investors, especially value investors, don’t display this attention-driven buying behavior.

Another new study documents a broader disconnect between attention and price movement. In “Are Cover Stories Effective Contrarian Indicators?” published in the Financial Analysts Journal, Tom Arnold, CFA, John H. Earl, Jr., CFA, and David S. North looked at headlines from feature stories in Business Week, Fortune, and Forbes over a 20-year period. They tried to determine whether positive stories spark superior future performance and negative stories result in inferior future performance for the featured company. (They define “superior” and “inferior” in comparison with an index or another company in the same industry and of the same size.)

Their conclusion? Whether positive or negative, news splashed across magazine covers tends to signal the end of the extreme performance. Specifically, there was only weak evidence that optimistic cover stories resulted in positive momentum in the six months following publication.

The takeaway here is both studies underscore the benefits of buying and holding a well-diversified portfolio. Hmm, sounds like good common sense doesn’t it?

Weekly Focus – Is the Organic Label Worth the Price?
Organic food differs from conventionally produced food in the way it is grown, handled, and processed. Organic farmers emphasize the use of renewable resources and the conservation of soil and water and eschew most conventional pesticides, fertilizers made with synthetic ingredients or sewage sludge, bioengineering, and ionizing radiation. Organic meat, poultry, eggs, and dairy products come from animals that are given no antibiotics or growth hormones. 

Organic2006, a report by the Hartman Group, finds that today almost three-quarters of U.S. shoppers buy organic products occasionally. At the core of the market, 23% buy organic products at least weekly. But is the higher price tag worth it? It depends on what you’re buying. According to data from the U.S. Department of Agriculture cited in Consumer Reports, even after washing, certain fruits and veggies have higher levels of pesticide residues than others. The article suggests buying organic for the so-called “dirty dozen:” apples, bell peppers, celery, cherries, imported grapes, nectarines, peaches, pears, potatoes, red raspberries, spinach, and strawberries.

Best regards,

Fredrick J. Livingston, CLU, CFP

Securities offered through LPL Financial, Member NASD/SIPC

* The Standard & Poor's 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general.

* The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. 

* The Nasdaq Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System.

* Yahoo! Finance is the source for any reference to the performance of an index between two specific periods.