VALUE INVESTING
Recent Events Syndrome

By Stephen Bland (TMFPyad)
November 12, 2004

I have written previously of what I termed 'recent events syndrome' (RES). This is a process well known to those who study human behaviour whereby many people are far more influenced in their actions by recent events than historical ones, even where it is likely that the historical situation is the one most likely to assert itself eventually. So strong is this effect that even if lengthy history suggests that a particular course of events is most likely to take place over time, many would be persuaded into ignoring that in favour of the more recent occurrences. This is even though the recent events may be completely contrary to what history is saying.

I don't know for sure why people sometimes act in this way, it is just one of those many irrationalities that afflict the human condition. My general cod psychology explanation is that we are at a stage of evolution that is part way between instinctive animal and totally rational being. This causes us to act rationally in a lot of ways whilst still causing us to act irrationally at times. We need another million years or so to evolve out such traits unless, and I've just had this thought, these irrational traits are somehow essential to survival by natural selection.

In the stock market one of the most common manifestations of RES are the bubbles that take place occasionally. Certain shares are rising sharply, which attracts wide publicity which brings in more people which drives them up even more and so on. The kind of investors that buy in at this stage will frequently be people who know nothing of the market and go in just because others are doing so. Despite the near certainty of an ultimate crash, people still go ahead and consequently many lose money eventually. RES blinds them to history and also to common sense. No market continues to rise indefinitely at some massive short-term rate.

The high yield portfolio strategy which feature on the Fool publicly and in my monthly Value Investor newsletter to subscribers is an example of betting on history asserting itself. In particular it requires that the investor studiously ignores recent events in the market and sticks to the very long-term trend that has been proven repeatedly. Namely that high yield large cap shares deliver excellent and market beating performance over time.

In fact even more than ignoring recent events, the investor can actually take contrarian advantage of them when constructing their portfolio. Unfashionable big caps will deliver higher yields when they are temporarily unloved by the market. Assuming then that dividends are not cut, always a risk of course, the investor locks into that higher yield for as long as they hold the share.

This is simply the well-known value strategy at work but with a concentration on the yield criterion. By investing in high yield shares, you are automatically directed to those which are out of favour. You can't help it. Long-term history being what it is, the likelihood is that these shares will go on to do better as a group over time than the market in general whilst delivering the additional knockout blow, a much higher income than the market. The whole idea is beautifully simple and moreover it is also anti RES, or you could say it is contrarian RES as I mention above. As with value investing generally, you are using peoples' weakness for RES to take advantage.

Readers can see this process at work with the newsletter's high yield portfolio which will be selecting its eleventh share in the November edition which will be published shortly. Each month I look through the sectors that do not already exist in the portfolio searching for a new high yielder. The mere fact that I use a high yield filter automatically directs me to those that are currently unfavoured. Naturally I have to consider why that may be so. Sometimes there may well be good reason. But, good old reliable human nature being what it is, there will be shares that are depressed for inadequate reasons when you consider them as very long term holds.

The performance of the high yield portfolio in the newsletter has been pretty decent so far and that is before most shares in it have had time to pay out a full year's dividends. Although short-term considerations count for little against the very long term, it is certainly moving strongly in the right direction.

Find out more about the high yield portfolio concept by taking a free 30-day trial to the Fool's Value Investor newsletter.