Don't listen to a word I have to say
When you listen to a financial expert's advice, your brain turns off.
This revelation came through Jason Zweig, who writes for the Wall Street Journal. In Zweig's blog, he highlighted a recent study by Dr. Gregory Berns of Emory University.
In Dr. Berns study, he watched how people's brain responded to inputs using a functional magnetic resonance imaging (fMRI) scanner. Specifically, he monitored blood flow to different parts of the brain of test subjects.
When subjects thought for themselves, two parts of their brain activated: one for determining the payoff of a sure win in the scenario presented, and one for calculating the possible gain from such a gamble.
Then, they did the same experiment, but with an "expert" with impressive sounding credentials. When that happened, the subject's brain activity faded. In other words, once the expert started suggesting, the subject's brain when into resting mode, "off-loading" the task of making the decision to the supposed "expert."
It seems obvious to me that not everyone falls for this gag, but, it's good to be aware of it.
I know I've paid for car maintenance I didn't need because I tried to make a decision too quickly in the presence of an "expert," so I feel keenly how easy it is to fall for such a trap.
How do you avoid "off-loading?"
Zweig suggests speaking to "experts" with a list of your concerns or the direction you'd like to go thought out and written down ahead of time. This will give you something to refer to when you're talking to an "expert."
Another thing he suggests is to make the decision later, after you've had a chance to think about it on your own. This lets you regain independence and get that blood flowing to the payout and gain portions of your brain.
There's nothing wrong with listening to investing advice, but doing so without the right approach may lead you to do something you'll regret.
So, listen to my advice, but turn it over in your mind on your own, think about what you thought beforehand, and give yourself some time before acting or deciding.
I always recommend this to my clients, too, because I've found I'd rather have happy clients for the long run than tricked clients that soon figure they aren't happy with my approach. In the long run, the truth will out.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, April 03, 2009
Friday, March 27, 2009
Bonds aren't as safe as they may seem
When stock markets tank, most people think, "boy do I wish I owned bonds."
Let me make this clear--bonds are NOT riskless. Although people perceive them as riskless, they are not! Bonds face risks from default and inflation.
Many people wish they owned bonds because U.S. Treasury bonds have done so well over the last year and a half. That doesn't mean all bonds have done well. Junk bonds, corporate bonds, investment grade corporate bonds, municipal bonds, mortgage backed bonds, etc. have all been decimated.
To have done well with bonds during this downturn, you'd have needed to be prescient enough to know exactly which bonds to buy and no others. Very few people are that good at forecasting beforehand. Everyone is afterward--but those are profits you can't eat.
So, what are the risks for bonds. The first risk is the same as for stocks--what you buy can become worthless. Government bonds rarely default, but rarely is not never. The second risk is inflation. Government bonds are very vulnerable to inflation risk (the exception being inflation protected bonds, but even they face inflation risk if the consumer price index differs from your cost of living increases).
How can a bond become worthless? A bond has a senior claim on a business's assets. That means bondholders get paid before equity holders. But, that claim comes after customers and after the tax man. If a company goes bankrupt, bond holders can still be wiped out. They get paid before equity holders based on what's left, but that doesn't mean they will get paid back in full, and it doesn't mean they will get paid back with certainty.
The bigger threat to bondholders is inflation. And, here, I believe stockholders are actually better off than bondholders.
Suppose you buy a 3% bond and inflation goes up. If you own a short term bond, your impact is smaller than if you own a long term bond. A short term bond can be rolled over into a higher yields as inflation goes up. A long term bond doesn't have this luxury.
How much of an impact am I talking about? Pretty big. Suppose inflation goes up by 3% more than the market expects: the value of a 10 year bond would decline by around 20% (all things equal). A 30 year bond would decline by almost 40%! If inflation went up 6% more than people expected, then a 10 year bond would decline by 40% and a 30 year bond would decline by over 60%! If you believe bonds can't go down like stocks, think again!
The price declines I referred to above would happen quickly, but you'd still get back your full principal at maturity, right? The problem is that those dollars will be worth a lot less than they are now. Whether you sold right away or held to maturity, higher than expected inflation will hammer long term bond holders.
That's true for government bonds as much as any other bond. In fact, I believe government bonds are much more risky than usual now. Almost every other type of bond is trading at record high relative yields, so they are safer from inflation risk than government bonds that are at record low yields. Government bonds are extremely unlikely to default, but the dollars you'd receive may not be worth much.
Most people seem to under-estimate the risks of bonds. Default risk and inflation risk make them risky, whether people recognize it or not. Talk to anyone who owned bonds in the 1970's, and they'll tell you what owning bonds felt like in an inflationary and recessionary environment.
Stocks may have a lower priority claim on a business's assets, but they do adapt to inflation better. The revenues and costs of most businesses tend to keep up with inflation over time and so do their earnings. This protects them, over the long run, from the ravages of inflation. Stocks may not do well when inflation increases, but they do very well when inflation levels off or decreases. In the long run, they protect shareholders from inflation better than bonds.
Is unexpected inflation likely? Perhaps not in the short term, but over the next 3 to 5 years, I believe high inflation is very likely, and perhaps more than the 3% or 6% I referred to above.
Stocks aren't riskless, but neither are bonds. Stocks face more risk from default, but less risk from inflation. When government spending is expanding like never before and the Federal Reserve is printing money at a rapid pace, it's a good time to consider inflation protection and the fact that stocks may turn out to be less risky than bonds over the long run.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
When stock markets tank, most people think, "boy do I wish I owned bonds."
Let me make this clear--bonds are NOT riskless. Although people perceive them as riskless, they are not! Bonds face risks from default and inflation.
Many people wish they owned bonds because U.S. Treasury bonds have done so well over the last year and a half. That doesn't mean all bonds have done well. Junk bonds, corporate bonds, investment grade corporate bonds, municipal bonds, mortgage backed bonds, etc. have all been decimated.
To have done well with bonds during this downturn, you'd have needed to be prescient enough to know exactly which bonds to buy and no others. Very few people are that good at forecasting beforehand. Everyone is afterward--but those are profits you can't eat.
So, what are the risks for bonds. The first risk is the same as for stocks--what you buy can become worthless. Government bonds rarely default, but rarely is not never. The second risk is inflation. Government bonds are very vulnerable to inflation risk (the exception being inflation protected bonds, but even they face inflation risk if the consumer price index differs from your cost of living increases).
How can a bond become worthless? A bond has a senior claim on a business's assets. That means bondholders get paid before equity holders. But, that claim comes after customers and after the tax man. If a company goes bankrupt, bond holders can still be wiped out. They get paid before equity holders based on what's left, but that doesn't mean they will get paid back in full, and it doesn't mean they will get paid back with certainty.
The bigger threat to bondholders is inflation. And, here, I believe stockholders are actually better off than bondholders.
Suppose you buy a 3% bond and inflation goes up. If you own a short term bond, your impact is smaller than if you own a long term bond. A short term bond can be rolled over into a higher yields as inflation goes up. A long term bond doesn't have this luxury.
How much of an impact am I talking about? Pretty big. Suppose inflation goes up by 3% more than the market expects: the value of a 10 year bond would decline by around 20% (all things equal). A 30 year bond would decline by almost 40%! If inflation went up 6% more than people expected, then a 10 year bond would decline by 40% and a 30 year bond would decline by over 60%! If you believe bonds can't go down like stocks, think again!
The price declines I referred to above would happen quickly, but you'd still get back your full principal at maturity, right? The problem is that those dollars will be worth a lot less than they are now. Whether you sold right away or held to maturity, higher than expected inflation will hammer long term bond holders.
That's true for government bonds as much as any other bond. In fact, I believe government bonds are much more risky than usual now. Almost every other type of bond is trading at record high relative yields, so they are safer from inflation risk than government bonds that are at record low yields. Government bonds are extremely unlikely to default, but the dollars you'd receive may not be worth much.
Most people seem to under-estimate the risks of bonds. Default risk and inflation risk make them risky, whether people recognize it or not. Talk to anyone who owned bonds in the 1970's, and they'll tell you what owning bonds felt like in an inflationary and recessionary environment.
Stocks may have a lower priority claim on a business's assets, but they do adapt to inflation better. The revenues and costs of most businesses tend to keep up with inflation over time and so do their earnings. This protects them, over the long run, from the ravages of inflation. Stocks may not do well when inflation increases, but they do very well when inflation levels off or decreases. In the long run, they protect shareholders from inflation better than bonds.
Is unexpected inflation likely? Perhaps not in the short term, but over the next 3 to 5 years, I believe high inflation is very likely, and perhaps more than the 3% or 6% I referred to above.
Stocks aren't riskless, but neither are bonds. Stocks face more risk from default, but less risk from inflation. When government spending is expanding like never before and the Federal Reserve is printing money at a rapid pace, it's a good time to consider inflation protection and the fact that stocks may turn out to be less risky than bonds over the long run.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, March 20, 2009
Short term madness
The average holding period of a stock on the stock market is only 7 months.
7 MONTHS!!!
Using some back-of-the-envelope math, that means that if a mere 2.4% of trading is done by long term holders (who hold an average of 4 years), then the average holding period of the other 97.6% of people is under 6 months!
That means that when you see the price of something you've bought go up or down, it is because the vast majority of traders--not investors--are only looking at how a stock will "perform" over the next 6 months.
But, what happens over the next 6 months is almost entirely random. How a company will perform over the next 3 to 5 years is based on underlying data. But, focusing on how stock will "move" in the next 6 months is not investing--it's just guessing at "price action."
Many investors have been shaken by recent price movements, and I have been, too. But, when I consider the fact that almost all trading is done by people with a focus on the next 6 months, I start to relax and focus on the long term.
When you aren't buying for the next 6 months--when you're truly a long term investor--you can focus on underlying businesses, and how they will perform over the next 3, 5, 10, even 20 years.
This is the way to invest.
Don't focus on short term price movements. Focus on the underlying business and how it will perform over the long term.
This won't prevent short term anxiety, but it may very well allow you to focus on the phenomenal growth prospects that await investors over the next 3 to 5 years.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
The average holding period of a stock on the stock market is only 7 months.
7 MONTHS!!!
Using some back-of-the-envelope math, that means that if a mere 2.4% of trading is done by long term holders (who hold an average of 4 years), then the average holding period of the other 97.6% of people is under 6 months!
That means that when you see the price of something you've bought go up or down, it is because the vast majority of traders--not investors--are only looking at how a stock will "perform" over the next 6 months.
But, what happens over the next 6 months is almost entirely random. How a company will perform over the next 3 to 5 years is based on underlying data. But, focusing on how stock will "move" in the next 6 months is not investing--it's just guessing at "price action."
Many investors have been shaken by recent price movements, and I have been, too. But, when I consider the fact that almost all trading is done by people with a focus on the next 6 months, I start to relax and focus on the long term.
When you aren't buying for the next 6 months--when you're truly a long term investor--you can focus on underlying businesses, and how they will perform over the next 3, 5, 10, even 20 years.
This is the way to invest.
Don't focus on short term price movements. Focus on the underlying business and how it will perform over the long term.
This won't prevent short term anxiety, but it may very well allow you to focus on the phenomenal growth prospects that await investors over the next 3 to 5 years.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, March 13, 2009
What is smart money doing right now?
Investors frequently wonder what the "smart money" is doing. Who or what is smart money?
Smart money usually refers to big investors who got that way by generating high investing returns over a long period of time. That doesn't necessarily mean big money.
A lot of money is managed by large organizations that didn't necessarily get that way from smart investing. Think about a large pension fund or insurance company. Those organizations have a lot of money because a lot of money has been contributed to them (pension contributions and insurance premiums), not necessarily because they've managed it well. Big money is not the same as smart money.
Smart money has a lot of money because they've compounded initial investments at high rates for a sustained amount of time. Smart money moves into and out of markets before they move, not after or as they are moving. Smart money includes the "lead bulls" that the rest of the herd follows. Knowing what the smart money is doing can help build wealth because you can buy before things move.
This last reason is why everyone, including me, wonders what the smart money is doing.
So, what is the smart money doing now? I don't know exactly, but I have an idea.
For example, a lot of smart money is still on the sidelines--in cash. It's not there because they sold at the top or because they were timing the market. It was in cash because the smart money has been waiting for opportunities, waiting for years most likely.
Why haven't they started buying? They have, but very selectively. Remember, smart money buys before things move, so you can't look at price movements to see what they are doing. They are buying things on the cheap, at prices they can only get once every two or three decades, but they are taking their time.
Why are they taking their time? That's the most important question, and I think I have an answer. They're taking their time because the rules have changed. When the rules change, you have to wait for new rules before you can act.
What new rules am I talking about? Let me use banking as an example. It used to be that bad banks went out of business and good banks thrived. But recently, bad banks have been deemed "too big to fail," and so they have been kept alive. Keeping them alive hurts good banks, and so the smart money is waiting for the new rules to invest. They don't want to invest in good banks only to find out the new rules will hurt the good for the benefit of the bad.
The same could be said for distressed debt investing. Whether a company survives or not has less to do with assets, liabilities, cash flows and business model, currently. Instead, it has as much to do with number of employees and perception. Look at U.S. car companies. No one cried when Circuit City or Pilgrims Pride declared bankruptcy, but if a U.S. car company is in trouble, it doesn't need to go bankrupt. The rules have changed, and the smart money doesn't want to invest until they know those news rules.
I think the key reason markets haven't been improving is because the rules have changed, and the smart money is waiting to learn those new rules. When those rules are made clear, then the smart money and, eventually, everyone else, will jump back into the pool. Market values are cheap enough, whether equity, debt or real estate. I don't believe the smart money is waiting for markets to get cheaper, they are waiting to discover the new rules of the game.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Investors frequently wonder what the "smart money" is doing. Who or what is smart money?
Smart money usually refers to big investors who got that way by generating high investing returns over a long period of time. That doesn't necessarily mean big money.
A lot of money is managed by large organizations that didn't necessarily get that way from smart investing. Think about a large pension fund or insurance company. Those organizations have a lot of money because a lot of money has been contributed to them (pension contributions and insurance premiums), not necessarily because they've managed it well. Big money is not the same as smart money.
Smart money has a lot of money because they've compounded initial investments at high rates for a sustained amount of time. Smart money moves into and out of markets before they move, not after or as they are moving. Smart money includes the "lead bulls" that the rest of the herd follows. Knowing what the smart money is doing can help build wealth because you can buy before things move.
This last reason is why everyone, including me, wonders what the smart money is doing.
So, what is the smart money doing now? I don't know exactly, but I have an idea.
For example, a lot of smart money is still on the sidelines--in cash. It's not there because they sold at the top or because they were timing the market. It was in cash because the smart money has been waiting for opportunities, waiting for years most likely.
Why haven't they started buying? They have, but very selectively. Remember, smart money buys before things move, so you can't look at price movements to see what they are doing. They are buying things on the cheap, at prices they can only get once every two or three decades, but they are taking their time.
Why are they taking their time? That's the most important question, and I think I have an answer. They're taking their time because the rules have changed. When the rules change, you have to wait for new rules before you can act.
What new rules am I talking about? Let me use banking as an example. It used to be that bad banks went out of business and good banks thrived. But recently, bad banks have been deemed "too big to fail," and so they have been kept alive. Keeping them alive hurts good banks, and so the smart money is waiting for the new rules to invest. They don't want to invest in good banks only to find out the new rules will hurt the good for the benefit of the bad.
The same could be said for distressed debt investing. Whether a company survives or not has less to do with assets, liabilities, cash flows and business model, currently. Instead, it has as much to do with number of employees and perception. Look at U.S. car companies. No one cried when Circuit City or Pilgrims Pride declared bankruptcy, but if a U.S. car company is in trouble, it doesn't need to go bankrupt. The rules have changed, and the smart money doesn't want to invest until they know those news rules.
I think the key reason markets haven't been improving is because the rules have changed, and the smart money is waiting to learn those new rules. When those rules are made clear, then the smart money and, eventually, everyone else, will jump back into the pool. Market values are cheap enough, whether equity, debt or real estate. I don't believe the smart money is waiting for markets to get cheaper, they are waiting to discover the new rules of the game.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, March 06, 2009
The investing world's Holy Grail
Archimedes once said that he could move the world with a large enough lever and a place to stand. Like Archimedes, I think I could "move the world" by dramatically improving investors' returns--if I could just eliminate their desire to time the market.
I don't believe there is anything that destroys long term investment returns as much as the desire to time the market. It is the investing world's Holy Grail--it doesn't exist, but people keep trying to find it anyway.
Every investor seems to wish he could sell at "the top" and buy at "the bottom." Very few consider whether this feat is possible with anything other than hindsight. If investors would consider this seriously, perhaps their returns would improve dramatically.
The stories investors hear about someone who supposedly sold at "the top" and bought back at "the bottom" seems to egg them on. Like feats of ESP, this supposed achievement is frequently sited but infrequently submitted to rigorous study.
Remember, even a broken clock is right twice a day. So, if someone repeats over and over again that the market is going to drop, at some point they will be right. Same with the market rallying. This is not a demonstration of skill, but that a broken clock can be right.
Have you ever examined the Forbes 400 list of richest people? Check it out some time, and look for the market timers. You won't find a single one. In fact, the guy topping the list, Warren Buffett, says timing the market is not possible. Take his advice, seek not the Holy Grail.
The investors who build wealth over the long run do it by PRICING, not TIMING. They figure out something is cheap and they buy it. They don't panic when it becomes cheaper, because they know what it's worth. They usually buy more.
Those who try to time the market end up guessing about market tops and bottoms, because such things can only be seen clearly in hindsight. They almost always end up buying high and selling low.
Look at the statistics on investor versus mutual fund returns. Mutual fund returns are anywhere from 4% to 8% higher than the returns investors get. Why? Because most investors, in their search for the Holy Grail, sell what's not "working" and buy what is "working." They almost always sell something that is about to take off and buy something that's about to tank.
I'm not saying people don't get lucky every once in a while and sell at the top or buy at the bottom. What I'm saying is such luck should be associated with winning the lottery or getting struck by lightning, not with a sound approach to reaching your financial goals.
Don't seek the Holy Grail. Buy when things are cheap and accept that they will almost certainly get cheaper. Buy more if it gets cheaper. Rinse and repeat. In 5 to 10 years, you'll be very happy you didn't pursue the investing world's Holy Grail.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Archimedes once said that he could move the world with a large enough lever and a place to stand. Like Archimedes, I think I could "move the world" by dramatically improving investors' returns--if I could just eliminate their desire to time the market.
I don't believe there is anything that destroys long term investment returns as much as the desire to time the market. It is the investing world's Holy Grail--it doesn't exist, but people keep trying to find it anyway.
Every investor seems to wish he could sell at "the top" and buy at "the bottom." Very few consider whether this feat is possible with anything other than hindsight. If investors would consider this seriously, perhaps their returns would improve dramatically.
The stories investors hear about someone who supposedly sold at "the top" and bought back at "the bottom" seems to egg them on. Like feats of ESP, this supposed achievement is frequently sited but infrequently submitted to rigorous study.
Remember, even a broken clock is right twice a day. So, if someone repeats over and over again that the market is going to drop, at some point they will be right. Same with the market rallying. This is not a demonstration of skill, but that a broken clock can be right.
Have you ever examined the Forbes 400 list of richest people? Check it out some time, and look for the market timers. You won't find a single one. In fact, the guy topping the list, Warren Buffett, says timing the market is not possible. Take his advice, seek not the Holy Grail.
The investors who build wealth over the long run do it by PRICING, not TIMING. They figure out something is cheap and they buy it. They don't panic when it becomes cheaper, because they know what it's worth. They usually buy more.
Those who try to time the market end up guessing about market tops and bottoms, because such things can only be seen clearly in hindsight. They almost always end up buying high and selling low.
Look at the statistics on investor versus mutual fund returns. Mutual fund returns are anywhere from 4% to 8% higher than the returns investors get. Why? Because most investors, in their search for the Holy Grail, sell what's not "working" and buy what is "working." They almost always sell something that is about to take off and buy something that's about to tank.
I'm not saying people don't get lucky every once in a while and sell at the top or buy at the bottom. What I'm saying is such luck should be associated with winning the lottery or getting struck by lightning, not with a sound approach to reaching your financial goals.
Don't seek the Holy Grail. Buy when things are cheap and accept that they will almost certainly get cheaper. Buy more if it gets cheaper. Rinse and repeat. In 5 to 10 years, you'll be very happy you didn't pursue the investing world's Holy Grail.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, February 27, 2009
Lessons from the Panic of 1907
Few remember that the Federal Reserve was created in 1913 because of the panic of 1907. This panic was caused by the failure of several banks that were overly indebted and had made a lot of bad loans. If this sounds familiar to you, you're not alone.
The lessons of 1907 were that when a banking panic occurs, the smart bankers of the world need to get together, examine the books of questionable banks, draw a line in the sand on which banks are solvent and should be supported, and let the rest go into bankruptcy to be sold off piecemeal to solvent institutions and investors.
Back in 1907, the leader of the smart bankers was J.P. Morgan. Although vilified for the power he displayed in this role, Morgan managed to save the economy from complete collapse because he understood banking better than most and had the knowledge, experience, and iron will to make things happen.
The Federal Reserve was originally created to serve this purpose (so that some would-be J.P. Morgan would not have so much power), but its mandate has drifted significantly. Instead of drawing a line in the sand between solvent and insolvent bankers, it now tries to set monetary policy to provide full employment and manage inflation at reasonable levels.
Note how markets have reacted to the Federal Reserve's policies over the last 2 years. At first, markets were assured (early 2007 to mid 2008). Now, markets are tanking because of the Fed's actions. If you believe markets are tanking because of conditions beyond our control, you're not alone, but I don't think you're right. Markets are tanking in reaction to inept policy, not because of economic circumstances, per se.
Instead of allowing bad banks to go under and supporting good banks, the Fed is doing the opposite. Its supporting the bad banks, thus punishing good banks for their prudence. Markets are tanking for good reason.
Letting bad banks go under would hammer the bond and equity holders of such institutions, but their customers need not suffer. In almost every bail-out so far, banking customers were safe. What was threatened were the bond and equity holders, including the stupid banks who had invested in such bonds and equities.
Bailing out the ineffectual at the expense of the effective is a recipe for disaster, and markets will continue to tank as long as such a policy is followed.
In the long run, the truth will out. The bad banks will go under anyway, and the day of reckoning will merely be delayed at great expense, pain and frustration.
If, instead, the government would draw a line in the sand and let the insolvent go under by effecting an orderly liquidation while supporting the solvent, the impact would be painful but over quickly.
Regardless of how the Fed and U.S. government try to solve this problem, the hardworking people of this country will provide the bailout. That bailout will come in the form of hardworking entrepreneurs, prudent businessmen, diligent workers, and rational consumers.
Inept policy will only delay recovery, it will not prevent it.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Few remember that the Federal Reserve was created in 1913 because of the panic of 1907. This panic was caused by the failure of several banks that were overly indebted and had made a lot of bad loans. If this sounds familiar to you, you're not alone.
The lessons of 1907 were that when a banking panic occurs, the smart bankers of the world need to get together, examine the books of questionable banks, draw a line in the sand on which banks are solvent and should be supported, and let the rest go into bankruptcy to be sold off piecemeal to solvent institutions and investors.
Back in 1907, the leader of the smart bankers was J.P. Morgan. Although vilified for the power he displayed in this role, Morgan managed to save the economy from complete collapse because he understood banking better than most and had the knowledge, experience, and iron will to make things happen.
The Federal Reserve was originally created to serve this purpose (so that some would-be J.P. Morgan would not have so much power), but its mandate has drifted significantly. Instead of drawing a line in the sand between solvent and insolvent bankers, it now tries to set monetary policy to provide full employment and manage inflation at reasonable levels.
Note how markets have reacted to the Federal Reserve's policies over the last 2 years. At first, markets were assured (early 2007 to mid 2008). Now, markets are tanking because of the Fed's actions. If you believe markets are tanking because of conditions beyond our control, you're not alone, but I don't think you're right. Markets are tanking in reaction to inept policy, not because of economic circumstances, per se.
Instead of allowing bad banks to go under and supporting good banks, the Fed is doing the opposite. Its supporting the bad banks, thus punishing good banks for their prudence. Markets are tanking for good reason.
Letting bad banks go under would hammer the bond and equity holders of such institutions, but their customers need not suffer. In almost every bail-out so far, banking customers were safe. What was threatened were the bond and equity holders, including the stupid banks who had invested in such bonds and equities.
Bailing out the ineffectual at the expense of the effective is a recipe for disaster, and markets will continue to tank as long as such a policy is followed.
In the long run, the truth will out. The bad banks will go under anyway, and the day of reckoning will merely be delayed at great expense, pain and frustration.
If, instead, the government would draw a line in the sand and let the insolvent go under by effecting an orderly liquidation while supporting the solvent, the impact would be painful but over quickly.
Regardless of how the Fed and U.S. government try to solve this problem, the hardworking people of this country will provide the bailout. That bailout will come in the form of hardworking entrepreneurs, prudent businessmen, diligent workers, and rational consumers.
Inept policy will only delay recovery, it will not prevent it.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, February 13, 2009
Sticking to the basics
For the last 5 months, markets have been nuts. The price swings have been awful and painful to watch.
During times like this, it's hard to focus on the fundamentals because watching your portfolio get diced every day is very distracting.
But, getting distracted, especially when great value are to be had, will lead you to poor returns over time.
How am I avoiding distraction? I'm sticking to the basics: looking at businesses I understand, evaluating underlying business economics, evaluating management, and examining valuation versus price.
First off, I can't get good returns by looking at businesses I really can't understand. No amount of research will allow me to understand a biotech firm, so I don't try to. Sometimes, I can educate myself enough to understand a firm, but it doesn't make sense to. Why figure out how to pick ripe fruit high on a tree when the same fruit can be picked off the low-hanging branches? If I can understand the firm without having to learn particle physics, I have a good candidate for further evaluation.
Second, I evaluate a business's underlying economics. What kind of returns will it generate over time? What competitive advantages does it have? Are those advantages stable, or does technological innovation and industry shifts make predicting the future almost impossible. Businesses with good economics are great candidates for potential investment.
Third, I evaluate management. Are they honest? Do they speak plainly and describe their business and its dynamics well? Are they compensated rationally? Do they own a chunk of the business themselves with shares purchased on their own (not options or restricted stock grants)? Do they do what they say over the years? Do they measure the business's performance rationally? A business I understand with good economics and management is an excellent candidate for potential investment.
Last, I examine price versus value. What is the company worth to a rational, long-term investor? What are the discretionary cash flows relative to the price of the business? What kind of growth rate and return on equity can be generated in a normal environment? Does the business carry too much debt making it susceptible to insolvency during difficult times (boy is this important)? If value is significantly above price, then the business is a very good candidate for purchase.
When the economy is in the tank and stock market prices are gyrating wildly, it's best to focus on the fundamentals. Right now, I'm focusing on businesses I understand with good economics and good management selling at cheap prices. There are a lot out there right now, so I have a lot of work to do. And, that's a nice "problem" to have.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
For the last 5 months, markets have been nuts. The price swings have been awful and painful to watch.
During times like this, it's hard to focus on the fundamentals because watching your portfolio get diced every day is very distracting.
But, getting distracted, especially when great value are to be had, will lead you to poor returns over time.
How am I avoiding distraction? I'm sticking to the basics: looking at businesses I understand, evaluating underlying business economics, evaluating management, and examining valuation versus price.
First off, I can't get good returns by looking at businesses I really can't understand. No amount of research will allow me to understand a biotech firm, so I don't try to. Sometimes, I can educate myself enough to understand a firm, but it doesn't make sense to. Why figure out how to pick ripe fruit high on a tree when the same fruit can be picked off the low-hanging branches? If I can understand the firm without having to learn particle physics, I have a good candidate for further evaluation.
Second, I evaluate a business's underlying economics. What kind of returns will it generate over time? What competitive advantages does it have? Are those advantages stable, or does technological innovation and industry shifts make predicting the future almost impossible. Businesses with good economics are great candidates for potential investment.
Third, I evaluate management. Are they honest? Do they speak plainly and describe their business and its dynamics well? Are they compensated rationally? Do they own a chunk of the business themselves with shares purchased on their own (not options or restricted stock grants)? Do they do what they say over the years? Do they measure the business's performance rationally? A business I understand with good economics and management is an excellent candidate for potential investment.
Last, I examine price versus value. What is the company worth to a rational, long-term investor? What are the discretionary cash flows relative to the price of the business? What kind of growth rate and return on equity can be generated in a normal environment? Does the business carry too much debt making it susceptible to insolvency during difficult times (boy is this important)? If value is significantly above price, then the business is a very good candidate for purchase.
When the economy is in the tank and stock market prices are gyrating wildly, it's best to focus on the fundamentals. Right now, I'm focusing on businesses I understand with good economics and good management selling at cheap prices. There are a lot out there right now, so I have a lot of work to do. And, that's a nice "problem" to have.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, February 06, 2009
In praise of idleness
When the economy is in the tank and the stock market is down 40% and going nowhere, there is a great temptation to do something--anything--to improve short-term results. This is almost always folly.
In almost any field, action is the mark of progress. An architect waiting for inspiration to hit is a slacker. A manager waiting for problems to solve is a buffoon.
But, an investor who doesn't trade frequently is an enigma. He's seen as being a slacker buffoon, but in reality may be doing a lot of thinking and research, and deciding that acting is a poor choice.
You see, stock market prices move much more than underlying values. Any attempt to chase these almost random price movements leads to poorer returns than doing nothing.
Because the common paradigm is that activity equals progress, most people are confused by an investor who isn't trading. When things aren't happening, progress doesn't seem to be achieved. Right?
That's why idleness in an investor is virtue. Doing research, comparing alternatives, watching underlying fundamentals of current investments, but infrequently trading denotes a capable investor.
Frequent trading is like chasing fog: a lot may seem to happen, but little is achieved.
Patience is truly a virtue in investing. If you've invested in the right businesses at the right prices, the best thing to do is not to trade.
Research alternatives? Yes. Study more deeply current holdings? Yes. But, don't mistake such work, and lack of trading, for lack of progress. In this case, idleness is praiseworthy.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
When the economy is in the tank and the stock market is down 40% and going nowhere, there is a great temptation to do something--anything--to improve short-term results. This is almost always folly.
In almost any field, action is the mark of progress. An architect waiting for inspiration to hit is a slacker. A manager waiting for problems to solve is a buffoon.
But, an investor who doesn't trade frequently is an enigma. He's seen as being a slacker buffoon, but in reality may be doing a lot of thinking and research, and deciding that acting is a poor choice.
You see, stock market prices move much more than underlying values. Any attempt to chase these almost random price movements leads to poorer returns than doing nothing.
Because the common paradigm is that activity equals progress, most people are confused by an investor who isn't trading. When things aren't happening, progress doesn't seem to be achieved. Right?
That's why idleness in an investor is virtue. Doing research, comparing alternatives, watching underlying fundamentals of current investments, but infrequently trading denotes a capable investor.
Frequent trading is like chasing fog: a lot may seem to happen, but little is achieved.
Patience is truly a virtue in investing. If you've invested in the right businesses at the right prices, the best thing to do is not to trade.
Research alternatives? Yes. Study more deeply current holdings? Yes. But, don't mistake such work, and lack of trading, for lack of progress. In this case, idleness is praiseworthy.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, January 30, 2009
Diversification works great...until it doesn't
Many financial advisers tout the benefits of diversification. They reason that spreading your eggs among many baskets can protect your aggregate egg count in case one basket drops.
But, what if there is some underlying reason that causes all baskets to drop all at once? Then, of course, all your eggs drop.
Most people didn't think this was possible, and yet it happened in 2008. Almost every asset class dropped as the market panicked. The one major exception was U.S. Treasury Bonds.
As John Authers put it in his "The Short View" column in the Financial Times, "...last year's sell-off was so extreme that diversification would not have helped one whit."
But, isn't it at times like this, when everyone is panicking, that diversification is supposed to provide benefits? Yes, it is supposed to. But, that doesn't mean it does.
The reason why is that all financial markets are linked. Just because everyone is running from one investment does not mean another "historically uncorrelated" asset is necessarily doing well. This was very clear in 2008.
Diversification seems to work best when you don't need it. People don't get excited about diversification during normal times. It just gives you average instead of slightly better or slightly worse returns.
If you have half your money in U.S. stocks that provide a 5% return and half your money in foreign stocks that provide a 15% return, you get 10% returns. All you manage to do is lock in mediocre returns all the time. Getting 5% returns versus 10% or 15% returns in a single year won't ruin someones retirement. Losing 40% the year after retiring almost certainly will.
When markets really panic, everything goes down together. Even a brief glance at economic history confirms this. Diversification fails when people want it most. Like...well, like in 2008.
There is a very real benefit to be gained from this situation, though. Not all investments have bad underlying characteristics. The very fact that a panic has occurred means both good and bad investments were sold off. So, you can currently buy excellent investments for the same price as the poor ones.
But, if you diversify you'll get both the bad and the good returns going forward. Someone down 40% will see a world of difference between getting a 67% return (being in the good investments and returning to starting principal value) and getting a 33% return (being diversified in half the good investments that go up 67% and half the bad investments that go nowhere, thus still being down 20% from starting principal value).
Or, as John Authers put it, "If there is any consolation, it is that the sell-off was so indiscriminate. The odds are overwhelming that some stocks and asset classes will now begin to outperform."
I don't know when, exactly, those good stocks and asset classes will take off, but I'm quite comfortable I have identified them and believe very strongly my clients and I will benefit going forward.
This may very well be a case where not being too diversified will reap great benefits.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Many financial advisers tout the benefits of diversification. They reason that spreading your eggs among many baskets can protect your aggregate egg count in case one basket drops.
But, what if there is some underlying reason that causes all baskets to drop all at once? Then, of course, all your eggs drop.
Most people didn't think this was possible, and yet it happened in 2008. Almost every asset class dropped as the market panicked. The one major exception was U.S. Treasury Bonds.
As John Authers put it in his "The Short View" column in the Financial Times, "...last year's sell-off was so extreme that diversification would not have helped one whit."
But, isn't it at times like this, when everyone is panicking, that diversification is supposed to provide benefits? Yes, it is supposed to. But, that doesn't mean it does.
The reason why is that all financial markets are linked. Just because everyone is running from one investment does not mean another "historically uncorrelated" asset is necessarily doing well. This was very clear in 2008.
Diversification seems to work best when you don't need it. People don't get excited about diversification during normal times. It just gives you average instead of slightly better or slightly worse returns.
If you have half your money in U.S. stocks that provide a 5% return and half your money in foreign stocks that provide a 15% return, you get 10% returns. All you manage to do is lock in mediocre returns all the time. Getting 5% returns versus 10% or 15% returns in a single year won't ruin someones retirement. Losing 40% the year after retiring almost certainly will.
When markets really panic, everything goes down together. Even a brief glance at economic history confirms this. Diversification fails when people want it most. Like...well, like in 2008.
There is a very real benefit to be gained from this situation, though. Not all investments have bad underlying characteristics. The very fact that a panic has occurred means both good and bad investments were sold off. So, you can currently buy excellent investments for the same price as the poor ones.
But, if you diversify you'll get both the bad and the good returns going forward. Someone down 40% will see a world of difference between getting a 67% return (being in the good investments and returning to starting principal value) and getting a 33% return (being diversified in half the good investments that go up 67% and half the bad investments that go nowhere, thus still being down 20% from starting principal value).
Or, as John Authers put it, "If there is any consolation, it is that the sell-off was so indiscriminate. The odds are overwhelming that some stocks and asset classes will now begin to outperform."
I don't know when, exactly, those good stocks and asset classes will take off, but I'm quite comfortable I have identified them and believe very strongly my clients and I will benefit going forward.
This may very well be a case where not being too diversified will reap great benefits.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, January 23, 2009
Economists are like diapers
Economists love to make forecasts. The problem is: most economists are like diapers, they require frequent changing and for the same reason (i.e. they are full of crap). Don't spend too much time thinking or worrying about economic forecasts, they are seldom if ever right.
This may seem like an overly harsh judgment, but I cannot think of any profession that has a worse track record (even politicians seem to do better, and from me that's quite a concession).
Most economists are either from or in academia. Their focus is on an other-worldly fantasy that has few similarities to the world we live in. Not surprisingly, this ivory tower approach leads to terrible forecasts.
You would think this would bug economists, but it doesn't. Most seem quite happy to profess theories based on assumptions they will gladly admit are false. They are more concerned with theoretical elegance and mathematical precision than with accurately predicting reality.
One school of thought is that markets are always efficient--they are always rational in the sense of an unemotional investor with all the facts at their disposal. I don't know any unemotional investors, and any experience with markets would quickly convince any honest person that markets are not rational in the short term (though they definitely are over the long term).
Another school of thought is that markets are irrational and thus require government intervention. But, if the human beings in the market are irrational, what prevents government employees--also human beings as far as I know--from not also make irrational decisions in their intervention? No answer is given.
Another school of thought is that the government printing money can solve bad lending. But, if printing money fixes problems, then why not just print it all the time and make everyone happy always. Sounds like a perpetual motion machine to me (more accurately: hyper-inflation).
Another school of thought is that the government can cut taxes while continuing to spend recklessly. But, if it's dumb for an individual to spend beyond his means forever, why would it be smart for a government to do so? Because the government exists on another plane of reality?
Another school of thought refuses to make precise predictions because it acknowledges the impossibility in the realm of human endeavors. Paradoxically, this seems to be the only school that correctly foresaw the Great Depression, the inflation of the 1970's, the Internet Bubble, and the Housing/Credit Bubble. No one listens to this school, it's considered fringe by many, and is taught in only a handful of colleges (Auburn is one).
Next time you hear or see an economist make a prediction--on the radio, in print, on TV--keep in mind the field's lousy record. Remember they are mostly academics with little success in predicting real world events.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Economists love to make forecasts. The problem is: most economists are like diapers, they require frequent changing and for the same reason (i.e. they are full of crap). Don't spend too much time thinking or worrying about economic forecasts, they are seldom if ever right.
This may seem like an overly harsh judgment, but I cannot think of any profession that has a worse track record (even politicians seem to do better, and from me that's quite a concession).
Most economists are either from or in academia. Their focus is on an other-worldly fantasy that has few similarities to the world we live in. Not surprisingly, this ivory tower approach leads to terrible forecasts.
You would think this would bug economists, but it doesn't. Most seem quite happy to profess theories based on assumptions they will gladly admit are false. They are more concerned with theoretical elegance and mathematical precision than with accurately predicting reality.
One school of thought is that markets are always efficient--they are always rational in the sense of an unemotional investor with all the facts at their disposal. I don't know any unemotional investors, and any experience with markets would quickly convince any honest person that markets are not rational in the short term (though they definitely are over the long term).
Another school of thought is that markets are irrational and thus require government intervention. But, if the human beings in the market are irrational, what prevents government employees--also human beings as far as I know--from not also make irrational decisions in their intervention? No answer is given.
Another school of thought is that the government printing money can solve bad lending. But, if printing money fixes problems, then why not just print it all the time and make everyone happy always. Sounds like a perpetual motion machine to me (more accurately: hyper-inflation).
Another school of thought is that the government can cut taxes while continuing to spend recklessly. But, if it's dumb for an individual to spend beyond his means forever, why would it be smart for a government to do so? Because the government exists on another plane of reality?
Another school of thought refuses to make precise predictions because it acknowledges the impossibility in the realm of human endeavors. Paradoxically, this seems to be the only school that correctly foresaw the Great Depression, the inflation of the 1970's, the Internet Bubble, and the Housing/Credit Bubble. No one listens to this school, it's considered fringe by many, and is taught in only a handful of colleges (Auburn is one).
Next time you hear or see an economist make a prediction--on the radio, in print, on TV--keep in mind the field's lousy record. Remember they are mostly academics with little success in predicting real world events.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, January 16, 2009
The perils of leverage
One of the biggest lessons of the current financial crisis is: don't take on too much debt.
This may sound like common sense advice, but it's amazing how often people forget it.
If you buy a house with cash and its value increases 20%, you've gotten a 20% return. If, however, you borrow 80%, put 20% down, and its value increases by 20%, you've just doubled your money. There's a big upside to using leverage.
But, debt is a double-edged sword. It doesn't just give you bigger returns if things go well, it also gives you bigger losses if they don't go well.
Using the same example above, someone who pays cash for a house that decreases 20% in value losses 20%. Someone who only puts down 20%, though, has lost everything.
Archimedes said he could move the world with a large enough lever. The lever multiplies the impact of your input. But, such leverage works both positively and negatively.
When banks were as free as they've been, in the late 19th century (1800's), they carried 40% equity and borrowed 60% (levered 2.5 to 1). Banks operated that way could generally survive the inevitable economic storms that come along with economic cycles.
But, banks nowadays are regulated to be levered 10 to 1: they borrow 10 dollars and only contribute 1 of their own (or shareholders'). Such leverage is a double-edged sword, too. If a bank levered 10 to 1 makes loans and 9.1% of them go bad, the bank is basically insolvent. That's what's been happening recently.
Investment banks were levered 30 to 1. The top 5 investment banks are all gone or have been forced to become levered 10 to 1. Mortgage insurers and bond insurers were levered as highly as 140 to 1, they are now almost all insolvent. Many other insurers were levered up too much, such as AIG, and they didn't understand the leverage they had taken on. That lack of understanding didn't save them (or taxpayers).
Our current crisis is a perfect illustration of the perils of leverage. Companies like GM and GE are in trouble because they financed their companies with too much debt. It is difficult for almost any but the least levered companies to borrow money, now. As a result, almost any company with too much leverage has had their stock price massacred.
Everyone seems to understand that too much leverage is bad. But many businesses and individuals took on too much leverage and they blew up. Those are the folks getting bailed out now, and they are being bailed out by those who didn't take on too much leverage. That just doesn't seem right.
It seems like taking on too much leverage is a lesson that must be learned periodically. Those who survived the Great Depression were terrified of borrowing money.
Unfortunately, our country is currently trying to fix our leverage problems by levering up our government. It's hard to understand how you can solve the problem of leverage with more leverage.
When a government gets too levered, the resulting problem is almost always inflation. Inflation solves the government's problem with leverage, but not its citizens'.
Beware leverage. Beware inflation.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
One of the biggest lessons of the current financial crisis is: don't take on too much debt.
This may sound like common sense advice, but it's amazing how often people forget it.
If you buy a house with cash and its value increases 20%, you've gotten a 20% return. If, however, you borrow 80%, put 20% down, and its value increases by 20%, you've just doubled your money. There's a big upside to using leverage.
But, debt is a double-edged sword. It doesn't just give you bigger returns if things go well, it also gives you bigger losses if they don't go well.
Using the same example above, someone who pays cash for a house that decreases 20% in value losses 20%. Someone who only puts down 20%, though, has lost everything.
Archimedes said he could move the world with a large enough lever. The lever multiplies the impact of your input. But, such leverage works both positively and negatively.
When banks were as free as they've been, in the late 19th century (1800's), they carried 40% equity and borrowed 60% (levered 2.5 to 1). Banks operated that way could generally survive the inevitable economic storms that come along with economic cycles.
But, banks nowadays are regulated to be levered 10 to 1: they borrow 10 dollars and only contribute 1 of their own (or shareholders'). Such leverage is a double-edged sword, too. If a bank levered 10 to 1 makes loans and 9.1% of them go bad, the bank is basically insolvent. That's what's been happening recently.
Investment banks were levered 30 to 1. The top 5 investment banks are all gone or have been forced to become levered 10 to 1. Mortgage insurers and bond insurers were levered as highly as 140 to 1, they are now almost all insolvent. Many other insurers were levered up too much, such as AIG, and they didn't understand the leverage they had taken on. That lack of understanding didn't save them (or taxpayers).
Our current crisis is a perfect illustration of the perils of leverage. Companies like GM and GE are in trouble because they financed their companies with too much debt. It is difficult for almost any but the least levered companies to borrow money, now. As a result, almost any company with too much leverage has had their stock price massacred.
Everyone seems to understand that too much leverage is bad. But many businesses and individuals took on too much leverage and they blew up. Those are the folks getting bailed out now, and they are being bailed out by those who didn't take on too much leverage. That just doesn't seem right.
It seems like taking on too much leverage is a lesson that must be learned periodically. Those who survived the Great Depression were terrified of borrowing money.
Unfortunately, our country is currently trying to fix our leverage problems by levering up our government. It's hard to understand how you can solve the problem of leverage with more leverage.
When a government gets too levered, the resulting problem is almost always inflation. Inflation solves the government's problem with leverage, but not its citizens'.
Beware leverage. Beware inflation.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, January 09, 2009
After a financial crisis, recessions are worse than average
Not all recessions are the same. Most recessions are a manifestation of the business cycle. But, when a recession is the result of a crisis in the financial sector, things get much worse.
What does that mean for investors? It means this is a once or twice in a lifetime opportunity to buy equities at very low prices. This opportunity may exist for some time, but trying to predict when markets will recover is a losing proposition. Get invested now and keep some cash on hand in case things get significantly worse.
A recent paper by Carmen Reinhart and Kenneth Rogoff, called "The Aftermath of Financial Crises," provides support for the view that recessions following a financial crisis are worse than average.
In their paper, they show that asset markets collapse more deeply and for a longer time period. Real (after inflation) housing prices collapse an average of 35% over 6 years. Equity prices collapse by 55% over 3 1/2 years. Unemployment rises an average of 7% over 4 years. Output falls 9% over 2 years. The real value of government debt explodes.
The average recession lasts 10 months. Using that average, we would have come out of this recession last October because we entered it in December of 2007. As I'm sure you know by now, that didn't happen. In fact, the recession hit high gear around that time.
Averages are not a proper expectation for what will happen. If you stuck your head in an oven and your feet in a freezer, your average temperature would be comfortable, but I guarantee you'd be miserable. Averages can be deceiving and misused.
But, averages can be useful for gauging what could happen. My intention here is to prepare you for the downside and how rough this ride will be, not to predict what will happen or when.
Asset markets have been down around 40%, so getting to down 55% would require another 25% decline from the down 40% level. I wouldn't be surprised to see markets go significantly lower, but that's impossible to predict. A decline to the 55% level, or even the 90% level like the Great Depression, is likely to be very short lived. The best thing to do is be prepared for the downside while acknowledging that the upside for equities from here is extraordinarily good. Try to pick the bottom is a fool's errand.
We're only a year and a half into the housing price decline, but this market was unusually over-valued at the top, so I expect it to end up more than 35% down. I also wouldn't be surprised to see this last shorter than it has historically because of how rapidly it declined and how actively the government is intervening.
Unemployment bottomed around 4.4%, so it would have to get over 11% to reach historical average. The rate is around 7.2% currently, so we are well on our way there. Remember, unemployment is a lagging indicator. It will almost certainly hit its peak long after the markets and economy are recovering.
Output has only started to fall, and getting to the down 9% level will be painful. Like with employment, this will be a lagging indicator. By the time we see it recovering, markets will almost certainly be up significantly.
Government debt is already ballooning and will continue to do so. Government officials are already calling for a $1.2 trillion deficit this year, and that is only the tip of the iceberg. When an institution issues a lot of debt, even the U.S. government, their cost of debt will go up. Be prepared for higher interest rates and inflation. This may take years to develop, but when it does it will be truly life-changing.
Recessions following financial crises are deeper and longer lasting than average. It looks like we're in such a situation. Be prepared for the downside. Be prepared for a lot of negative news going forward. But, most importantly, get invested to take advantage of the recovery and be prepared for even lower prices--in case they happen--in the future.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Not all recessions are the same. Most recessions are a manifestation of the business cycle. But, when a recession is the result of a crisis in the financial sector, things get much worse.
What does that mean for investors? It means this is a once or twice in a lifetime opportunity to buy equities at very low prices. This opportunity may exist for some time, but trying to predict when markets will recover is a losing proposition. Get invested now and keep some cash on hand in case things get significantly worse.
A recent paper by Carmen Reinhart and Kenneth Rogoff, called "The Aftermath of Financial Crises," provides support for the view that recessions following a financial crisis are worse than average.
In their paper, they show that asset markets collapse more deeply and for a longer time period. Real (after inflation) housing prices collapse an average of 35% over 6 years. Equity prices collapse by 55% over 3 1/2 years. Unemployment rises an average of 7% over 4 years. Output falls 9% over 2 years. The real value of government debt explodes.
The average recession lasts 10 months. Using that average, we would have come out of this recession last October because we entered it in December of 2007. As I'm sure you know by now, that didn't happen. In fact, the recession hit high gear around that time.
Averages are not a proper expectation for what will happen. If you stuck your head in an oven and your feet in a freezer, your average temperature would be comfortable, but I guarantee you'd be miserable. Averages can be deceiving and misused.
But, averages can be useful for gauging what could happen. My intention here is to prepare you for the downside and how rough this ride will be, not to predict what will happen or when.
Asset markets have been down around 40%, so getting to down 55% would require another 25% decline from the down 40% level. I wouldn't be surprised to see markets go significantly lower, but that's impossible to predict. A decline to the 55% level, or even the 90% level like the Great Depression, is likely to be very short lived. The best thing to do is be prepared for the downside while acknowledging that the upside for equities from here is extraordinarily good. Try to pick the bottom is a fool's errand.
We're only a year and a half into the housing price decline, but this market was unusually over-valued at the top, so I expect it to end up more than 35% down. I also wouldn't be surprised to see this last shorter than it has historically because of how rapidly it declined and how actively the government is intervening.
Unemployment bottomed around 4.4%, so it would have to get over 11% to reach historical average. The rate is around 7.2% currently, so we are well on our way there. Remember, unemployment is a lagging indicator. It will almost certainly hit its peak long after the markets and economy are recovering.
Output has only started to fall, and getting to the down 9% level will be painful. Like with employment, this will be a lagging indicator. By the time we see it recovering, markets will almost certainly be up significantly.
Government debt is already ballooning and will continue to do so. Government officials are already calling for a $1.2 trillion deficit this year, and that is only the tip of the iceberg. When an institution issues a lot of debt, even the U.S. government, their cost of debt will go up. Be prepared for higher interest rates and inflation. This may take years to develop, but when it does it will be truly life-changing.
Recessions following financial crises are deeper and longer lasting than average. It looks like we're in such a situation. Be prepared for the downside. Be prepared for a lot of negative news going forward. But, most importantly, get invested to take advantage of the recovery and be prepared for even lower prices--in case they happen--in the future.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, January 02, 2009
Happy New Year!
I enter 2009 as enthusiastic as I've ever been about future returns.
That's not a forecast for returns this year. I don't know what returns the market will generate over the next week, month or year, and anyone who tells you they do know is lying.
What I do know is that stock prices are as low as they've been relative to fundamental business values since the early to mid 1980's.
Does that mean the stock market won't go lower? No.
If the stock market bottoms where it did in the 1970's, it would be 33% lower than it was at year end.
If the market bottoms where it did in the early 1950's, it would be 40% lower than it was at year end.
If the market bottoms where it did during the early 1930's--at its worst during the Great Depression--it would have to go down another 60% or more.
Those aren't forecasts, that's just a report of how bad things could get based on historical information.
But, as Mark Twain said, history doesn't repeat, but it sure does rhyme. No one knows what precisely will happen, even if they get lucky and their prediction turns out to be right.
All a prudent investor can do is invest based on the facts, and the facts say that stocks are cheap. If they get cheaper, then even better bargains will be had. If they get dearer, investors will see their portfolio values climb.
Based on fundamentals, it's reasonable to expect the S&P 500 to be up 10% - 15%, annualized, over the next 5 years. That's unlikely to be a smooth path upward, but it's a very likely outcome.
Even better, carefully selected stocks are likely to do much better than that.
And, that's why I'm as optimistic as I've ever been in my 13 years of investing.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
I enter 2009 as enthusiastic as I've ever been about future returns.
That's not a forecast for returns this year. I don't know what returns the market will generate over the next week, month or year, and anyone who tells you they do know is lying.
What I do know is that stock prices are as low as they've been relative to fundamental business values since the early to mid 1980's.
Does that mean the stock market won't go lower? No.
If the stock market bottoms where it did in the 1970's, it would be 33% lower than it was at year end.
If the market bottoms where it did in the early 1950's, it would be 40% lower than it was at year end.
If the market bottoms where it did during the early 1930's--at its worst during the Great Depression--it would have to go down another 60% or more.
Those aren't forecasts, that's just a report of how bad things could get based on historical information.
But, as Mark Twain said, history doesn't repeat, but it sure does rhyme. No one knows what precisely will happen, even if they get lucky and their prediction turns out to be right.
All a prudent investor can do is invest based on the facts, and the facts say that stocks are cheap. If they get cheaper, then even better bargains will be had. If they get dearer, investors will see their portfolio values climb.
Based on fundamentals, it's reasonable to expect the S&P 500 to be up 10% - 15%, annualized, over the next 5 years. That's unlikely to be a smooth path upward, but it's a very likely outcome.
Even better, carefully selected stocks are likely to do much better than that.
And, that's why I'm as optimistic as I've ever been in my 13 years of investing.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, December 19, 2008
At some point, inflation
Sometimes it's useful to look beyond the current headlines to what may be coming over the next 3 to 5 years.
From my vantage point, what I see coming is inflation.
Currently, the news is filled with signs of deflation. Asset prices are collapsing. Housing prices are down significantly. Almost anything, other than U.S. Treasury securities, seems to be down over the last year.
Commodities have been particularly hard hit. It wasn't that long ago that oil was at $147 per barrel and people were talking about it going over $200. Now, it's below $40.
But, what has changed? Mostly, demand has dropped dramatically. As Economics 101 will tell you, when the demand curve shifts down and the supply curve stays the same, you get lower prices. I think I can safely say that has happened.
So, why had demand been crushed. In a word, deleveraging. The economy as a whole--businesses and consumers, at least--have been paying back debts to keep from going bankrupt. Not everyone is succeeding.
This reduction in debt has led to a tremendous fall-off in demand for goods and services of all sorts. You can see that clearly in the GDP and employment numbers. For those those who thought only Wall Street was in trouble, take another look.
But, the biggest debtor out there--the U.S. government--has been borrowing and printing money like it's going out of style.
Eventually, such borrowing and printing will get credit markets going. And, when they do, we'll all owe a lot more debt and have a lot more dollars chasing the same number of goods. In other words, inflation.
I don't think it will happen soon. Although the Fed is printing money and Congress is finding all kinds of ways to spend it, economic activity has slowed down so much that all it's doing is making deflation happen less quickly. Eventually, and over the next several years, economic activity will pick back up again and this will be visible in the so-called velocity of money.
When that happens, the demand curve will shift back up and prices will recover. But--and there's always a but--the government will be in a lot more debt and there will be a lot more dollars chasing the same amount of demand.
In 3 to 5 years, and perhaps sooner, the news won't be about deflation, but inflation. And, that inflation will be a lot higher than in the 80's, 90's or 00's. In fact, it wouldn't surprise me to see $300 a barrel oil and double digit inflation rates (not the core rate, but including food and energy).
With that in mind, you may want to consider inflation-proofing your portfolio over the coming years. Think about companies that can jack up their prices and customers will still pay. Think about commodity producing companies. Be wary of bonds with low payouts or higher risk of default.
It may not happen right away, but over the next several years, get prepared for inflation.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Sometimes it's useful to look beyond the current headlines to what may be coming over the next 3 to 5 years.
From my vantage point, what I see coming is inflation.
Currently, the news is filled with signs of deflation. Asset prices are collapsing. Housing prices are down significantly. Almost anything, other than U.S. Treasury securities, seems to be down over the last year.
Commodities have been particularly hard hit. It wasn't that long ago that oil was at $147 per barrel and people were talking about it going over $200. Now, it's below $40.
But, what has changed? Mostly, demand has dropped dramatically. As Economics 101 will tell you, when the demand curve shifts down and the supply curve stays the same, you get lower prices. I think I can safely say that has happened.
So, why had demand been crushed. In a word, deleveraging. The economy as a whole--businesses and consumers, at least--have been paying back debts to keep from going bankrupt. Not everyone is succeeding.
This reduction in debt has led to a tremendous fall-off in demand for goods and services of all sorts. You can see that clearly in the GDP and employment numbers. For those those who thought only Wall Street was in trouble, take another look.
But, the biggest debtor out there--the U.S. government--has been borrowing and printing money like it's going out of style.
Eventually, such borrowing and printing will get credit markets going. And, when they do, we'll all owe a lot more debt and have a lot more dollars chasing the same number of goods. In other words, inflation.
I don't think it will happen soon. Although the Fed is printing money and Congress is finding all kinds of ways to spend it, economic activity has slowed down so much that all it's doing is making deflation happen less quickly. Eventually, and over the next several years, economic activity will pick back up again and this will be visible in the so-called velocity of money.
When that happens, the demand curve will shift back up and prices will recover. But--and there's always a but--the government will be in a lot more debt and there will be a lot more dollars chasing the same amount of demand.
In 3 to 5 years, and perhaps sooner, the news won't be about deflation, but inflation. And, that inflation will be a lot higher than in the 80's, 90's or 00's. In fact, it wouldn't surprise me to see $300 a barrel oil and double digit inflation rates (not the core rate, but including food and energy).
With that in mind, you may want to consider inflation-proofing your portfolio over the coming years. Think about companies that can jack up their prices and customers will still pay. Think about commodity producing companies. Be wary of bonds with low payouts or higher risk of default.
It may not happen right away, but over the next several years, get prepared for inflation.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, December 12, 2008
Keeping your head in trying times
The hardest part of watching the stock market recently has been keeping things in the right context.
The stock market is not a crystal ball that reveals a company's true worth. It merely shows what people are willing to buy and sell partial ownership of companies at any point in time.
But who is buying and who is selling?
Are sellers under pressure because they bought with borrowed money? Are they professional investors who are selling because their customers are cashing out in a panic?
Are buyers carefully considering the value of companies? Are they waiting to see what the government or other buyers and sellers will do next?
Markets do not reveal underlying worth, they simply reveal what people are willing to pay at a point in time. But, those assessments change over time--sometimes dramatically.
The way I'm keeping my head in these difficult times is to look past stock prices at the underlying businesses I own. Such businesses are in good shape and have bright futures.
Focusing on the underlying business is key to keeping your head. It allows the market to be your servant instead of your master.
Right now, and for some time to come I think, that servant will provide wonderful bargains on great companies.
As long as you look past the price at the underlying business, you too can keep your head and benefit from trying times.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
The hardest part of watching the stock market recently has been keeping things in the right context.
The stock market is not a crystal ball that reveals a company's true worth. It merely shows what people are willing to buy and sell partial ownership of companies at any point in time.
But who is buying and who is selling?
Are sellers under pressure because they bought with borrowed money? Are they professional investors who are selling because their customers are cashing out in a panic?
Are buyers carefully considering the value of companies? Are they waiting to see what the government or other buyers and sellers will do next?
Markets do not reveal underlying worth, they simply reveal what people are willing to pay at a point in time. But, those assessments change over time--sometimes dramatically.
The way I'm keeping my head in these difficult times is to look past stock prices at the underlying businesses I own. Such businesses are in good shape and have bright futures.
Focusing on the underlying business is key to keeping your head. It allows the market to be your servant instead of your master.
Right now, and for some time to come I think, that servant will provide wonderful bargains on great companies.
As long as you look past the price at the underlying business, you too can keep your head and benefit from trying times.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, December 05, 2008
Things are looking up
I'm not a market timer, but when market sentiment is as negative as it is now, it's not a bad idea to look for the silver lining which may mean things are improving.
Today, new unemployment claims came in at over 500,000, the worst report since the brutal 1974 recession. After these figures are fully adjusted over the next several years, it would not surprise me to see this number close to 1,000,000.
How is that good news? Because the market is up today!
When extremely negative numbers come out about the economy and the stock market doesn't go down by much or even goes up, it means people have fully grasped how negative things are and are starting to look for a future recovery.
That doesn't mean the market has bottomed or that all the bad news has been announced. But, it does mean that market participants are recognizing how bad things are and are perhaps seeing that things won't be so bad in the future.
Added to this, employment figures are a lagging indicator. That means that employment figures tend to look worst near stock market bottoms. Employment is a reaction to economic conditions, not a forecaster of them. Employment figures look bad when employers are throwing in the towel and laying people off. This is usually when the stock market begins to recover.
Why? Because the stock market is a forecasting mechanism. The price of a stock should be equal to all future cash flows. Prices shouldn't reflect current conditions, or even conditions over the near term, but should reflect all future possibilities of a company.
That's why the stock market tends to recover long before the economy, and why waiting for economic figures to improve is a sure fire way to miss out on huge market rallies.
I don't know if the stock market will go up next week, month or year, but I do know that many companies are trading at depression levels even though they have bright futures.
In other words, the best bargains in 25 years can be found right now, if you can see the silver lining.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
I'm not a market timer, but when market sentiment is as negative as it is now, it's not a bad idea to look for the silver lining which may mean things are improving.
Today, new unemployment claims came in at over 500,000, the worst report since the brutal 1974 recession. After these figures are fully adjusted over the next several years, it would not surprise me to see this number close to 1,000,000.
How is that good news? Because the market is up today!
When extremely negative numbers come out about the economy and the stock market doesn't go down by much or even goes up, it means people have fully grasped how negative things are and are starting to look for a future recovery.
That doesn't mean the market has bottomed or that all the bad news has been announced. But, it does mean that market participants are recognizing how bad things are and are perhaps seeing that things won't be so bad in the future.
Added to this, employment figures are a lagging indicator. That means that employment figures tend to look worst near stock market bottoms. Employment is a reaction to economic conditions, not a forecaster of them. Employment figures look bad when employers are throwing in the towel and laying people off. This is usually when the stock market begins to recover.
Why? Because the stock market is a forecasting mechanism. The price of a stock should be equal to all future cash flows. Prices shouldn't reflect current conditions, or even conditions over the near term, but should reflect all future possibilities of a company.
That's why the stock market tends to recover long before the economy, and why waiting for economic figures to improve is a sure fire way to miss out on huge market rallies.
I don't know if the stock market will go up next week, month or year, but I do know that many companies are trading at depression levels even though they have bright futures.
In other words, the best bargains in 25 years can be found right now, if you can see the silver lining.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, November 21, 2008
Market prices are only relevant if you have to sell
Andy Kessler wrote an excellent opinion piece that appeared in the Wall Street Journal yesterday. His article was titled "Ignore the Stock Market Until February."
His basic point is that a lot of selling in the stock market over the last 2 months has been due to reasons other than a rational assessment of investment merit.
He goes on to list the reasons why many people have been selling:
- tax loss selling - selling to book losses, thus reducing taxes
- mutual fund redemptions - people selling mutual funds cause the effected money manager to have to sell something, and such managers tend to chose things that have gone down the least
- mutual fund cap-gain distributions - investors are selling to pay their capital gains taxes
- hedge fund redemptions - just like mutual fund managers, hedge funds facing redemptions have to sell something, and they are choosing to sell things that have gone down the least
- margin calls - people, both individual and institutional investors, who bought stocks on margin are selling to cover margin calls as stocks go down--the so-called process of de-leveraging
I'll add another thing to that list--stop loss orders. People who think that putting in stop loss orders will save them from losses are having their stop loss orders triggered over and over again as the market goes down. This tends to be sell-reinforcing on the way down.
The result is a bunch of forced selling that is causing the stock market to go down more than it otherwise would. This may seem bad, but it's actually a good thing. (If there were a self-reinforcing cycle that made flat screen TVs go down in price, we'd be tickled pink because the value of the TV to us doesn't go down as the price does--how are stocks different?)
Why are declining stock prices good? Because that means the stocks being sold are getting pushed down to lows they would not otherwise hit. The underlying value of the business isn't changing, just the quoted price other people want to buy/sell it. If you hold a company whose price has gone down, you are free to disagree with the market by not selling, or even buying.
As long as you don't have to sell, the current market quote isn't relevant.
Only when you have to sell are market prices relevant. If you don't have to sell, you don't have to book losses. And, if you don't have to book losses, then you haven't really lost anything, yet.
Benjamin Graham once said the market should serve you, not be your master. Right now, the market is serving up unbelievable discounts on some of the best companies around. This is a great time to buy, or a great chance to sell things that haven't gone down and buy great companies that have gone down significantly.
Kessler makes the point that the market will continue to go down in December as tax loss harvesting continues and leverage is unwound. In January, a bunch of money managers will get fired for lousy performance, and the new managers will be selling in January to get rid of the previous manager's mistakes. That means market prices are likely to be far off underlying values until at least February.
That means you have 2 months--2 glorious, happy months--to buy into the best bargains seen in almost 25 years. I've never been so excited about future returns.
When February comes, I'll be well positioned to benefit, and so will my clients.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Andy Kessler wrote an excellent opinion piece that appeared in the Wall Street Journal yesterday. His article was titled "Ignore the Stock Market Until February."
His basic point is that a lot of selling in the stock market over the last 2 months has been due to reasons other than a rational assessment of investment merit.
He goes on to list the reasons why many people have been selling:
- tax loss selling - selling to book losses, thus reducing taxes
- mutual fund redemptions - people selling mutual funds cause the effected money manager to have to sell something, and such managers tend to chose things that have gone down the least
- mutual fund cap-gain distributions - investors are selling to pay their capital gains taxes
- hedge fund redemptions - just like mutual fund managers, hedge funds facing redemptions have to sell something, and they are choosing to sell things that have gone down the least
- margin calls - people, both individual and institutional investors, who bought stocks on margin are selling to cover margin calls as stocks go down--the so-called process of de-leveraging
I'll add another thing to that list--stop loss orders. People who think that putting in stop loss orders will save them from losses are having their stop loss orders triggered over and over again as the market goes down. This tends to be sell-reinforcing on the way down.
The result is a bunch of forced selling that is causing the stock market to go down more than it otherwise would. This may seem bad, but it's actually a good thing. (If there were a self-reinforcing cycle that made flat screen TVs go down in price, we'd be tickled pink because the value of the TV to us doesn't go down as the price does--how are stocks different?)
Why are declining stock prices good? Because that means the stocks being sold are getting pushed down to lows they would not otherwise hit. The underlying value of the business isn't changing, just the quoted price other people want to buy/sell it. If you hold a company whose price has gone down, you are free to disagree with the market by not selling, or even buying.
As long as you don't have to sell, the current market quote isn't relevant.
Only when you have to sell are market prices relevant. If you don't have to sell, you don't have to book losses. And, if you don't have to book losses, then you haven't really lost anything, yet.
Benjamin Graham once said the market should serve you, not be your master. Right now, the market is serving up unbelievable discounts on some of the best companies around. This is a great time to buy, or a great chance to sell things that haven't gone down and buy great companies that have gone down significantly.
Kessler makes the point that the market will continue to go down in December as tax loss harvesting continues and leverage is unwound. In January, a bunch of money managers will get fired for lousy performance, and the new managers will be selling in January to get rid of the previous manager's mistakes. That means market prices are likely to be far off underlying values until at least February.
That means you have 2 months--2 glorious, happy months--to buy into the best bargains seen in almost 25 years. I've never been so excited about future returns.
When February comes, I'll be well positioned to benefit, and so will my clients.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, November 14, 2008
"buy some good stock and hold it till it goes up"
I recently got back from a trip to Rome. Wow, what an amazing place. I've spent the last several years learning all about ancient Rome, and making a trip there really capped it off nicely.
On part of the plane ride back, for there were many legs, I sat next to a nice man who is an architect.
In conversation, it came up that I was a professional investor. He commented that this must be a terrible time to be in this field, and I retorted that it's a wonderful time because I'm good at what I do and the opportunities are legendary.
His response was that someone who sold several months ago would have proven brilliant.
I didn't respond because I was dumb-founded that someone who seemed so intelligent was suffering from such powerful case of hindsight bias.
It reminded me of the Will Rogers quote, "take all your saving and buy some good stock and hold it till it goes up, then sell it. If it doesn't go up, don't buy it."
Of course, Rogers was making fun of the concept of hindsight bias. He was poking fun at the people who think you can successfully invest by only buying things that went up in hindsight.
But, most investors seem to think that's the way to make money. Just sell at the top and buy at the bottom. The problem is that no one can do this consistently. Some people have done it because they were lucky once or twice, but no one does it consistently. Even worse, the people who try are almost always doing worse than someone who just buys and holds.
People who try to sell at the top and buy at the bottom end up guessing on the roll of a die and either getting lucky or unlucky. That's not investing wisdom.
A smart weather predictor doesn't try to boldly guess the weather. They look at the facts, consult a lot of data, read a lot of history, and make judgments based on hours of analysis. And, even then, they use percentages to forecast how likely certain weather phenomenon are to occur.
The stock market is even more difficult to predict than the weather. There aren't any successful investors who time the market, just like there aren't any successful weather predictors who guess about the weather.
The secret isn't to look into the past and wish you had timed things perfectly. The secret is to do analysis, consult history, and make bets where the odds are heavily in your favor--even though you don't know exactly what will happen.
The people who try to sell high and buy low almost always end up doing the opposite, and their investing results and overall wealth reflect that strategy.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
I recently got back from a trip to Rome. Wow, what an amazing place. I've spent the last several years learning all about ancient Rome, and making a trip there really capped it off nicely.
On part of the plane ride back, for there were many legs, I sat next to a nice man who is an architect.
In conversation, it came up that I was a professional investor. He commented that this must be a terrible time to be in this field, and I retorted that it's a wonderful time because I'm good at what I do and the opportunities are legendary.
His response was that someone who sold several months ago would have proven brilliant.
I didn't respond because I was dumb-founded that someone who seemed so intelligent was suffering from such powerful case of hindsight bias.
It reminded me of the Will Rogers quote, "take all your saving and buy some good stock and hold it till it goes up, then sell it. If it doesn't go up, don't buy it."
Of course, Rogers was making fun of the concept of hindsight bias. He was poking fun at the people who think you can successfully invest by only buying things that went up in hindsight.
But, most investors seem to think that's the way to make money. Just sell at the top and buy at the bottom. The problem is that no one can do this consistently. Some people have done it because they were lucky once or twice, but no one does it consistently. Even worse, the people who try are almost always doing worse than someone who just buys and holds.
People who try to sell at the top and buy at the bottom end up guessing on the roll of a die and either getting lucky or unlucky. That's not investing wisdom.
A smart weather predictor doesn't try to boldly guess the weather. They look at the facts, consult a lot of data, read a lot of history, and make judgments based on hours of analysis. And, even then, they use percentages to forecast how likely certain weather phenomenon are to occur.
The stock market is even more difficult to predict than the weather. There aren't any successful investors who time the market, just like there aren't any successful weather predictors who guess about the weather.
The secret isn't to look into the past and wish you had timed things perfectly. The secret is to do analysis, consult history, and make bets where the odds are heavily in your favor--even though you don't know exactly what will happen.
The people who try to sell high and buy low almost always end up doing the opposite, and their investing results and overall wealth reflect that strategy.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, October 31, 2008
How low can you go?
A lot people are wondering how bad the stock market can get.
I don't know how low it will go, but I have a pretty good idea of how low it can go.
Before I outline my reasoning, let me forewarn you: the answer is ugly.
I'm not trying to predict what the market will do or when--no one really can. I'm just trying to prepare you for the worst case scenario just in case it happens.
You don't want to sell at the bottom. Nothing will hose up your long term goals as much as going to cash in hopes you can sell at the top and buy at the bottom. The odds are highly in favor of you doing just the opposite--most people do. Knowing how bad things can get may help you avoid selling at the bottom, and that's what I'm trying to do in this blog.
The reality is I've never been as bullish as I am now. I'm projecting the highest returns going forward I've seen in 13 years! I'm terribly excited about the returns I believe I'll get over the next 5 years. But, and there's always a but, the stock market could go a lot lower before it goes back up again.
How low? History indicates the market can get as low as 7 times normalized earnings. I've talked about normalized earnings in the past, but let me explain it again briefly.
The stock market's per share earnings have grown quite steadily at around 6% a year over the last 50+ years. In boom times earnings are above this trend, and in bust times earnings are below. But, over time, the earnings always return to trend.
Such earnings are like true north to a navigator. They point the way in all circumstances and provide a ready reference for where you are and where you're going.
That's why I use normalized earnings--it's a steady guide. In boom times, the stock market sells at over 20 times earnings. In bust times, it tends to go down below 10 times earnings. In the worst times, it gets down to around 7 times normalized earnings.
What would 7 times normalized earnings mean for the S&P 500? Normalized earnings in the next year for the S&P 500 will be around $67 a share. 7 times that gives you a value of $469 for the S&P 500, roughly 52% below today's closing price of around $970 on the S&P 500. That would correlate to a Dow Jones Industrial Average of $4,500.
I'm not saying we'll get that low. In fact, I consider that quite unlikely. I'm not saying I want to see it go that low--I'd feel terrible if it did. But, I am saying be prepared for it to go that low just in case it does.
Benjamin Graham, the father of value investing, once said you shouldn't invest in the stock market unless you're ready to see your investment cut in half and double in value. I agree with that sentiment. Be prepared for the worst, hope for the best.
On a brighter note, the stock market usually trades at an average of 15 times normalized earnings. That would mean an S&P 500 of around $1,000 and a Dow of $9,600. In other words, the market is already below fair value.
The problem is the stock market almost always goes below fair value after boom times. It already has, but could go lower still. Be prepared for how low it can go and don't sell at the bottom.
Like I said above, I'm finding the best values I've found in years. Great companies are selling at prices that are likely to generate very high returns over the long run. Even if things go significantly lower, this is an absolutely great time to invest!
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
A lot people are wondering how bad the stock market can get.
I don't know how low it will go, but I have a pretty good idea of how low it can go.
Before I outline my reasoning, let me forewarn you: the answer is ugly.
I'm not trying to predict what the market will do or when--no one really can. I'm just trying to prepare you for the worst case scenario just in case it happens.
You don't want to sell at the bottom. Nothing will hose up your long term goals as much as going to cash in hopes you can sell at the top and buy at the bottom. The odds are highly in favor of you doing just the opposite--most people do. Knowing how bad things can get may help you avoid selling at the bottom, and that's what I'm trying to do in this blog.
The reality is I've never been as bullish as I am now. I'm projecting the highest returns going forward I've seen in 13 years! I'm terribly excited about the returns I believe I'll get over the next 5 years. But, and there's always a but, the stock market could go a lot lower before it goes back up again.
How low? History indicates the market can get as low as 7 times normalized earnings. I've talked about normalized earnings in the past, but let me explain it again briefly.
The stock market's per share earnings have grown quite steadily at around 6% a year over the last 50+ years. In boom times earnings are above this trend, and in bust times earnings are below. But, over time, the earnings always return to trend.
Such earnings are like true north to a navigator. They point the way in all circumstances and provide a ready reference for where you are and where you're going.
That's why I use normalized earnings--it's a steady guide. In boom times, the stock market sells at over 20 times earnings. In bust times, it tends to go down below 10 times earnings. In the worst times, it gets down to around 7 times normalized earnings.
What would 7 times normalized earnings mean for the S&P 500? Normalized earnings in the next year for the S&P 500 will be around $67 a share. 7 times that gives you a value of $469 for the S&P 500, roughly 52% below today's closing price of around $970 on the S&P 500. That would correlate to a Dow Jones Industrial Average of $4,500.
I'm not saying we'll get that low. In fact, I consider that quite unlikely. I'm not saying I want to see it go that low--I'd feel terrible if it did. But, I am saying be prepared for it to go that low just in case it does.
Benjamin Graham, the father of value investing, once said you shouldn't invest in the stock market unless you're ready to see your investment cut in half and double in value. I agree with that sentiment. Be prepared for the worst, hope for the best.
On a brighter note, the stock market usually trades at an average of 15 times normalized earnings. That would mean an S&P 500 of around $1,000 and a Dow of $9,600. In other words, the market is already below fair value.
The problem is the stock market almost always goes below fair value after boom times. It already has, but could go lower still. Be prepared for how low it can go and don't sell at the bottom.
Like I said above, I'm finding the best values I've found in years. Great companies are selling at prices that are likely to generate very high returns over the long run. Even if things go significantly lower, this is an absolutely great time to invest!
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, October 24, 2008
Hanging in there is tough, no doubt about it
October has been a brutal month.
I saw this crisis coming years ago, and my returns have benefited from that foresight, but this hasn't kept me from feeling the pain.
I was feeling pretty good about myself at the end of September. Having beat the market by more 8% over the last two years and by more than 4% over the last three years (annualized, after fees), I was feeling pretty cocky.
But, that was before October. In October, my returns have paralleled the market's path down. I haven't enjoyed the ride, even if I started from a higher place.
This has been particularly frustrating because I've invested in some of the strongest companies around. You'd think the strongest businesses would be untouched, or much less touched, by recent turmoil.
That hasn't been the case. When people are under a lot of pain, they do crazy things, like selling great companies at huge discounts to underlying value. Many of those investors were probably buying on margin. Some were hedge funds that were forced to sell long positions and cover short sales after the SEC banned shorting certain companies.
What's been happening is the usual capitulation you tend to see when markets are bottoming. People are under so much pain that they're selling everything, regardless of the price they're getting.
This isn't fun for a value investor like me because I hate to see my clients' money or my own money decline in value. I work hard to be sheltered by the storm, even though I know some markets are so brutal that everything goes down.
What's a person to do? I'm on a buying spree.
I'm taking the opportunity to sell strong performers and buy poorly performing great companies. I'm finding some absolutely astounding bargains and, most likely, boosting future returns. And, although it's no fun to see the market and portfolios go down dramatically, I'm having a lot of fun putting things in place to benefit when the market does recover.
When will the market recover? No one knows. The market could go down by another 33% to hit historical lows reached in the past, or it could rally by 67% (a 40% decline requires a 67% increase to get back to break even) as it's also done in the past.
You don't need to be a fortune teller or have a crystal ball to make money from here, you just need the gut wrenching fortitude to buy great companies at great prices--now. As long as you believe our economy won't permanently collapse, this is a great time to invest.
Although it's no fun to live through, I'm quite confident that buying at times like this make for very high long term returns in the future.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
October has been a brutal month.
I saw this crisis coming years ago, and my returns have benefited from that foresight, but this hasn't kept me from feeling the pain.
I was feeling pretty good about myself at the end of September. Having beat the market by more 8% over the last two years and by more than 4% over the last three years (annualized, after fees), I was feeling pretty cocky.
But, that was before October. In October, my returns have paralleled the market's path down. I haven't enjoyed the ride, even if I started from a higher place.
This has been particularly frustrating because I've invested in some of the strongest companies around. You'd think the strongest businesses would be untouched, or much less touched, by recent turmoil.
That hasn't been the case. When people are under a lot of pain, they do crazy things, like selling great companies at huge discounts to underlying value. Many of those investors were probably buying on margin. Some were hedge funds that were forced to sell long positions and cover short sales after the SEC banned shorting certain companies.
What's been happening is the usual capitulation you tend to see when markets are bottoming. People are under so much pain that they're selling everything, regardless of the price they're getting.
This isn't fun for a value investor like me because I hate to see my clients' money or my own money decline in value. I work hard to be sheltered by the storm, even though I know some markets are so brutal that everything goes down.
What's a person to do? I'm on a buying spree.
I'm taking the opportunity to sell strong performers and buy poorly performing great companies. I'm finding some absolutely astounding bargains and, most likely, boosting future returns. And, although it's no fun to see the market and portfolios go down dramatically, I'm having a lot of fun putting things in place to benefit when the market does recover.
When will the market recover? No one knows. The market could go down by another 33% to hit historical lows reached in the past, or it could rally by 67% (a 40% decline requires a 67% increase to get back to break even) as it's also done in the past.
You don't need to be a fortune teller or have a crystal ball to make money from here, you just need the gut wrenching fortitude to buy great companies at great prices--now. As long as you believe our economy won't permanently collapse, this is a great time to invest.
Although it's no fun to live through, I'm quite confident that buying at times like this make for very high long term returns in the future.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, October 17, 2008
Warren Buffett is buying American stocks
I'm not the only one feeling more bullish lately--so is Warren Buffett (yeh, I'm flattering myself).
Warren Buffett is the richest man in the world and probably the best investor alive today. To top it off, he seems like a grounded, happy guy. He still lives in the house he bought in his 30's, still drives himself around town, and has good relationships with his kids. Pretty amazing for a multi-billionaire.
Buffett wrote a letter to the editor of the New York Times that was published today titled "Buy American. I Am." You can access it here to read the whole thing.
Buffett's basic argument is that because the financial world is a mess, this is a historic time to buy American stocks.
He cautions that unemployment will rise, business activity will slow and headlines will be scary. Despite these issues, he's buying stocks in his personal account (not just for Berkshire Hathaway, the holding company he runs). Up until recently, his personal money was all is U.S. government bonds. But soon, he will be 100% invested in U.S. equities.
As Buffett has said many times before, "Be fearful when others are greedy, and be greedy when others are fearful." In other words, buy when everyone is scared and sell when everyone is euphoric. This is very difficult to do, but it is also very profitable.
He cautions against investing in highly leveraged companies and businesses with weak competitive advantages. He also cautions that he can't predict short term movements in the stock market. Let me let you in on a secret--no one can!!! It may keep going down over the next year or two, but in 5 years, it's the best place to invest (especially at today's low prices).
Buffett is seldom if ever outright bullish. But, when he says, "What is likely...is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up," I stand up and listen. What he's saying is you can't wait until things look good to invest, because by then you'll have missed significant gains. I've rarely, if ever, heard Buffett say something so bullish. The last time he seemed to be this optimistic was 1982, and that was an outstanding time to invest.
He goes on to give examples of why waiting doesn't work. During the Great Depression, the stock market bottomed in the summer of 1932, long before the economic picture improved. During World War II, the market bottomed in the spring of 1942, long before it was clear the Allies would defeat Axis powers. In the early 1980's, when inflation was double-digit and the economy was in a deep, double-dip recession, the time to buy was in 1982, long before the economy's recovery was clear in 1983 and 1984.
The lesson from a guy who has generated 20%+ returns for over 50 years is: you buy when everyone is pessimistic, and that time is NOW!
He warns that buying stocks only when you feel comfortable leads to poor results, so does selling because you feel scared.
He also warns against sitting in cash. Holding cash now feels comfortable, but it's an unwise investment decision. Cash doesn't pay much of a return, especially now, and it will depreciate in value. As he warns, government policies directed at alleviating the current crisis will probably prove inflationary and make cash an even worse investment.
He believes that "[e]quities will almost certainly outperform cash over the next decade, probably by a substantial degree." You should invest for where things are going, not for where they are today.
At a time when people are looking for something to hang their hopes on, Warren Buffett is a voice of clarity in the maelstrom. I'm listening, and so should you.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
I'm not the only one feeling more bullish lately--so is Warren Buffett (yeh, I'm flattering myself).
Warren Buffett is the richest man in the world and probably the best investor alive today. To top it off, he seems like a grounded, happy guy. He still lives in the house he bought in his 30's, still drives himself around town, and has good relationships with his kids. Pretty amazing for a multi-billionaire.
Buffett wrote a letter to the editor of the New York Times that was published today titled "Buy American. I Am." You can access it here to read the whole thing.
Buffett's basic argument is that because the financial world is a mess, this is a historic time to buy American stocks.
He cautions that unemployment will rise, business activity will slow and headlines will be scary. Despite these issues, he's buying stocks in his personal account (not just for Berkshire Hathaway, the holding company he runs). Up until recently, his personal money was all is U.S. government bonds. But soon, he will be 100% invested in U.S. equities.
As Buffett has said many times before, "Be fearful when others are greedy, and be greedy when others are fearful." In other words, buy when everyone is scared and sell when everyone is euphoric. This is very difficult to do, but it is also very profitable.
He cautions against investing in highly leveraged companies and businesses with weak competitive advantages. He also cautions that he can't predict short term movements in the stock market. Let me let you in on a secret--no one can!!! It may keep going down over the next year or two, but in 5 years, it's the best place to invest (especially at today's low prices).
Buffett is seldom if ever outright bullish. But, when he says, "What is likely...is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up," I stand up and listen. What he's saying is you can't wait until things look good to invest, because by then you'll have missed significant gains. I've rarely, if ever, heard Buffett say something so bullish. The last time he seemed to be this optimistic was 1982, and that was an outstanding time to invest.
He goes on to give examples of why waiting doesn't work. During the Great Depression, the stock market bottomed in the summer of 1932, long before the economic picture improved. During World War II, the market bottomed in the spring of 1942, long before it was clear the Allies would defeat Axis powers. In the early 1980's, when inflation was double-digit and the economy was in a deep, double-dip recession, the time to buy was in 1982, long before the economy's recovery was clear in 1983 and 1984.
The lesson from a guy who has generated 20%+ returns for over 50 years is: you buy when everyone is pessimistic, and that time is NOW!
He warns that buying stocks only when you feel comfortable leads to poor results, so does selling because you feel scared.
He also warns against sitting in cash. Holding cash now feels comfortable, but it's an unwise investment decision. Cash doesn't pay much of a return, especially now, and it will depreciate in value. As he warns, government policies directed at alleviating the current crisis will probably prove inflationary and make cash an even worse investment.
He believes that "[e]quities will almost certainly outperform cash over the next decade, probably by a substantial degree." You should invest for where things are going, not for where they are today.
At a time when people are looking for something to hang their hopes on, Warren Buffett is a voice of clarity in the maelstrom. I'm listening, and so should you.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
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