contrarian investing

Memento Mori

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In ancient Rome, it was customary for the city to throw lavish triumphal parades in honor of victorious generals. The whole city would turn out to celebrate those who had brought glory to Rome. For a successful general, it was an intoxicating reward.

Lest their generals become too intoxicated with success, however, the Romans would assign a servant with a unique task. Their job was to follow the triumphant general throughout the festivities and periodically whisper in their ear memento mori: “Remember, you are mortal.”

It is humbling advice, and one that we would do well to remember. The markets have had several great quarters lately, leading to the Dow average topping the dizzying benchmark of 20,000 points for the first time last week. We have no way of knowing how high it may get in this rally or the next, either.

We do know one thing, however: no rally lasts forever. No matter how high the market soars, it can always drop back down. We don’t know when, and we don’t know how much, but someday that day will come. There is always a recession in our future.

Our goal is to try to minimize the damage by avoiding stampedes when we see them. When investor sentiment gets overly exuberant, when we start hearing people say “You can’t lose money in the stock market”, this is when we must pay heed: “Remember, market rallies are mortal.” We are confident that in the long run the markets may bounce back from future downturns as they have always done before and we can potentially be better off afterwards—but the recovery will undoubtedly be slower and more painful if we fall into the trap of thinking that our portfolios are invincible just because they’re doing well now.

We’re thrilled with our performance over the past year and excited about the continued evolution of our portfolio strategies. At the same time, we know that nothing lasts forever. At some point in the future, we will have to reckon with another downturn. It might be in a year, or it might be in five years. Either way we must keep this inevitable fact in mind if we hope to try to mitigate the damage. If this weighs on your plans and planning, give us a call or email us to discuss your situation.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries and widely held by individuals and institutional investors.

Stealthy is the Bull

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The broad stock market indicators like the Dow Jones Average and the S&P 500 Stock Index reached a low point in March 2009, near the end of the financial crisis. Looking back a year or four years or seven years later, hindsight showed that the crisis was potentially a great buying opportunity.

Many investors missed out on the multi-year rise, however. (Or should they be called former investors?) In real time, nobody ever knows what will happen next, particularly in the short term. And rising markets, or ‘bull markets’ as they are known, seem to have many disguises.

After a rebound begins from a long decline, inevitably some pundits label the rise with an overly colorful phrase, “dead cat bounce.” The implication is that, while there might be a bounce, it certainly won’t go very high or last very long—the market is going nowhere.

Next comes the idea that if buying has produced a slight turnaround, it is just “short-covering.” This means that speculators who profited from the drop are now booking their profits, reversing their positions. Supposedly, there are no ‘real’ buyers.

When the market persists in the upward trend, the next excuse might be that “the market got oversold.” Therefore a temporary bounce is to be expected, before the market slumps again.

Then when the next slump fails to show, pessimists start saying things like, “We can’t know we are in a new uptrend unless the market reaches new all-time highs.” Or “It has gone up too far, too fast.”

When you take a step back and look at the big picture, those poor pessimists never could get back into the stock market. They had one rationale after another to doubt the recovery; meanwhile the market went up and up.

Do not worry about the bears, however: they have a new story. “The market is too expensive.”

Fortunately, we don’t buy the whole market anyway—we seek the bargains. You can read about our current strategies in this article. If you would like to talk about your portfolio or situation, please write or call.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries and widely held by individuals and institutional investors.

The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

Investing involves risk including loss of principal. No strategy assures success or protects against loss.

Annual Market Forecast

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It is that time of year. Prognosticators and pundits issue their forecasts for the year ahead. Wouldn’t it be nice to know what the future holds! Some forecasts are hedged, and don’t really say much. Our prediction is quite specific.

Many of those who have visited our offices know that we actually do have a crystal ball. It forecasts the direction of the stock market for the coming year. It does not say how far the market will go, but it always predicts the direction.

If you knew which way the stock market was going to go, could you make money investing?

Here’s the catch: our crystal ball has only been 76% accurate. So perhaps the question should be, if you knew which way the stock market was going to go 76% of the time, could you make money investing?

Without further ado, here is what my crystal ball says about the direction of the stock market for the year beginning January 1: it will go up.

Long-time observers will not be surprised. The crystal ball always says the market is going up. It has never predicted a down year. And checking back over the past hundred years, according to Standard & Poor’s, it has been right 76% of the time.

We don’t know how well its track record will hold up, but we believe this presents a favorable backdrop to buy bargains, avoid stampedes in the markets, and seek to own the orchard for the fruit crop. In other words, to keep on keeping on, following our plans and strategies.

It is tempting to include a discussion of the economy, the strengths we perceive, and the faint possibility of recession. We’ll leave that to people with more time on their hands. If your plans or planning will be evolving in the new year and require our attention, please call.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Investing involves risk including loss of principal. No strategy assures success or protects against loss.

The Longest Journey, Part Two

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W is the person we know who made the longest journey to become an effective investor. Before, he chased performance, jumped on popular investments, and focused only on the short-term action of his holdings.

In Part One we profiled how he managed to learn the correct lesson from the Tech Wreck in the year 2000. W learned that popular but over-priced assets are dangerous. Others learned the wrong lesson, “stocks are dangerous.” Those who learned that lesson generally went on to buy over-priced real estate, or withdrew completely from investing.

W profited by owning equity investments in the recovery from the technology bubble, all the way up to the stock market peak in 2007.

Approaching his retirement years, the ensuing market value losses terrified him. He told us later he did not know how he was going to explain to his wife how he had ruined their financial situation.

Although he was tempted to sell out at low points several times during the financial crisis, three things helped him stay invested, but just barely:

  1. The realization that the damage was probably already done, and selling out would only lock in the losses from the peak.
  2. Our relentless reminders of how market cycles work, and the positive perspective that comes from taking the long view.
  3. The dawning realization that portfolio income is what would supplement his retirement—not the market value that appeared on his statements. “If the fruit crop is big enough, why would you have to worry about what the neighbor would pay you for the orchard?”

There is no polite way to say it. W was a difficult client in these years. We spent a lot of time talking him down from the ledge, so to speak. But it was worth it, for the kind of investor that W became.

When the recovery from the financial crisis arrived, W’s portfolio was in position to potentially rebound, and it did. Free from worry about short term action, he could stand to own bargains that might be volatile in the short run. It paid off.

W went through the valley of the shadow of death, and learned that fear was optional. More accurately, he learned that fear did not need to be acted upon. When he emerged on the far side of the valley with more wealth than ever before, his experience had inoculated him against worrying about short term fluctuations.

W had completed the second part of his journey. He had learned two crucial lessons. But he was not yet fully formed as an effective investor. One more lesson was needed. It came entirely from within himself, with no help from us. We’ll write about that in the next installment.

If you would like to talk about your journey or your situation, please call or write.

Part Three

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

This is a hypothetical situation based on real life examples. Names and circumstances have been changed. To determine which investments or strategies may be appropriate for you, consult your financial advisor prior to investing.

Investing involves risk including loss of principal.

The Biggest Stampede Ever?

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We think it every day. We’ve written it scores of times. We’ve said it thousands of times. We believe it is the most valuable principle we follow: “Avoid stampedes in the market.”

In our view of the world, a stampede has two criteria: large money flows in, and irrational pricing. For example, in the technology boom of the late 1990’s, very large money flows went into technology stocks. Some were new issues that had no business, no earnings, only a plan. Others were real businesses, but priced five or ten times what they would have been in more normal times.

(We usually speak of stampedes rather than bubbles, because ‘stampede’ connotes herd behavior that is an integral part of the process.)

The flight to safety, or money pouring into the supposed safety of fixed income investments, has reached historic levels. The large money flow satisfies one criteria of a stampede. What about the other one, irrational pricing?

The government of Italy recently issued fifty year bonds. A very few years ago, Italy could barely sell bonds due to the well-publicized economic problems of Europe and the systemic flaws of the Euro common currency. Italian bonds, of course, are denominated in euros. So investors in the bonds issued by a country thought to be going broke a few years ago, denominated in a troubled currency that was born only fourteen years ago, will not get their money back for fifty years.

In a sane world, what ridiculously high rate of interest would be required to persuade you to buy these bonds, if you could even be convinced at any price?

How about 2.85% per year? That is where the bonds were issued. It seems every bit as ridiculous as the most over-priced dot-bomb stock of the tech wreck. Both criteria of a stampede have been met, in spades.

We are working hard to understand the threats and opportunities presented by this stampede. We believe it is the key issue in the markets for the years ahead. If you are interested in how your situation might be affected, please write or call.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

International debt securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical and regulatory risk, and risk associated with varying settlement standards. These risks are often heightened for investments in emerging markets.

The Melting Pot Matures

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A few weeks ago the Nobel Prize Committee announced the latest round of Nobel laureates for 2016. Seven Americans were named to this high honor—and six of the seven were immigrants, born outside of this country.

Immigration is frequently a hot topic during an election year, this one perhaps more than most. On the one side, we are told that immigration is costing us jobs, lowering our wages, and causing more crime. On the other side we are given a moral argument, that we are a nation of immigrants who should welcome others into our melting-pot culture as we have welcomed those who came before.

We set aside the moral side of this debate; while we occasionally dip into moral philosophy, this blog concerns itself chiefly with practical matters of economics. And as a practical matter, there are very good reasons why we should appreciate the value that immigrants bring to our country, above and beyond whatever Nobel prizes they may win.

As a country we are facing a demographic crisis. Since the 1970s, we have been having noticeably fewer children per family than we did previously. As our generation reaches retirement age, record numbers of Americans are leaving the workforce. I still plan on working until I’m 92—but many of my contemporaries have other plans. As we leave, there are more openings left behind than we have children and grandchildren to fill.

This demographic wall creates a major drag on the economy: we want to grow our economy faster, but we simply don’t have enough workers to do it. For the past year we’ve seen the unemployment rate hovering at 5% and below. Even as the economy recovers and we start to add jobs, there’s going to be a very real question as to who will be filling them. The workers simply aren’t there. To some extent this is a regional issue—some of our employment woes could be fixed by having job-seekers move from economically depressed areas to thriving areas where jobs are being created too quickly to fill. But not everyone can uproot their lives for work, and where people cannot or will not relocate, the only alternative is to import workers from elsewhere.

Ours is not the only country facing this demographic crisis. We need only look at Japan, Europe, and other parts of the developed world to see what happens when an aging population is not replaced. Many first world countries have a lower birth rate and lower immigration rate—and, not coincidentally, lower GDP growth. We would do well to learn from their example what not to do.

This is not to say that we endorse open borders or encourage illegal immigration. We are a nation of law. We should have sensible laws that are enforced in a fair and even-handed manner. But to suggest that we should slam the door shut on immigrants is to ignore the economic reality we face. One of the best and surest ways to expand our economy is to add new people to it—and we will need to, if we wish to continue growing at a reasonable rate.

The opinions voiced in this material are for general information only.

Nattering Nabobs of Negativism

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Once upon a time in America, a sitting vice president was investigated for extortion, tax fraud, bribery and conspiracy. In a plea bargain deal, he pled no contest to a tax charge and resigned. Although historians judge Spiro Agnew as perhaps the worst vice president in history, he did bequeath us the memorable phrase in our headline.

We begin our essay this way for two reasons. First, although some believe the current times are the worst ever or the most this or the least that, there probably are no new things under the sun. Second, the pervasive rotten mood of the country has reached fairly extreme levels.

As contrarians, we believe the times of greatest danger in the markets are when optimism reigns and it seems like clear sailing ahead. Think 1999.

Conversely, the times of greatest opportunity are when the mood is in the toilet. There was a lot to be negative about in 1974, when Nixon resigned and the Arab Oil Embargo meant there was no gas at the gas station and inflation was heating up. And 1982, when mortgage interest rates hit 15% and businesses paid 20% interest and the economy slipped into a double-dip recession. And 1990, with war in the Mideast and falling house prices and the fallout from a huge financial crisis in the S&L’s…same thing. And 2002, when we were dealing with recession and the aftermath of 9/11 and terrorism.

Following each of those episodes, major gains ensued in the stock market. Why is this pertinent today?

Contrarians have to be delighted with the pervasive pessimism of the public. (Or the nattering nabobs of negativism, if you prefer.) LPL Research strategist Ryan Detrick has documented a variety of sentiment measures that have reached multi-year or multi-decade extremes. Gallup reports the most prolonged negative poll readings for the question of whether the country is on the right track or wrong track. You can learn in any barber shop or café that we are going to hell in a handbasket, just listen.

Warren Buffett stated our view more concisely when he wrote, “Be greedy when others are fearful.” If you would like to know more about how this relates to your situation, call or write.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

Human Nature Creates Investment Opportunity

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Economists like to believe that human beings act rationally. Those of us that know otherwise follow the theory of Behavioral Economics instead.

One of the key findings of Behavioral Economics is that the pain of a loss is twice as great as the pleasure of a corresponding gain. Rationally speaking, $5 is $5, whether it is gained or lost. But we still feel the sting of the loss as a bigger deal than the pleasure arising from the gain. This is human nature in its raw, untrained state.

Confounding this finding is an extremely pertinent point, one that is ignored by the academics and the finance types who trade off their work. They treat a temporary decline as a loss. There is no shortage of expensive products designed to pander to this tendency by selling the promise of stability at a premium.

In the real world, many successful investors treat a temporary decline as either an opportunity, or a matter of no long term consequence. For most of us it takes education and training to overcome our behavioral tendency to feel the pain of a loss over short-term volatility. We’re here to help you with that.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Things Warren Buffett Never Said

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Warren Buffett may be the most famous investor in the world. The annual meeting of his company is known as ‘Woodstock for Capitalists,’ and is attended by 40,000 people. Countless articles, essays, and books have been written (including by us) about the things he has said.

As far as we know, nobody has ever written anything about things Buffett NEVER said. But here are our top three things Buffett never said:

1. “The stock went down, so I sold it.” Buffett knows the market goes up and down. He studies companies, not stock ticker symbols. When the fundamentals are in place, he buys. Then he holds. Then he holds some more. If the price declines, he typically buys more. This is what ‘buy low, sell high’ is all about.

2. “I’m waiting to invest until we get more economic data to clear up the uncertainty.” In his seven decades of investing, Buffett has noticed that uncertainty is always with us. He reads and studies ceaselessly, and when he finds something to buy, he buys it. Frequently, this turns out to be when the price is depressed because of temporary factors. Others are paralyzed by uncertainty when Buffett is taking action.

3. “A lot depends on what the Federal Reserve does next month.” Buffett has run his company for more than five decades, while seven different people held the chairmanship of the Federal Reserve Board, through innumerable cycles of Federal Reserve tightening and loosening. He can tell you what he paid for his stake in Coca Cola and when it was purchased. He probably cannot say what the Federal Reserve did at the meeting before, or the meeting after, the transaction. Why? Because it doesn’t matter in the long run.

Warren Buffett does not wear a halo. He is a human being and that means he makes mistakes. But he has made more money investing than any other human being on the planet. We think it pays to listen to the things that he has said. But there may be even more value in understanding the things he never said.

If you would like to discuss these concepts or your specific circumstances at greater length, please write or call.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. Stock investing involves risk including loss of principal.

It’s a Market of Stocks, not a Stock Market

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In the financial press you hear a lot of talk about “the market”: the market is up, the market is down, the market is jittery, and so on. Sometimes they’ll cite a specific index, such as the Dow Jones Industrial Average or Standard & Poor’s 500, using them as shorthand for the stock market as a whole.

This is a generalization, of course. There is no single monolithic “stock market” that tracks the performance of all publicly traded companies. What happens with one company’s stock price may not be happening with others—even within the big indexes.

For example, the S&P 500 Index rose 19.81% in 1999: the peak of the dot-com bubble. According to Standard & Poor’s sector research, the tech sector of the S&P Index went up a whopping 98.27% that year while boring sectors like consumer staples and utilities actually went down. “The market” had a great year, but a tech-heavy portfolio fared much better than a portfolio invested in old economy stocks. The reverse was true the next year, when the tech bubble popped and S&P’s tech sector dropped over 40% while banks, utilities, and staples went shooting up.

We find S&P’s index to be a useful barometer for the stock market as a whole and are sometimes guilty of using it as a generalization for all stocks. But it’s important to remember that the index is still made up of individual stocks, each with their own story.

Sometimes when you average all of those stocks together some compelling stories can get lost in the mix. Some advisors recommend a broad-based index approach, hoping that overperforming stocks will balance out underperforming stocks. While there is a time and place for indexing, we would really just prefer to own the overperforming stocks and try to leave the others out of it. Obviously this is not really feasible—we cannot know in advance which stocks will do well. However, we believe we can try.

As contrarian investors, we are interested specifically in stocks that look like they have the potential to buck the trend of the market. When there’s a stampede, we prefer to be running the other way. So it’s little surprise that some of our favorite holdings may be up when the indexes are down (or, unfortunately, vice versa.)

At 228 Main, we often deal with generalizations about the market because of the broad scope of our writings. If you want to talk specifics, call or email us and we’ll see if we can help.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.