How to Really Ruin Your Financial Life and Portfolio Page 3
But, une fois de plus, the kids who like to make you cry out by the monkey bars would tell you that your returns were merely average.
The horrible truth is that these bad boys have some truth on their side. Yes, the returns from indexes will be excellent compared with the returns of the average investor. But you will not get the returns that (used to) make a Warren Buffett or a Seth Klarman, genius manager of the hedge fund called Baupost Group. You will get good enough returns to satisfy a normal human being, but that just brings us back to the basic issue:
You are not a normal, average Jane or Joe and you do not want average returns. In your heart, as you very well know, you are legions ahead of those average investors, and even legions ahead of the indexes. You are a superior man or woman, and you must have deeply superior results. You do not want stocks that do well. You want the next super-stock, the next Microsoft, the next Google, the next Facebook. You want the stocks that will go up 10,000 times in value and make you the owner of an estate in Bel Air with showgirls on your arm and doormen bowing and scraping as you walk into the lobby of every fine hotel in the world.
That means you have to go past the indexes—way, way past them. You have to roll your sleeves up and do the basic research, the in-depth analysis, the burning of the midnight oil that will get you to the Gates of Eden.
Now, some of those same spoilsports who told you that your results with indexes were merely average will tell you that there are already tens of thousands of young brilliant minds working with every tool in the book to find these great companies. (A mind is a terrible thing to waste.) And with all of the tools and devices on this earth, they rarely if ever beat the markets by picking individual stocks.
These same mean-spirited creeps will tell you that those people (or ones like them) brought us the catastrophic Internet crash of 2000–2001 and the financial wipeout of 2008–2009. The masters of Wall Street turn out to be outgunned by reality decade after decade. (What is an index-fund investor? A stock picker mugged by reality.)
By the way, some might say that those same types of geniuses work for the big mutual funds and bank trust departments, and whose results do not even come close to the results of the indexes. Those same people write the advice-to-the-investment-lorn columns and pick stocks on TV shows that rarely do well over long periods. (How do you know when to sell? When they say to buy.) Those meanies will tell you that, really, there are hardly any ways to beat the market. (These are the nice meanies, not the evil meanies who urged you to get way-above-average returns.)
DON’T LISTEN TO THEM! YOU CAN PICK STOCKS AND BEAT THE MARKET!!!
You don’t need libraries and mainframes. All you need is love of yourself, the trust you have in your own fingertips running down the lists of stocks online, and a feeling that tells you when to buy and when to sell.
It’s that feeling, not intellectual rigor, not experience—just that feeling—that will take you to the next Facebook, the next Berkshire Hathaway, the next Microsoft. You can pick stocks.
Chapter 4
Assume That Recent Trends Will Continue Indefinitely
Are Internet stocks hot, or were they in 1999? That’s great. If they are hot, they’ll stay hot. Ooops. They didn’t? Well, they’ll come back. You say most are in the afterlife? Well, that’s an exception. Usually stocks that are hot stay hot.
Are social media stocks hot as I am writing this? They will stay hot. Yes, you can take it to the bank. Buy as much social media as you can and you will never regret it. There is Newton’s first law of motion that says that a body in motion tends to stay in motion. Translated to stocks, that means a sector that’s hot will stay hot.
Now, to be sure, there are laws of thermodynamics stating categorically that when an object deviates from the mean temperature in the nearby environment, it will tend to revert to that mean temperature. That is, even hot items will cool down to the general level in the neighborhood.
But that law does not apply to investing. Instead, you want to keep piling into stocks and funds that are hot. They will stay hot. Our friend, Professor Dichev, and many others in his field, have clearly demonstrated with facts and history that when a stock or a sector, or the market generally, is hot (Dichev is more about the market generally), it will cool down. Sometimes it will downright freeze.
So, when money flows into stocks are the largest, and when the market capitalization of stocks generally has risen to abnormal levels—that’s when it will soon come down. The prime example might be the Nifty Fifty of the 1960s. These were superhot stocks like Xerox, Kodak, and Litton that just could do no wrong—they were the wave of the future and you could never lose if you were invested in them. They then turned down and have stayed down for a long time. Too bad for Xerox. They invented Windows but saw little commercial application for it so they gave it away, basically, to a fellow named Gates (and no one’s ever heard of him again!). Too bad for Kodak, who did not see digital cameras coming and also did not see Fuji coming. IBM has done well, but the others have been a mixed bag.
Too bad for the Nifty Fifty companies: Most of them learned the hard way about “reversion to the mean.” Oh, didn’t they tell you about the term “reversion to the mean” back in finance classes, or maybe in statistics? It is the simple rule that if a stock or anything else in the world of randomness—and stocks do live in that world—deviates far from the average (i.e., the mean), it will eventually return to the mean, as the mean is calculated over long periods.
But that does not apply to you. You live in your own special universe. The normal laws of financial entropy (or anything else random and normal) do not apply to you. So, go ahead anyway, and bet the farm on the stocks that are hot right now. You will never be disappointed.
That goes for the stock market as a whole. If it’s hot, thanks to the innovations of exchange-traded funds (ETFs) and index funds, you can just buy the whole market. That’s what the nerdy kids are doing right now anyway. As I already told you, that’s a silly way to go when a genius like you can pick stocks that will outperform the market. But if you persist in buying indexes, just know that the best time to buy them is when the whole market is sizzling. If it is hot today, it will stay hot.
To be sure, two astonishing geniuses named John Bogle and Warren Buffett, and also Phil DeMuth, another astounding genius, and even pitiful old Ben Stein, have pointed out that when stocks rise a lot, usually it’s somewhat because of rising earnings—which is a great thing—and somewhat because Mr. Market is applying a higher valuation to those earnings.
That is, stocks trade as a multiple of their earnings. It’s nice when earnings rise, but when the world at large has determined that good times are here for good, and raises the multiple it applies to earnings—that’s when things get really great and jiggy. For example, if grouchy old fools think that there should be some caution applied to stocks or maybe to the whole economy, they will say that a stock is worth, say, eight times earnings. That was the way it was long ago in the bad old days of inflation in the 1970s and early 1980s. After all, cranky people argued, if you can get 10 percent on a safe Treasury bond—that was in the days long, long ago when Treasury bonds were considered a safe asset—why should you pay more than eight times earnings for a stock that has uncertainty in it? The stock will be yielding 12.5 percent and the bond will be yielding 10 percent. That seemed about right to those old fuddy duddies. But when “morning came to America” in the Reagan, Bush, and Clinton years, horizons were unlimited. No inflation. Rising earnings. Why shouldn’t stocks sell for 30 times earnings? After all, their earnings will soon rise to the point where the stock you bought when it was earnings 3.3 percent will be earning 10 percent. Why not put that in the price right away? Why not hold a stampede to buy? That’s when the world suddenly decides that the market is not worth 1,000 on the Dow. Now, it’s worth 6,000!
That’s when they are using champagne to wash their Bentleys on Wall Street. That’s when money is bubbling forth under every sidewalk in Manhattan and Greenwich.
You can be sure that when those days come, they will last. They always do. So, to make sure you fully understand, buy in when things are hot, and keep on buying, buying, buying. They won’t go down.
Chapter 5
Pour Continuer . . . Sell When Things Look Bleak . . . and Stay the Heck Out of the Market
That’s right. Just as it was vital to buy when things were hot, it’s just as vital to sell when they are cool. If stocks take a really big dive, then it’s time to sell them, and fast. There is no bottom, really, except for zero, and you sure don’t want to be there when the stock market hits zero.
Plus, your friends who say they have already sold will be telling you to sell, and you want to take their fine advice. It’s interesting, by the way, that as I navigate through my older years, I can recall with such vividness the friends who comforted me when I was in distress about the stock market by telling me they had sold at the peak. These are good friends indeed, and you can be sure they wish you well. My old Mom used to tell me that her friends would always tell her when they had sold at exactly the right moment but never when they didn’t sell at the right moment. And they would discuss the stocks that went right but never the stocks that went wrong. She must have been right. Obviously, not everyone makes all of the right moves in stocks or everyone would be a billionaire and no one would ever lose money. We know that neither of those scenarios is true.
But to get to the main point, it is crucial to realize that when things are looking bad financially and economically and perhaps even politically, there simply is no limit except annihilation to what can happen to your stocks.
Think of Custer at The Little Big Horn. His unit was annihilated by the marauding Native Americans in about a half hour. Can you be sure the
same won’t happen to you? No, you cannot.
That means it’s time to sell when things are looking bleak.
My dear pal Phil DeMuth and I have written a book you can still get called Yes, You Can Time the Market. It documents that ordinary investors panic and sell at exactly the wrong time. They suffer from what social scientists call the recency bias. They firmly believe that whatever trend has happened recently will keep on happening. This is the same bias that makes investors buy when the market is rising to what later turns out to be unsustainable levels.
Phil and I documented—as others have as well—that when the market is low in terms of the ratio of price to earnings, when it is low compared with its price history over the past decades, that is when it’s generally time to buy, not to sell.
But (and we will get to more on this later), this time it’s different. This time, there really and truly is no bottom at all. In fact, this time you might well find that for the first time in history—and even though it’s arithmetically not possible—stocks fall to a negative level. That’s right. You might well find that you owe money on your portfolio.
So, get out when things are bleak and get out fast. Hoard your cash. You will well know when it’s time to get back in. (More about that to come as well.)
When you get out, stay out until you get that certain mysterious golden feeling. You may have heard that if you are out of the market when certain big things happen—like when the market stages a huge turnaround day after day as it did in early March of 2009, you will miss a great chunk of the gains for the whole decade.
You may have heard that there will be a few incredible days when the market is up 3 or 4 percent or even more, and if you miss one of those days, you miss out on an immense share of the market’s total gains for your lifetime. You may have heard that the market’s total gains over many decades are far from evenly distributed but instead are concentrated on a few explosive days.
But don’t worry about that. When you are completely out of the market and one of those spectacular days comes along, or rather is about to come along, you will know it by an itching in your fingertips. You’ll know when your love comes along, as the old song goes. You will know, and the day before you will buy in at just the right moment to “catch a wave” and be sitting on top of the world.
In fact, that Beach Boys’ song captures exactly when it’s going to happen to you in your whole life of investing if you just follow the rules in this tome: The world of investing is ruled by certain waves, and if you just trust in yourself, if you really believe in yourself, you can and will do it so you wind up pretty damned rich pretty quick.
So, again, when the market is going down, get out and stay out until the exact moment comes to get right back in. And you’ll know it the night before. Or two nights before. Why? Because you are you!
Chapter 6
Know in Your Heart That This Time It’s Different . . . and Act on It
Several years ago, I was regularly on a Fox News panel with one of the most successful investor/speculators of all time, a true genius named Jim Rogers. Jim and I were debating about some facet of the stock market and I said something I do not entirely recall. It was roughly about how even though the Fed was printing so much money, this time it would not create inflation, even though it generally does.
Jim called me on it immediately.
“There you go,” he said. “You’ve just said the most dangerous words in the investors’ dictionary: ‘It’s different this time.’”
Jim is a billionaire many times over, I am sure, and he learned his trade at the school of the redoubtable investor George Soros. Messrs. Soros and Rogers have learned that there are certain recurring themes in investing, and that once you deviate too far from these norms, you are going to get in real trouble. George Soros reportedly made a billion dollars personally, back when that was a lot of money, by selling short the British pound. When the pound was in fact allowed to float radically downward, he reaped the rewards, and he’s now free to be a patron to the political causes he endorses. Jim’s picks in commodities have proved to be startlingly on target, as he relentlessly applies common sense and arithmetic when the rest of us apply hope and fear.
His point on that panel was brilliant. If you believe that “this time it’s different,” that this time stocks can sell at 40 times earnings and stay there, if you believe that social media companies with no earnings to speak of are worth as much as GE, if you believe that the federal government can endlessly go deeper into hock without someday having a rude awakening—you are going to be stunned and beaten up badly. That was his point about the average Joe or Jane.
When pundits and experts say it’s going to be different this time, that there is a “new paradigm” or something like that—look out below. Again, that’s for the average Joe or Janette.
That is what Jim or any other seasoned, successful speculator would say to most investors. But don’t worry about that: because for you, and only for you, this time it really will be different.
You can forget all historical precedent and just go right on with making money and believing there is a new paradigm. Just for example, this time, the value of your portfolio will NOT depend on the earnings of the companies in it. This time, it is possible—nay, likely—that even if earnings are zero or negative right now, future earnings will increase so fast that any historical metric of the price/earnings ratio will be meaningless and only the new paradigm will make sense.
This time, trees really do grow to the sky. The old verities of investing are, well, OLD. The way you make money is with something NEW. And those are the ideas that earnings don’t matter, only growth matters, and that securities are not about generating money but about rising in price based on wild public love of the security.
This brings to mind a painful memory. Back at the end of 1999, as the Internet bubble was frothing madly, and my “old economy” stocks like oil and banks were languishing, I examined the charts for those two kinds of companies. Sure enough, the ones I owned had generated real earnings, sometimes superb earnings. Their prices were pitifully low.
The “new economy” stocks that were soaring off to the moon had no earnings at all, and often had enormous losses.
I thought to myself, “Well, Benjy, what is a security? Isn’t it a share in ownership of an entity that generates income (and eventually dividends) for its owners? Doesn’t it have to be that?
“Or is it perhaps something else entirely? Perhaps a stock/security is more like a lottery ticket, a wager that the company in which you are buying an ownership stake will someday become the biggest company in the world.” That certainly seemed to be the way the market was behaving. That was what the market was telling us.
The shameful part of this memory is that I did not just say to myself, “Why you poor idiotic fool. Of course a security is ownership in something that generates earnings for you. Otherwise it has zero meaning and is not a security but a lottery ticket.” Instead, I took some of my life savings and bought some Internet stocks and indexes of Internet stocks.
For several months, the results were staggeringly good. I would sometimes look at the stock prices at the end of the day and actually laugh out loud with glee.
Obviously, that came to a crashing end when the Bubble burst and the stocks I owned that had been trading above 100 times earnings—sometimes priced at over 100 with zero earnings—were suddenly worth at most a few cents. I had asked the right question: Can it possibly be different this time? Can a whole new definition of stocks be the correct definition? But I had given myself the wrong answer. Luckily for me, enough of me was still sane so that I had only taken a small amount out of the sane money world and put it in the insane money world. Still, it hurt like the dickens when it all came crashing down. I had believed that it would be different that time. That was a belief that cost me.