Sunday, August 23, 2009


As some of you already know, I count the race track as one of the two leading educational institutions in my life. (The United States Marine Corps is the other.) The essence of successful handicapping at the track rests primarily on integrating two important variables. The first is the selective past performance of races, parts of races, and workouts under similar track conditions for each horse in a race. For younger colts and fillies, breeding plays a role in the absence of sufficient race history. The second statistical measure to be integrated is the odds that are currently being quoted or calculated for Win (first), Place (second), and Show (third). These are compared with the handicapper’s own belief as to what the proper odds should be. This way of thinking and intense studying essentially looks for a return to some past result which we consider to be normal. One could say this approach is an exercise in selective extrapolation. I would suggest that this gambling. Gambling that some part of the past will repeat itself.

Examine most of the “sage” comments on today’s economy and markets. (Very little of what I read these days looks forward to a distant time horizon.) The focus is a return to normal or the "new normal." The essential belief is the past foretells the future. A security may be “cheap” because its valuation is below some other point in its history.

The size of the recent declines and the destruction of numerous market mechanisms are perhaps similar to the period in American history between the 1920s up through WW II. In my opinion, we have closed an era of excessive demand without the ability to pay for it.

There is a difference between gambling and speculating. Gambling, as I indicated, is essentially reworking the past to find a difference between the current compared with a selected past. Speculation is looking forward and trying to predict the future.

I recently visited Sacramento’s “Old Town” with my youngest grandsons and their parents. My son pointed to the highest structure, a platform over a merchant’s store, and commented that it was a good example of successful speculation. From his high perch, this enterprising merchant was the first to see the oncoming arrival of a ship coming up the river. My son guessed that the vessel carried merchandise for the town, probably items in short supply. Upon the ship’s arrival, the prices for these items would drop. With this sole knowledge, the merchant could immediately lower the prices of his current merchandise, saving his business from the significantly lower price realizations expected to occur as a result of the ship’s deliveries.

Curiously, I did not see similar viewing platforms in the town. Thus, I concluded the speculation worked more than once. This merchant was following the literal definition of the word’s Latin roots: to look ahead.

While speculating is much more difficult than gambling on various elements of history to repeat itself, the returns on successful speculating are likely to be much greater.

Successful speculation can be a result of the following elements:

  • Changes in demographics in any large consumer market.

  • Major discoveries in the fields of energy or curative medicine.

  • Significant productivity advances in the production, delivery and consumption of goods and services.

  • Technological break-throughs.

  • More effective advertising through old and new media.

Many of these searches/speculations are being carried out by large companies who will benefit from being early. However, the big winners are likely to be smaller, or mid-sized companies.

Unfortunately, I am not seeing portfolios being built on these types of speculations. As analysts, perhaps we need to be spending more time with directors of research, marketing planning staff, and purchasing agents rather than just the financial and investor relations people. In many ways, this was how I used to follow companies. The rewards to investing in these speculations are greater than investing in the general economy.

If any of you see a future trend that is radically different from those of the past, please share them with me. I always appreciate sound examples of fresh thinking for the investment accounts for which I am responsible.

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