Introduction
Many years ago I heard an
unoriginal line in the elevator (lift for my British friends) coming down from
the New York Stock Exchange Luncheon Club. “Do you know how to make a small
fortune,” the old floor broker asked then
he quickly supplied the answer, “start with a large one.”
There are two important
axioms about a major stock (and bond) market decline.
1. Big
losses are only possible after big gains. This is not quite as earth-shattering
as Sir Isaac Newton’s discoveries. But the result to one’s portfolio is indeed
grave.
2. Historically
by far the biggest loss suffered by investors is not the decline from the peak
to the bottom. A much larger loss over time is sustained by the
disheartened investors who feel foolish or embarrassed
by the loss and withdraw from participating in future markets. One of the
reasons that those of us who entered the US market in the mid to late 1950s did
so well was that many of the more senior investors were concerned about
another Roosevelt 1937-38 type collapse and so were sellers and not buyers.
Part
1: The Market Can Go Higher
My last several posts
focused on some of the pre-conditions present in past peaks. I am not flashing
red lights for investors to come to a stop of what they are doing. I am
stressing that I perceive the need for additional caution. I fully recognize that the stock markets in many countries can get
further extended by those who are focusing on the upside by touting the
following points:
1. In
a chart supplied by Strategas Research Partners and T. Rowe Price*, after
57 months of expansion of the last 13 Bull Markets, the average gain was 165%
which compares with our present rise through mid November of 164%. Thus we are
on track in terms of up phases. There were four Bull Markets which showed
further up-side. In terms of greater S&P500 advances the 1990-2000,
1932-37, 1949-56 and the 1982-87 Bull Markets performed greater than we have achieved in
this phase. The first two on the list had gains of about twice to three times
what we have gained so far. So there is potential for more upside. Morgan
Stanley* is leading the cheering section with a published view that
we will see 2014 on the S&P 500 in the year of same number.
2. The
financial conditions in Europe are not only not getting worse, but Moody’s* is
selectively raising up various lowly-rated sovereign debt ratings. (In the end,
if he could have held on, Jon Corzine would have made money on MF Global’s leveraged
bet on the euro.)
3. Surprising
to some, the US domestic economy is showing a pickup in growth. One might
wonder whether what we need are more bouts of government shutdowns to help
productivity?
4. There
appears to be some chance that we won’t see another US government furlough
program as some members of Congress are putting together a budget that takes us
through next year’s elections.
Part
2: Deep Structural Problems Are Not Being Addressed
All is not well or
improving in our world with some very serious structural problems not being
part of current proposals.
1. We
live in a paradoxical world where there is substantial unemployment and
under-employment at the very same time that businesses cannot find qualified
applicants to fill job openings. The missing elements for the employers are not
just a mismatch of training skills. In talking with employers what are
missing are basic academic skills, work and discipline attributes as well as
work-oriented integrity. Even with an expanding economy many may not find work.
In effect we have structural unemployment.
2. Around
the world the size of individuals’ retirement capital is significantly
insufficient. To the extent that this lack of retirement funding is going to be
addressed by individuals, the only place that they can get the money is by
spending less and saving more which will hurt our consumption models.
3. As
a nation there is every chance that, in aggregate, US health care costs will go
up beyond various budget assumptions. The strong odds are that society
will pay more with less-strong odds that the quality and efficacy of health
will improve to the same degree as costs will rise.
Part
3: The Trap is Being Set
There is nothing that I
have laid out in this post that is startling new. Most investors will focus on
Part 1, the upside. With the rising momentum people will not be overly
concerned about Part 2, the problems not being addressed. This behavior is
similar to the aforementioned Sir Isaac Newton who bought and then sold out of
the parabolic rise in the South Sea Bubble caper only to be sucked back into
re-purchasing out of envy and then again lost all that he had committed in the
subsequent collapse. He fulfilled the same role that my professor friends at
Caltech have demonstrated in the study of the brain which focuses on past
successes or pleasures. As a junior securities analysts we quickly learned of
the power of the greater fool theory. For a long time fools have more buying
power than prudent investors.
What
to Do?
I have five suggestions:
1. Be
careful it is easy to get sucked in, many bright people will.
2. Focus
on investment with well-financed companies that have quality products and
services that remain essential in the future. You probably will earn less, but
probably will also lose less.
3. Reduce
the ratio of your net purchases to your net sells. While cash is the equivalent
of trash today in these low interest rate markets, Warren Buffett has amply
demonstrated his acumen at Berkshire Hathaway*, emphasizing the
value of cash during periods of stress and accepting under-performance until
the rising cash pile can be used dynamically.
4. Remember
that future opportunities will occur and in the long run that will be good for
you.
5. Use
the time horizon strategy I have previously suggested separating your
intermediate time horizon investments from your longer-term investments. (Please
contact me if you would like these posts emailed to you.) The intermediate investments
should be current price-oriented. When the bidding for these good companies gets
excessive on a historic basis, be a supplier (seller) into the market. Ride out
your long time horizon investments and when they periodically decline due to
short term factors buy more.
Do You Disagree? Please
let me know I am always anxious to learn from wise people.
*Stocks of the companies mentioned
are either owned in my private fund or are in my personal portfolio or both.
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