Selling low and buying high

Sometimes the stock market seems like a machine designed to produce regret.

When the market goes down, most people hang on until they reach a point of maximum pain and they sell. That’s when the market starts to climb back up again.

When the market goes back up, most people wait for the market to pull back (so they can “buy back in”). When the pull back doesn’t occur and the market continues to climb, they reach a point of maximum regret and buy back in. That’s when the market starts to tank again.

And so the story goes on and on over time. People end up buying at the top and selling at the bottom, en masse, because they invest using their psychological inclinations instead of their heads. That’s what allows calmer minds to make money over time.

The financial press is full of articles about those who sold at the bottom and are now regretting it and buying back in at the top. Why don’t people learn that trying to time the market doesn’t work?

This fear and regret cycle has repeated twice over the last 6 months. As the market tanked in October and November of last year, people sold at the bottom. As the market climbed out of those lows, the same people bought back in only to see the market tank again in March. Guess what happened from March to May? Rinse and repeat.

Why don’t people just accept that their psychological inclinations are almost always wrong when it comes to investing in the stock market? I don’t know. Tons of studies have shown that people make bad investing decisions using their psychological reactions. And yet they continue to do so.

The stock market will go up and down, I guarantee it. When it feels awful to hold on, you should be buying. When it feels wonderful because things are going up, you should be selling. Do almost the exact opposite of what you feel, and you’ll be a better, more successful investor.

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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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.

Being a value investor requires painful patience

I’ll spare you the academic citations, but there’s a solid body of evidence that value investing beats growth investing over the long run.

If it works so well, why isn’t everyone a value investor?

Because it hurts.

Value investing is based on a couple of key principles:
1) you can determine the value of a business
2) the price of a business on a stock exchange diverges from value
3) at some point in time, stock price converges on value

The hard part in value investing is point 3).

No one is surprised that you can determine the value of a business.

Not many are surprised (finance and economics academics excluded) that stock prices diverge from value.

The hard part is that first phrase in point 3), “at some point in time.” How long do you have to wait for “at some point in time”? As Shakespeare put it, there’s the rub.

No value investor knows when the herd mentality of the stock market will converge on underlying value. Why not? You might as well as ask why a weather expert can’t predict how many inches of rain will fall on one square inch of land in Bowie, Maryland during a 12 hour period on June 30, 2014. The system is simply too complex for an accurate prediction to be made.

And, as any value investor can tell you (ask Bill Miller), it seldom works the way you think it will.

If the company you’ve bought consistently reports growing earnings per share, surely then the market will converge. No, it doesn’t.

Sometimes price converges on value without any news whatsoever. Sometimes price converges when a company announced declining earnings for quarters on end. Most of the time, while you wait, it doesn’t converge at all.

You simply can’t know when it will happen.

I’ve seen it happen in one day, and I’ve seen it take over 7 years.

And, that’s why it works. Most people don’t have the patience to wait. They want prices to go up soon…today…RIGHT NOW!!!

Value investing works because few people have the intestinal fortitude to wait.

It’s like asking an overweight person about losing weight or a poor person how to become wealthy. They both know the answer. The overweight person will tell you it requires a good diet and exercise, but they won’t do it. The poor person will explain that you need to spend less than you make to become wealthy, and yet they won’t do it.

The reason it works is not because people don’t understand what to do, but because it hurts to do it.

That’s why I say that value investors get paid to endure pain. It’s painful to wait if you don’t know when price will reflect value. It’s painful to buy something cheap just to watch it become dramatically cheaper. It’s painful to watch fundamental performance deteriorate even though you know it will improve several years from now.

Anyone who has done their homework knows what it takes to beat the market. Value businesses, buy when price is significantly below value, sell when price reflects value. Everyone knows it, but hardly anyone does it.

Why? Because it’s painful. But, boy, does it work!

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.

It’s a great time to invest!

As pessimistic as many of my blogs sound about the stock market as a whole, I must admit I’m very bullish about the specific investments I’m making today.

You see, the market as a whole can be over-valued, or in for a rough ride, and yet you can find specific, long term investments that are very enticing.

I’m finding the best investment opportunities I’ve seen since the 2002-2003 market trough (when we were coming out of the 2001 recession).

Not only are the investments I’m finding likely to provide excellent returns, they are also higher quality companies than I usually get the opportunity to invest in.

Usually, large, high quality companies are priced at a premium to the market. Today, though, many great businesses are selling at prices that are at distinct discounts to the market and to my assessed business values.

I can’t remember a time in the last 12 years where I’ve been able to buy such premium companies at such low prices!

I don’t know when the market will turn, or when my specific investments may out-perform, but I do know I’ve spent a lot of time assessing their value and I’m very confident that high returns are quite likely over the next 3 to 5 years.

Now, I just need to be patient and wait for the seeds I’ve planted to sprout and grow. This is a high quality “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.

Is the stock market projecting a recession?

With the terrible jobs report last weekend and poor retail sales report this week, I would have thought the market would be projecting a recession.

But, the Dow Jones Industrial Average is down only 16.3%, the S&P 500 is down only 18.3%, and the Russell 2000 (the most grossly over-valued of the three) is down only 22.6% from their most recent highs.

These may sound like significant falls, but it’s normal for the stock market to be down 30-40% during a recession.

In other words, the stock market still seems to be projecting a mid-cycle slowdown despite a lot of data suggesting otherwise.

How should one react to such a situation? This is a great time to be buying!

I can’t forecast the top or bottom of the market. And, I’ll let you in on a little secret: no one else can, either.

When there’s blood running in the streets, you should be buying. That doesn’t mean things won’t go down further–they almost certainly will. But, knowing that you can’t pick the bottom of the market means you should be greedy when others are fearful and fearful when others are greedy. I’m feeling pretty greedy right now.

This is the time to buy cheaply priced businesses with good economics and management. If you take this path, either yourself or with the help of an advisor, your results will be quite satisfactory over the next several years.

I’m finding value in specific companies whose industries are feeling a lot of pain now. Think retail, real estate, building construction and airlines. I still think it’s too early for financial services (except some select insurance companies), but that time will come in the not-too-distant future, too.

I think this is a great time to invest, so if you’re looking for someone to manage your money and are curious about my services, contact me soon.

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.

Mid-cycle slowdown…or recession?

This question has occurred to me over and over again recently, because some very smart people are coming down on both sides of the argument.

To some, this may not seem very important. In a mid-cycle slowdown, the stock market goes down. In a recession, it goes down even more. If the market goes down either way, who cares?

But, the magnitude and period of decline make this difference very important to people with short term time frames. I’m not one of those people.

The yield curve, retail sales, the housing market, and credit markets all seem to be signaling a recession. The stock market seems to be indicating a mid-cycle slowdown. Employment data and factory activity are near recession levels, but not quite there, yet.

I’m guessing (with the emphasis on guessing) that we’re entering a recession. My guess is based on my analysis of past credit cycle declines. Our economy has been increasingly levering itself since the mid-1980’s. If deleveraging is occurring–and I believe it is–then a recession seems much more likely.

How does this alter my investment approach? Not much. I know I’m not smart enough to time the market, and especially not to time the economy!

So, how do I invest? Simply put, for the long term. I don’t think our economy will go into a 10 year depression. If that were the case, then I’d be building a fallout shelter.

Instead, I’m investing for the eventual recovery that will happen either sooner, or later. Whether sooner or later is less important to me than having selecting good companies–those with good economics, honest and competent managers, that are selling at large discounts to what the company will be worth over full economic cycles.

That’s a lot easier to do than trying to figure out what the economy will do in the short term. And, just between you, me and the fencepost…it’s also a lot more profitable!

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.

Is the Fed easing interest rates because it thinks we AREN’T entering a recession???

Surprisingly, the market did well this week.

This is surprising, to me at least, because the Fed cut interest rates another 0.5% and the jobs report came in looking pretty bad.

The Fed did not cut interest rates this week because it thinks the economy is doing well. It especially wouldn’t have done so after dropping rates between meetings by 0.75% just last week.

The Fed is clearly signaling the economy is in serious trouble. So why is the market rallying on news the Fed thinks the economy is in serious trouble?

In addition, the job report today was simply awful. It showed the first monthly decline in jobs since the economy was slowly coming out of the last recession. Cause for celebration? Apparently so.

In my opinion, market participants are still digesting the market’s significant drop during January. They are also digesting recent economic news, government actions and election results.

The reality is that much more deck-clearing is required in the financial sector, credit markets and housing sector before the next bull market can really take off.

In the meantime, some excellent bargains can be found in select places in the market. Troubling times like this are a big opportunity to prepare for the next upswing, regardless of when or how it comes.

I’m seeing some of the best opportunities I’ve seen since 2003, and I think those opportunities will grow in number and size in the not-too-distant 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.