A10, Stock Trader Dude

After a large drop in the Dow and S&P 500 index the pattern has been a partial rebound the following day or soon after… once that ends the market may have asserted long-term values will remain at a lower level – and for good reason – perceptions were inflated for many years and the long-term outlook going forward is not promising. So, the players that can still play the game will be defensive, that means catching stocks on the way up and selling inventory at a slightly higher price to the next batch of buyers hoping to do the same. But in that case, the investment community, including the public, isn’t there to propel those stocks much further and those stocks naturally sell off. The only thing that will matter – for those that want meaningful returns is to have a keen sense of awareness of the companies that will rise to the top or continue to do well. And if you can’t compete in that way, you’re wishing that your shares rise in value for some reason, but that’s not investing.

Don’t let them fool you. The media and financial pundits aren’t going to pay your bills, now or in retirement and they aren’t going to reimburse you for losing any money in your investments. The media has put financial people forward for years when the stock market dips and their motto is always, “Don’t panic/Don’t sell.” We’ve heard this talk before, and it hasn’t made you rich. Don’t panic isn’t advice… it’s telling you to disregard the most obvious facts of the situation: Rescuing stocks, PAWS & effectSell, sell now, you fool 

The only way to lose is to hang on to investments that nobody else wants. You lose your margin of safety if your stocks decline past the price you paid for them. That is the time to sell, as your margin of safety is reduced – it’s defensive. The only way the game works to make you money is when people are willing to pay more. Most folks do not hedge their exposure, and so they are left vulnerable in the event of a severe decline. When you have properly protected your position – you’ve limited your loss in advance to an acceptable amount, and if the stock price gets crushed you’ll get back most of your capital.  PAWS (plenty of almost worthless stock) and effect, if your stock holdings stay down for the long-term you do not benefit – it causes more frustration to hold investments all the way down than to sell and at least have the chance to buy greater amounts of stock when the price is extremely low and due for a rebound. What is the path of least resistance? There is a valid reason for stocks to sell off – the glory days have passed long ago (since early 2000) and the perception is that boom times are far off. Use logic, the only people that get hurt financially when stock prices decline significantly and stay down for years are the people that held on!

I’ve been thinking the stock market was due for a major decline since 2004… but I got it wrong. The market index went where it wanted to go – on it’s timeline – not mine. I had bought puts on the index years ago and quickly won and lost or lost and won. But when I won or lost on those particular bets it was done with risk capital, money not essential to providing for myself in any way. I simply wanted to test a belief. But you, those out in stock land, who don’t understand how or why the game is played, referring to a post last week titled Sell, sell now, you fool may help you realize that no one is going to save you from your own poor decisions. 

A retired lady asked me in a panic about what she should do – “Is my money safe?” Of course not, cheap stocks can get cheaper, her money had been shifted into a money market fund years ago but she had one particular stock holding remaining and it hadn’t been doing much of anything other than slowly going down over the past few years and working up part of the way only to slowly decline. She claimed she doesn’t need the money for her retirement if the stock declines (she acquired the shares twenty to thirty years ago, perhaps more), but you never know when an emergency will arise. I asked her to think about the solution logically: If you short the stock, you are hedged from any further decline (although you are on the hook for any margin interest), and if you buy in-the-money puts it will cost you several hundred dollars, and if you sell out-of-the-money calls and use that money to buy out-of-the-money puts the partial hedge/insurance on your position doesn’t cost you anything. She is protected from a worst-case scenario: PAWS (plenty of almost worthless stock). This is when you are stuck with a holding and hoping it goes up so you don’t lose almost all of your money on it. This kind of situation produces stress – and it could take years for a particular stock to recover. There is only one situation that must be planned for: you must accept the risk of PAWS – and for those that dispose of holdings in their retirement accounts there are no tax consequences – so, why not use a little logic? If your stock holdings go up a little, it doesn’t change your financial standing, if your stocks double in price – great, but that outcome isn’t likely (so why are you still hanging around?), and if your holdings decline a little from the price you paid it doesn’t materially affect your financial standing. There is only one case that changes your financial standing significantly adversely: your holdings go down significantly and stay down. That’s the only way you really lose. The choice is yours, while you still have one.

The title reflects one of Buffets favorite sayings: “Life is like a snowball; the important thing is finding wet snow and a really long hill.” The author states that it is not an investment book and that, “Part of the book’s point is that while you can learn from him and get some ideas, you can’t really replicate his feat. It was very hard to do what he did, and part of it had to do with the times he lived in.” Writing the book took five years and the author noted that Buffet didn’t tell her how to write it and didn’t ask for any changes. “He said he really wanted me to get at the truth. And whenever his version differed from anyone else’s, he wanted me to use the less flattering version.” So, how do you get rich from Buffet’s advice? The best answer I’ve heard is that you don’t have to invest in stocks at all, although not confirmed by the author, she received mid-seven figures for an advance. For the average person or investor, wealth isn’t locked up inside the market; it’s found in distributing ideas about the market. That’s a great return on her time, instead of fussing around with choosing stocks over the last five years she simply talked to Buffet about his childhood – and he’s the one who suggested she should write a book one day, although he never suggested any topics.

The stock market works on the greater-fool theory, you buy something in the hope that you can sell it to someone else for more than you paid. Even in good times it doesn’t always work, as there are shortages of fools from time to time. What retail investors don’t see is that the days when technology shares were rapidly moving up and creating wealth for their founders and those that bought early enough and held for a few years are long gone. So, if the conditions for easy money are gone, such as an abundance of fools with money, why are you still invested? 

I think the answer is that the retail investor has been consistently lied to about long-term investing and wealth building in the stock market: specifically that holding stocks for the long-term is common sense. It’s not common sense; it’s been disguised as common sense. Let me explain: Most retail investors have no business being in the stock market, they got in due to going along with the belief that it is a good way for them to build wealth and prepare for retirement – now, and now is the only time that matters, because if you lose your money now “in the market” there may not be a later to make it back. As a precaution, wouldn’t it be wise to sell investments that you do not know enough about? If you sell and your stock holdings significantly decrease in value you will be better off mentally, emotionally, and financially and you still have a chance to buy those stocks back cheaper. What this means is: If you sell now – you have a choice! If you hold and your investments lose substantial value and do not recover for many years, who’s going to bail you out? If you sell and the market recovers with more fools and stock prices go up – you miss part of the move, but it will not make you rich even if stocks go up, it will not make you secure about your holdings if the market goes up, it will only matter if your particular stocks go up very, very, very far. And how likely is that is that, especially if you didn’t benefit during the easy money of the tech bubble? If you sell, and the stocks you held go up, you still have a choice to buy them back, and most importantly when those stocks are going up, that’s at least proof that there are some fools going into them. The worst situation is to find out that most of the fools are out and you’re stuck with stocks that aren’t worth much to most of the remaining buyers. 

Fortune magazine published an article online titled, What investors should do now, but Fortune doesn’t get it, it’s not about what they think, it’s not about fundamentals – it’s whether you’re invested for the right reason to begin with. The Fortune magazine article clearly states: We don’t think the financial system is on the verge of collapse. Fine. Neither do I. That is not the point. The market fundamentals aren’t strong, and there is no instant way to change the market temperament to the euphoria of 1996 to early 2000. It is in those exceptional periods where it is possible for the unsophisticated retail investor to make large sums of money. But getting back to the article it states: By our count some 300 articles were published last month telling investors “don’t panic” or “not to panic.” Urging calm is one thing. But too much soothing talk implies that there are no lessons to be learned. What’s the use of a vertigo-inducing bout of market turbulence if the only conclusion is “stay the course”? 

Stay the course? The course hasn’t been good for you for quite some time. If the road you’re on doesn’t appear to be getting you to your destination with your financial vehicle in good working order, get off that road. For the past fifteen years you’ve heard promises that you’ll be well off with long-term investing. Promises from institutions that took your money, promises injected into the media, but if your holdings go down substantially and stay down for years, have you been promised anything other than bearing the burden of the risk. The media and institutions will not pay your bills and you think they’ll share in your losses? The 300 articles telling you to hold on is a warning sign – they need time to get out first! 

Here’s the best part of that article: Here’s another reason to be concerned: The professionals managing your money haven’t gotten this market right. Consider that at the market low on Sept. 17, only five diversified U.S. equity mutual funds – out of a universe of 9,100 – had positive total returns for the year, according to Morningstar. FIVE! Even after the market rebounded, there were still only three funds with returns this year of 10% or better. 

Did you get that – you’re risking your life savings for a 10% return? Good luck, the important thing to remember is that even if the stock market declines and stays down for an extended period the rich people will still be rich, perhaps less rich, but what about you? No one is going to bail you out of picking the wrong funds or stocks and diminishing your capital. A few funny books that kind of relate (Expert stuff):Bailout shirt: (found on page 3)

I wouldn’t classify the last twenty years as an age of turbulence. I would reserve such a description for a world with persistent pandemics. In terms of the investment markets, if Mr. Greenspan believes in such a description for the market environment then I don’t see why the average non-professional investor should risk his capital in a market environment that is unfavorable to the way the average investor places his or her bet – invests. What you’ll learn from the book is that Mr. Greenspan believed paying down the national debt was the top priority when the government had a surplus, but he was outfoxed politically by the Bush Jr. team. The other thing you’ll learn related to the recent economic climate is that Mr. Greenspan believes that economic conditions had built up to a point, historically, where if the market hadn’t been susceptible to subprime default, it would have experienced another crisis of similar magnitude. Regarding the future of the U.S. stock market, let’s review how the market is composed of value – perception and intellectual property. The DJIA was at 3,200 in 1993 – Greenspan’s comments regarding irrational exuberance were made in 1996 as the DJIA reached 6,500. So, in Greenspan’s view, even when times were good they weren’t that good! If I consider the outlook of the stock market from this point I would review from the book: 

The President’s Council of Economic Advisors in early 2006 cited output by industries “Highly dependent on patent… and copyright protection,” such as pharmaceuticals, information technology, software, and communications, as according for almost a fifth of U.S. economic activity in 2003. The council also estimated that a third of market value of publicly traded U.S. corporations in September 2005 ($15 trillion) was attributed to intellectual property; of that third, software and other copyright-protected material represented nearly two-fifths, patents a third, and trade secrets the remainder. It is almost certainly the case that intellectual property’s share of stock-market value is much larger than its share of economic activity. Industries with disproportionately large shares of intellectual property are also the most rapid growing industries in the U.S. economy. 

Most of this value built up cannot be identified in a tangible form – it exists in the minds of consumers, my belief is that as emerging economies learn to play the brand management game as well as the U.S. has, a shift will begin to take place, and values could evaporate in the U.S. stock market as foreign companies become more adept at serving their own consumer markets. As other nations learn the art of compelling storytelling, and manufacture their own kind of Hollywood, they will begin to create and own their own significant intellectual property that serves their markets better. So while there may be great consternation regarding the economic climate due to the subprime crisis, what has changed – investors in the 1920s gambled on the stock market on margin and investors/institutions over the past several years gambled on securitized-subprime mortgages. 

Mr. Greenspan has stated: The fundamental problem had been the underpricing of risk worldwide, an anomaly that built slowly to near-historic levels over the preceding few years. Equity premiums-the added returns that investors expect on stocks over the yields of “risk-free” investments like U.S. treasuries-had also contracted significantly. In their quest for slightly greater returns, investors had come to accept very much greater risk. 

I would describe it as, even if investors weren’t reaching for a little extra return in unfavorable market conditions (post stock market bubble), the risk the small stock market investor faces is that he hopes for great wealth to be produced from his small sum, and it is almost as difficult to achieve this as it is for him to win the lottery.

The proponents of long-term stock investing ignore the concept of stability; market averages don’t take into account the dire consequences of war. Most equity markets around the world have been interrupted for multi-year periods by war. The author points to the fact that the equity market in Germany peaked before the German army ever lost a battle, and market bottoms in the US and Britain happened significantly before pivotal moments in the war benefited the Allies, and attempts to make the case that the collective wisdom of the crowd of stock market investors prevailed before the outcome of the war unfolded. 

Wisdom of the Crowds: it is the collective judgment of crowds and their instincts that we should be respectful of. 

The Crowd: A study of the popular mind – “Crowds can never accomplish acts demanding a high degree of intelligence and they are always inferior to the isolated individual.” 

Wealth, War & Wisdom offers several points: When asked or required to make judgments independently and in a rational way, the record of crowds is impressive. Strategists and economists often in the preamble to their reports boast that their view is contrary to the consensus as though that supposition alone is more important than all their analysis. It is a truism that human beings are reactive imitators and are subject to emotional extremes of euphoria and despair. Whether or not you agree with the book’s assertion that collectively the investor crowd often has superb intuitions about long-term events and that these judgments should be respected and followed the book still has enough to offer to make it an interesting read. I say, it’s all a gamble on the part of the investor; when the outlook is dire, equity prices are greatly reduced, and if you operate under the belief that the world and your way of life is not coming to an end you’ll have bought at extremely favorable prices. And if the world ends, or some type of planetary calamity overtakes life as we know it, your investments won’t matter, you’ll have greater problems to address.

Act by means of non-action. Accomplish by not undertaking. Taste while a thing is tasteless. Consider small things great and the few as though they were many. The most difficult tasks in the world should be performed while they are still easy. The greatest projects should be dealt with while they are still small. On this principle the sage never tackles things when they have become great, and so he achieves greatness. Many difficulties are encountered when men treat hard things as though they were easy. Therefore the sage, by treating easy things as though they were difficult, ends by finding nothing difficult. 

*** 

Everyone in the world says that my Way is great but seems to be impracticable. It is just because it is great that it seems impracticable. If it were practicable it would long ago have become insignificant. 

*** 

Which lies closest, fame or self? Which counts for most, self or goods? Which is worse, gaining or losing? Therefore, the more things are cherished, the greater the trouble. The more things are hoarded the heavier the loss. He who is contented will not suffer humiliation. He who stays put will not be in danger. He will be able to remain for a long time.

The flaw is thinking that the market builds great wealth… it doesn’t, only having large amounts of the right stocks produces wealth… but that can be said about anything moving in your favor, including risky bets. After all, placing $50,000 in roulette on an even money bet and winning five times in a row while leaving your entire stake at risk will produce $1.6 million lying on the table. If you kept $50,000 in reserve after the first spin, so that even if you lost it wasn’t any of your original risk capital you’d have $800,000 on the table at the fifth spin. 

The stock market is a form of gambling; it’s just that it offers you greater protection from losing your money all at once, while offering you extremely high returns if you pick the right stock and are able to hold it while it goes up incredibly far. In traditional gambling you don’t have the luxury of holding onto your losers to hope that they come back… but in stocks and commodities trading you can fool yourself into still believing you have an investment. 

If most of your investments will be made in U.S. financial markets because you consider the U.S. stock market the most efficient in the world because it is huge, highly liquid, well regulated, and thoroughly studied please consider the following: It will be almost impossible for the average investor to know something about the value of a particular stock that someone else hasn’t already discovered and acted upon. Without the ability to discover and act on quality information or other essential knowledge you are gambling and will almost always be too far removed from guiding your investment to great wealth. 

So perhaps the best answer for the average investor is to focus on his or her finances rather than on controlling his or her investments. There are risks in any approach to investing; sometimes the greatest thing we can embrace is luck.

Some people use charts to guide their investment decisions. But where are the rich chartists? Some believe in charts or the possibility of charts because what we study influences us and interacts with our intellect and shapes our thoughts and personality. We then transform this view into ideas and actions according to our own nature and particular needs. Charts may illustrate some excess of greed and fear, some transformation of energy, but they cannot, in and of themselves put money in your pocket. Charts are the collective conscious of yesterday, the point being, the most important factor for profit is not found in charts, it appears in the question: What will drive prices today?