Dear Diary,
Gold was unchanged in yesterday’s trading. US stocks lost a little ground… but not much.
Yesterday, we took part in an “Ask Me Anything” session related to our latest book, Hormegeddon, on social news site Reddit. (You can find extracts from the resulting exchange in today’s edition of Market Insight, below.)
The format – the public writes in with questions and the interviewee (your editor in this case) answers them in “real time” – was new to me. So, many thanks to all those who tuned in. And many more thanks to all those who had cheerful words of encouragement.
One of the questions to come to us yesterday: What happened to our old, tattered “Crash Alert” flag?
The answer is we had to take it down. The ol’ Black ‘n Blue flag had been up for so long – battered by wind, rain, sun… and trampled by stampeding bulls – that there was barely anything left of it.
It was becoming embarrassing. But it should be flying high again now… warning of the danger of a surprise bear market.
October is coming. And according to one of our favorite economists, Richard Duncan, the risk of heightened volatility is rising… as excess liquidity disappears from the marketplace. Beware.
Unanswered Questions
Now, let’s continue with our look at how you should invest in a world of ignorance and irrationality.
There are many unanswered questions:
Should you put your money in a company just because you like the product?
Should you buy companies with rising earnings?
Should you trade in and out of stocks?
What should you do if the market is “too high”?
Should you be trying to beat the market at all? Is it not better to content yourself with whatever the market returns?
The answer to these questions will be far more important than any stock pick you ever make.
This is one of the reasons my son Will and I set up our new publishing venture, Bonner & Partners. We wanted to publish research not just about what to invest in and when to invest in it… but how you should be investing in the first place.
First, consider this from Forbes:
According to the latest 2014 release of Dalbar’s Quantitative Analysis of Investor Behavior (QAIB), the average investor in a blend of equities and fixed-income mutual funds has garnered only a 2.6% net annualized rate of return for the 10-year time period ending Dec. 31, 2013.
The same average investor hasn’t fared any better over longer time frames. The 20-year annualized return comes in at 2.5%, while the 30-year annualized rate is just 1.9%. Wow!
The average investor exclusively investing in just fixed-income funds has had an even worse experience. The annualized return is 0.6% over 10 years, 0.7% over 20 years, and 0.7% over 30 years.
Investors may only have themselves to blame.
According to Dalbar’s QAIB, investors make poor investment choices that hurt their investment returns. These decisions, including when to buy and sell, are often driven by emotion.
By contrast, almost any investment sector or category did better. Over the last 10 years, the S&P 500 rose 7.4%. International stocks rose 6.9%. Bonds went up 4.6%. Only commodities underperformed, with a negative 0.8% annual return.
Is the Market “Efficient”?
Academics and financial theoreticians have confronted these facts in the context of the Efficient Market Hypothesis (EMH).
The evidence, say EMH advocates, supports the hypothesis: There is no point in trying to beat the market. You won’t win.
“Nothing of the sort,” reply EMH critics, among them Warren Buffett. There’s plenty of evidence that: (1) irrational investors frequently misprice stocks in an exploitable way, and (2) investors using old-fashioned Graham-and-Dodd value investing techniques consistently beat the market in a way that is not attributable to luck.
More evidence on this point came yesterday. Our old friend and colleague Chris Mayer – and another disciple of Graham and Dodd – had the track record of his value-investing newsletter Capital & Crisis verified by outside auditors. Chris writes:
The report is not perfect. They exclude dividends, which is ridiculous.
But even so, from September 2004 through July 31, 2014, the annualized return for Capital & Crisis were 16% over the last decade versus 4.8% for the S&P 500.
I count dividends, so my figures are a touch higher – 17% for Capital & Crisis. But pretty close.
So you see, you can “beat the market.”
But as we pointed out yesterday, both EMH advocates and detractors exaggerate.
It may be true that prices are never “perfect”… in the sense that they perfectly reflect the real value of the underlying investment. But it is also true that investors can never be sure they have discovered a more perfect price than the market has set.
In other words, Mr. Market is never wrong; he just changes his mind.
A Moral Rule
For us, the EMH is better regarded as a moral rule. It is not exactly true. But it is not exactly false, either.
A savant such as Warren Buffett would be a much poorer man today had he believed it. But most investors are probably better off taking it as gospel… just as they are better off believing they will go to hell if they disobey the Ten Commandments.
For most investors, riding along with the market will be far more rewarding than trading in and out trying to beat it. There may be $100 bills lying around from time to time, but most investors probably won’t find them before Buffett and other pros like him do.
This is the approach we take at our family wealth advisory, Bonner & Partners Family Office – where the main focus is on asset allocation, not stock picking.
The core message of EMH is that the market is very hard to beat in a consistent way. It tells us to be humble… and realistic about what we can expect from stocks.
For most people, investing is not a good way to make a fortune. It is just a good way to keep… and maybe grow… a fortune.
You make your real money by providing real goods and services to others. It is not realistic to think you can make much money, while you sleep, from the hard work and enterprise of others.
That is revealed in the figures above cited by Forbes.
Our Investment Philosophy
Another way to look at this is to think of investing as a “losers’ game.”
A successful amateur investor realizes he is not likely to beat the pros. He doesn’t try for home runs or grand slams. He just wants to get on base.
He assumes the market is fairly efficient… and that he’s not likely to beat it. He avoids buying expensive stocks. (How does he know they’ll continue to go up?) He avoids investment themes he doesn’t understand. (How does he know they make sense?)
He aims only to not lose, by sticking with the very, very basics.
That is the point of the Simplified Trading System (STS). And it’s what we spend most of our time doing in our new newsletter, The Bill Bonner Letter. We’re not trying to find things that will work. (How do we know?) We’re just trying to identify those that probably won’t.
Here’s our investment philosophy:
1) Think a lot. Do a little.
2) Always buy low. And for safe measure, buy very low.
3) Never believe anything a salesman says about an investment. There’s a good chance that he is ignorant, dishonest or stupid. Or all three.
4) Be reasonable. But take a swing at a grand slam pitch from time to time. Heck, it’s not just about the money; it should be fun, too.
5) Remember, the investment world is like the rest of life. Patience, modesty and hard work pay off. Vanity, weakness and cupidity do not.
Regards,
Bill
Further Reading: Have you read Hormegedddon? If so, we need your help. We want to get the word out about Bill’s new book to as many folks as possible. And to do that, we need you to tell them what you thought of it by writing a review on Amazon.
It doesn’t have to be long – just a few lines will do. Let’s get the truth out about how the world really works…. and why central planners are doomed to fail. To make your voice heard, go here now.
Reddit “Ask Me Anything” Edition
As Bill mentioned above, he took part in an “Ask Me Anything” session on social news website Reddit yesterday.
Don’t worry if you missed it.
Here are some of the highlights – including why you should own gold now… why a money “helicopter drop” is on the way… and why the dollar’s days are numbered as the world’s sole reserve currency.
Then an embarrassing admission…
*** Hey Bill, what do your observations say about a Dow to Gold ratio in the foreseeable future?
I don’t really have that degree of foresight. I mean, all we know is that over time the Dow and gold tend to converge and diverge.
In the big picture view, I think they are converging… but it is very sloppy.
Most likely the coming changes in the financial world will bring with it the destruction of the dollar… and of existing capital assets. At the same time, people will be desperate to protect their assets.
Historically, the best protection is gold. So the price of gold should go up… and the price of most other assets (particularly bonds… but also stocks) should go down.
At some point, we’ll see an ounce of gold at the same price as the Dow stocks. Just as we did, briefly, in 1980.
*** Bill – I’m reading Harry Dent’s book The Demographic Cliff and he predicts deflation and gold prices plummeting in the near future. Your thoughts on this scenario….?
Good book. He could be right.
We’re seeing the deflation part in Japan and Europe. And the underlying trend is evident here, too.
It makes sense that economies are strongly influenced by demographics. Economic activity in a single person changes dramatically as he ages. It must do so for a whole economy too.
And overall, he is probably right that we are in a contracting period… not an expanding one.
On the other hand, we’re in an expansive money-printing period. Bernanke was right when he said a determined central bank could always cause inflation… and hyperinflation; it would drop money from helicopters if need be.
I think that’s what will happen. In the end.
But we could very well be in for a Japan-like period of deflation – including a lower gold price – before the end comes.
*** Hey Bill! The dollar-based fiat monetary system is clearly on the fast track to hormegeddon. What comes next? A globalized centrally-planned system? A return to gold? Chaos? Also, are there truly competing interests between the Anglosphere and the BRIC nations or are the power elite buddies when the camera is off?
A lot to think about.
I was just in China. Apparently, Alibaba has come out with new financial products that are a big success. It is probably just a matter of time until some company is able to create a decent currency – something like Bitcoin – and make it work in the real world of savings and transactions.
It wouldn’t be at all surprising if that new currency were backed by gold. The yellow metal is not the perfect thing to use as a reserve currency. But it’s the best thing found so far.
Your question about the competition between the Anglosphere and the BRICs is a good one. They don’t have the same interests. The old, established economies want to stop the earth from turning. The new ones want a bit more revolution, so they will have their “place in the sun.”
This brings us back to China. The Chinese are well aware that having a convertible, world currency is a big deal. It makes it possible to export not just products but money itself. The margins on money are much higher than on other things; they want to be in the money-exporting business.
They now have about 2% of the world transaction settlement business. It is likely that that number will rise to 10% in the next couple of years…and to 30% or so a few years later.
But if people are using RMB [renminbi] to settle global trade accounts, they won’t be using dollars. So they won’t need so many dollars. Expect the greenback to fall…
*** And finally, sharp-eyed reader Lawrence H. takes us to task for an embarrassing error in yesterday’s Diary…
Bill, I’m a 40-year veteran of the investment game, but only a fairly recent subscriber to your views, having started with Hormegeddon.
Great perspectives, but not all that well conveyed, and horribly proofed. I wasn’t going to bother until your email today, which contained this:
“When a stock is worth more than the market price, sell. When it is worth less, buy. When it is in between, just sit tight. There, what could be simpler?”
How the hell did this get by you!?
*** Thanks, Lawrence. Well spotted. This should, of course, have read:
“When a stock is worth less than the market price, sell. When it is worth more, buy.”
As the guy who edits the Diary before it goes out, you can pin the blame firmly on me…
P.S. Here’s that link again to review Hormegeddon on Amazon. Let others know what you got from Bill’s new book here.