The market continues to gyrate along and is now trading at record highs. Before we get too terribly excited about that factoid it is important to keep in mind most of the heavy lifting was done in 2013. The S&P 500 is up less than 5% in 2014 and in spite of all the noise about new highs and market melt ups there is not a long going on in stocks right now. The real issue among the people I have spoken with lately is the confusion between stocks, bonds and gold. Stocks are moving up as if the economy is improving while binds and gold are predicting the economic collapse of Western Civilization.
I am not smart enough to know which way this all plays out but in my lifetime bonds have been the smarter market. The GDP numbers this morning would seem to give bonds the valedictorian status once again but it is pretty much beyond unpredictable we shall have to see how this plays out. The GDP report is concerning but it has never been a predictive indicator of stock prices. The specter of lower rates could keep money flowing into stock prices all summer long as some of pundits are anticipating.
There was interesting exchange this morning between Stephen Dubner and Steven Levitt of Freakanomics and the CNBC anchors. The pair told the network that most investors would be better off throwing a dart instead of relying on a portfolio manager. Dubner said “We talk about the ability of experts to predict the future, whether the future is geopolitical or financial. And if you look at, let’s say, stock picking advice specifically, you find that the experts, the people that we must revere, the people that we pay the most, are generally about as good as a monkey with a dart board. So if you’re a buyer you have to consider what their incentives are, what their research says and how counter intuitive you can afford to be.”
Levitt went on to add “There’s somebody on the other side of that trade who is just as confident, just as optimistic…one of you is right and one of you is wrong. It’s part of what markets are so great. You have all of these incredibly smart people and that’s why markets are so efficient. Because on every side of the transaction you’ve got these good people doing it.”
While most will take this as an argument for indexing I would suggest that this thought process is exactly why value investing works as well as it does. Consider the fact that with short term trading dominating the market and even the alleged long term investors like mutual funds turning portfolios over by more than 80% a year you have a lot of smart guys buying and selling to each other in a compressed time frame. Most of them are also trading the same 1000 or so stocks as the first job of a portfolio manager is too not get fired and no one ever got fired for buying IBM. The short term guys need the liquidity of the large cap stocks and indexes. They tend to move in herds as well and buy the same stuff at the same time. If you randomly flip through 13f filings each quarter as I do you will quickly discover that the vast majority of the portfolios look a lot alike.
These attributes create tremendous opportunities for individual investors. As the big and fast money dumps a sector because of poor short term prospects huge opportunities are created for those who have longer time frames and an affinity for safe and cheap stocks regardless of near term prospects. Consider gold and silver miners right now. The near term outlook for these stocks is pretty poor as the metals markets have been terrible. Now many of these stocks trade for far less than their tangible book values and they have decent balance sheets. If you are willing to step in here and buy these businesses with an eye on the next five to seven years there is a tremendous amount of money to be made. If they just drift back to their asset value you can double your money. If the metals markets get hot again, a reasonable assumption over the next five years, the returns can be many multiples of the current prices. The same situation exists in companies in industries like natural gas and offshore drilling right now as well. Those focused on the quarterly performance derby are selling them and now you have these incredibly attractive long term assets priced at huge discounts. By extending your time frame and focusing on the margin of safety you can exploit the movements of all these smart professional stock pickers for your long term profits.
You can also use their size restrictions to make money for yourself. Consider the small bank stocks. There are no high frequency traders or swing traders trying to trade these little $30, $40 or $50 million market cap banks. In spite of the very favorable economic and demographic reasons these stocks should move a lot higher over the next decade your order won’t run into competition or Goldman Sachs or Fidelity. No one is mentioning them on TV driving the price up. You can buy a nice collection of them trading under book value and reap the benefits of the changing banking industry.
These size restrictions are also the reason that things like net-net stocks work so well. There is not much competition to buy these little out of favor stocks so you have time to get in and hold them until conditions improve and the stock price moves higher on its own merits.
The vast majority of Wall Street is trading the same stuff at the same time and they have a relatively short time frame. By extending your time frame and adopting that 5 to 7 year private equity mindset and buying what Wall Street is either selling or avoiding your chances of making money in the markets go a lot higher.
The unofficial start of summer has come and gone and we are moving into the best of the year. My orioles are fighting in the AL East with a powerful offense and a horrid bullpen leading to some inventive new language explosions around Chez Melvin. The new release list for publishers so far in May has been semi-spectacular and the hits keep coming in June. I am about halfway through Tiger, Meet My Sister And Other Things I Probably Shouldn’t Have Said by Rick Reilly and if you are sports fan at all you should like this book. Jeff Shaara’s has a new book out next week , The Smoke at Dawn. On the same day Stephen King and Alan Furst have new titles appearing. Fans of Lee Childs Jack Reacher series will be glad to know he has a new one out in June as well.
I have no idea what the market will do over the summer or even beyond. I do know that buying cheap stocks that have a margin of safety should continue to work as well in the future as it has for the past 100 years or so. Smart and patient works as well in the market as well as it does in other areas of life.
Song of the week: