34 replies to this topic

[thefirstimmortal]

It seems to me the list of qualities ought to include patience, self-reliance, common sense, a tolerance for pain, open-mindedness, detachment, persistence, humility, flexibility, a willingness to do independent research, an equal willingness to admit to mistakes, and the ability to ignore general panic.

[thefirstimmortal]

The true geniuses, it seems to me, get too enamored of theoretical cogitations and are forever betrayed by the actual behavior of stocks, which is more simple-minded than they can imagine.

It’s also important to be able to make decisions without complete or perfect information. Things are almost never clear on Wall Street, or when they are, then it’s too late to profit from them.

[thefirstimmortal]

it’s crucial to be able to resist your human nature and your “gut feelings.” It’s the rare investor who doesn’t secretly harbor the conviction that he or she has a knack for divining stock prices or gold prices or interest rates, in spite of the fact that most of us have been proven wrong again and again. It’s uncanny how often people feel most strongly that stocks are going to go up or the economy is going to improve just when the opposite occurs. This is borne out by the popular investment-advisory newsletter services, which themselves tend to turn bullish and bearish at inopportune moments.

[thefirstimmortal]

According to information published by Investor’s Intelligence, which tracks investor sentiment via the newsletters, at the end of 1972, when stocks were about to tumble, optimism was at an all-time high, with only 15 percent of the advisors bearish. At the beginning of the stock market rebound in 1974, investor sentiment was at an all-time low, with 65 percent of the advisors fearing the worst was yet to come. Before the market turned downward in 1977, once again the newsletter writers were optimistic, with only 10 percent bears. At the start of the 1982 sendoff into a great bull market, 55 percent of the advisors were bears, and just prior to the big gulp of October 19, 1987, 80 percent of the advisors were bulls again.

[thefirstimmortal]

The problem isn’t that investors and their advisors are chronically stupid or unperceptive. It’s that by the time the signal is received, the message may already have changed. When enough positive general financial news filters down so that the majority of investors feel truly confident in the short-term prospects, the economy is soon to get hammered.

What else explains the fact that large numbers of investors (including CEOs and sophisticated business people) have been most afraid of stocks during the precise periods when stocks have done their best (i.e., from the mid-1930s to the late 1960s) while being least afraid precisely when stocks have done their worst (i.e., early 1970s,the fall of 1987 and recently in the past three years). Does the success of Ravi Batra’s book The Great Depression of 1990 almost guarantee a great national prosperity?

[thefirstimmortal]

It’s amazing how quickly investor sentiment can be reversed, even when reality hasn’t changed. A week or two before the Big Burp of October 87, business travelers were driving through Atlanta, Orlando, or Chicago, admiring the new construction and remarking to each other, “Wow. What a glorious boom.” A few days later, I’m sure those same travelers were looking at those same buildings and saying: “Boy, this place has problems. How are they ever going to sell all those condos and rent all that office space?”

[thefirstimmortal]

Things inside humans make them terrible stock market timers. The unwary investor continually passes in and out of three emotional states: concern, complacency, and capitulation. He’s concerned after the market has dropped or the economy has seemed to falter, which keeps him from buying good companies at bargain prices. Then after he buys at higher prices, he gets complacent because his stocks are going up. This is precisely the time he ought to be concerned enough to check the fundamentals, but he isn’t. Then finally, when his stocks fall on hard times and the prices fall to below what he paid, he capitulates and sells in a snit.

[thefirstimmortal]

When E.F. Hutton talks, everybody is supposed to be listening, but that’s just the problem. Everybody ought to be trying to fall asleep. When it comes to predicting the market, the important skill here is not listening, it’s snoring. The trick is not to learn to trust your gut feelings, but rather to discipline yourself to ignore them. Stand by your stocks as long as the fundamental story of the company hasn’t changed.
If not, your only hope for increasing your net worth may be to adopt Paul Getty’s surefire formula for financial success: “Rise early, work hard, strike oil.”

[thefirstimmortal]

Obviously you don’t have to be able to predict the stock market to make money in stocks. I’ve sat right here at my Desk through some of the most terrible drops, and I couldn’t have figured them Out beforehand if my life had depended on it. In the middle of the summer of 1987, I didn’t warn anybody, and least of all myself, about the imminent 1,000-point decline. I didn't see this last massive drop coming.

I wasn’t the only one who failed to see. In fact, if ignorance loves company, then I was very comfortably surrounded by a large and impressive mob of famous seers, prognosticators, and other experts who failed to see it, too. “If you must forecast,” an intelligent forecaster once said, “forecast often.”

Nobody called to inform me of an immediate collapse a few years ago, and if all the people who claimed to have predicted it beforehand had sold out their shares, then the market would have dropped the much earlier due to these great crowds of informed sellers.

[thefirstimmortal]

Since the stock market is in some way related to the general economy, one way that people try to outguess the market is to predict inflation and recessions, booms and busts, and the direction of interest rates. True, there is a wonderful correlation between interest rates and the stock market, but who can foretell interest rates with any bankable regularity? There are 60,000 economists in the U.S., many of them employed full-time trying to forecast recessions and interest rates, and if they could do it successfully twice in a row, they’d all be millionaires by now.

They’d have retired to Bimini where they could drink rum and fish for marlin. But as far as I know, most of them are still gainfully employed, which ought to tell us something.

[thefirstimmortal]

There’s another theory that we have recessions every five years, but it hasn’t happened that way so far. I’ve looked in the Constitution, and nowhere is it written that every fifth year we have to have one. Of course, I’d love to be warned before we do go into a recession, so I could adjust my portfolio. But the odds of my figuring it out are nil. Some people wait for these bells to go off, to signal the end of a recession or the beginning of an exciting new bull market. The trouble is the bells never go off. Remember, things are never clear until it’s too late.

[thefirstimmortal]

There was a 16-month recession between July, 1981, and November, 1982. Actually this was the scariest time in my memory. Sensible professionals wondered if they should take up hunting and fishing, because soon we’d all be living in the woods, gathering acorns. This was a period when we had 14 percent unemployment, 15 percent inflation, and a 20-percent prime rate, but I never got a phone call saying any of that was going to happen, either. After the fact a lot of people stood up to announce they’d been expecting it, but nobody mentioned it to me before the fact.

[thefirstimmortal]

At the moment of greatest pessimism, when eight out of ten investors will have sworn we are heading into the 1930s, the stock market will rebound with a vengeance, and suddenly all will be right with the world.

[thefirstimmortal]

No matter how we arrive at the latest financial conclusion, we always seem to be preparing ourselves for the last thing that’s happened, as opposed to what’s going to happen next. This “penultimate prepared­ness,” is our way of making up for the fact that we didn’t see the last thing coming along in the first place.

[thefirstimmortal]

The day after the market crashed on October 19 of 87, people began to worry that the market was going to crash. It had already crashed and we’d survived it (in spite of our not having predicted it), and now we were petrified there’d be a replay. Those who got out of the market to ensure that they wouldn’t be fooled the next time as they had been the last time were fooled again as the market went up.

[thefirstimmortal]

The next time is never like the last time, and yet we can’t help readying ourselves for it anyway. This all reminds me of the Mayan conception of the universe.

In Mayan mythology the universe was destroyed four times, and every time the Mayans learned a sad lesson and vowed to be better protected- but it was always for the previous menace. First there was a flood, and the survivors remembered it and moved to higher ground into the woods, built dikes and retaining walls, and put their houses in the trees. Their efforts went for naught because the next time around the world was destroyed by fire.

After that, the survivors of the fire came down out of the trees and ran as far away from woods as possible. They built new houses out of stone, particularly along a craggy fissure. Soon enough, the world was destroyed by an earthquake. I don’t remember the fourth bad thing that happened, maybe a recession or high interest rates, but whatever it was, the Mayans were going to miss it. They were too busy building shelters for the next earthquake.

[thefirstimmortal]

Two thousand years later we’re still looking backward for signs of the upcoming menace, but that’s only if we can decide what the upcoming menace is. Not long ago, people were worried that oil prices would drop to $5 a barrel and we’d have a depression. Two years before that, those same people were worried that oil prices would rise to $100 a barrel and we’d have a depression. Once they were scared that the money supply was growing too fast. Now they’re scared that it’s growing too slow. The last time we prepared for inflation we got a recession, and then at the end of the recession we prepared for more recession and we got inflation.

Someday there will be another recession worse than the one we are in, which will be very bad for the stock market, as opposed to the inflation that is also very bad for the stock market.

[thefirstimmortal]

If professional economists can’t predict economies and professional forecasters can’t predict markets, then what chance does the amateur investor have? Well, just go to a “cocktail party” for your market forecasting. Just stand in the middle of living room or near punch bowls, listening to what the nearest ten people are saying about stocks.

In the first stage of an upward market-one that has been down awhile and that nobody expects to rise again-people aren’t talking about stocks. In fact, if they lumber up to ask you what you do for a living, tell them you manage an equity mutual fund, and they will nod politely and wander away. If they don’t wander away, then they quickly change the subject to the Celtics Game, the upcoming elections, or the weather. Soon they are talking to a nearby dentist about plaque.

When ten people would rather talk to a dentist about plaque than to the manager of an equity mutual fund about stocks, it’s likely that the market is about to turn up.

In stage two, the new acquaintances linger a bit longer-perhaps long enough to tell you how risky the stock market is-before they move over to talk to the dentist. The cocktail party talk is still more about plaque than about stocks. The market’s up 15 percent from stage one, but few are paying attention.

In stage three, with the market up 30 percent from stage one, a crowd of interested parties ignores the dentist and circles around you all evening. A succession of enthusiastic individuals takes you aside to ask what stocks they should buy. Even the dentist is asking you what stocks he should buy. Everybody at the party has put money into one issue or another, and they’re all discussing what’s happened.

In stage four, once again they’re crowded around you-but this time it’s to tell you what stocks you should buy. Even the dentist has three or four tips, and in the next few days you look up his recommendations in the newspaper and they’ve all gone up. When the neighbors tell you what to buy and then you wish you had taken their advice, it’s a sure sign that the market has reached a top and is due for a tumble.

[thefirstimmortal]

I’d love to be able to predict markets and anticipate recessions, but for me, that’s impossible.

Just for the sake of argument, let’s say I could predict the next economic boom with absolute certainty, and I wanted to profit from my foresight by picking a few high-flying stocks. I still have to pick the right stocks, just the same as if I had no foresight.

If I knew there was going to be a Florida real estate boom and I picked Radice out of a hat, I would have lost 95 percent of my investment. If I knew there was a computer boom and I picked Fortune Systems without doing any homework, I would have seen it fall from $22 in 1983 to $l in 1984. If I knew the early l980s was bullish for airlines, what good would it have done if I invested in People Express (which promptly bought the farm) or Pan Am (which declined from $9 in 1983 to $4 in 1984 thanks to inept management)?

[thefirstimmortal]

In the slower-growth, initial disbelief phase of transforma­tions-that is, the slow foundational run-up to the fast-growth breakout stage-most people unfamiliar with the dynamics of change underestimate the degree or rate at which an industry, a company, or an economy can change.

[thefirstimmortal]

History is full of examples. Oil forecasters in the 1970s could not imagine $30-per-barrel oil; PC manufacturers in 1983 could not imagine1-GHz, 10-gigabyte computers costing less than the original PC.

The enormous gravity of “anchored context” in the world’s smartest people manifests itself in their complete failure to see past their existing reality. This anchored context phenomenon-being blinded by the truth you know today-is absolutely spectacular in its power. Con­sider these examples:

“Who the hell wants to hear actors talk” was a famous line from H. M. Warner in 1927. “I think there is a market for maybe five computers,” said Tom Watson, chairman of IBM, in 1943. “There is no need for any individual to have a computer in their home said Ken Olson, president of Digital Equipment Corp., in 1977. (Wonder why Digital went feet up?)

My favorite line is from Charles H. Duell, commissioner of the U.S. Patent Office, who in 1899 said, “Everything that can be invented has been invented.”
You get the point.
Forecasting errors
Overestimation

100%
90%
80% Too Late
70%
60%
50%
20%
10% Too soon
0%

[thefirstimmortal]

UNDERESTIMATION

In the early stages of growth, as an investor you must count on all the experts being wrong. Why? Human nature and the basic psychology of change. Experts are anchored in the logic and reasoning of their current frame of reference-that is, their past experience. Experts unaware of transformations have always misforecast- underforecast-the magnitude and effect of the transformational change.

Investors count on this disbelief stage in investment analysis. Indeed, it is the disbelief stage where the seeds of super-colossal wealth are sown.

[thefirstimmortal]

The most recent example of this underestimation phenomenon was the curve-like eruption of initial dial-up Internet usage. Early forecasts about usage, penetration, and adoption rates were all terribly wrong and grossly underestimated.

The huge wave of online adoption that resulted from the introduc­tion of disruptive technologies, or that spawned the killer Internet applications like e-mail and the Netscape browser was pre­dictable.

Or think of a company like AES Power, which exploded its old struc­ture and replaced it with a radically new one. For years, the company’s open or distributed style of decision making in the electrical-power ­generation business was ridiculed by those who knew the “old company.

“It will never work” was all I heard about the radical strategic shift in their business.

When AES became the largest independent electrical energy compa­ny in the world, I swear I still heard the “experts” say it would never work.

Investors should try to load up on stocks during the early foun­dational stages of growth when others fail to recognize the signals. This incredibly profitable moment in an investor’s life the “blinding flash of the not-yet-obvious:’

[thefirstimmortal]

The fact that a majority of people-investors, portfolio man­agers, and institutions-don’t understand transformations is a good thing. In fact, a large part of future success in Investing depends on human nature and the fear, uncertainty, and doubt that accompanies all high-magnitude transitions.

Thankfully, the fact is that people recognize and respond to radical change differently, something that is as hardwired into our indi­vidual personalities as are our levels of smell and touch. This phenome­non is known as the Law of Disruption.

[thefirstimmortal]

First identified by consultants Larry Downes and Chunka Mui, the law postulates that where “social sys­tems [read: “people”] improve incrementally, technology improves expo­nentially.” In other words, there will always be a gap between those who grasp the early on, and the pragmatists waiting for “clear evidence” before they accept that change has actually occurred.

The Law of Disruption means we can have an edge in our personal wealth building during times of great disruption or transformational change. Because, as aggravating as it can be to work with head-in-the-sand Luddites, there is a marvelous silver lining. Without the head start we get from pragmatic late-adopters to irreversibly transforming economies, industries, or companies, our investment results would not be nearly as dramatic.

[thefirstimmortal]

The Investment Sweet Spot

From the disbelief stage of transformations, we hit the breakout phase. This is the part of the curve where it goes from moving sideways to moving steeply upward, and it’s the safest time to invest in radical change.

[thefirstimmortal]

OVERESTIMATION


From start to peak, change can last for years. The steep upward leg, or growth period, of fundamental shifts in technology platforms like the PC Change lasted 15 years. In fact, major fundamental technological shifts historically go in 10- to 15-year cycles. This means the transition from client/server platform to Internet-based computing has a very long upward slope.

Industry-specific changs typically last three to five years, and corporate changes can last even longer.

But all changes in their steep, upward-sloped hypergrowth stages eventually suffer the problem opposite to the underestimation phenome­non: the overestimation phase. When previously skeptical experts become entrenched believers in the previously unbelievable transformation, their once-anchored imaginations become “unanchored” and they replace old logic with new logic to understand what they are observing. This new logic phase causes the experts to overestimate the result.

Once oil hit $30 a barrel, it was not hard to imagine $80 to $ 100-per-barrel prices-which many experts did. Once the Nasdaq hit 5,000, CNBC threw a party in downtown New York City and got a bunch of its market pundits on top of a bus calling for “Next stop-Nasdaq 10,000? A popular book in 1999 was Dow 100,000: Fact or Fiction?

The key point you must understand in analyzing changes is this: What follows every, repeat every, hypergrowth phase of transformations is the “flattening phase.” This is the point where satura­tion starts to set in and the growth engine runs out of fuel.

[thefirstimmortal]

Transformation, just like an ocean wave, hits a peak and flattens, without exception. By definition, when most everyone who could own a PC owned one, the PC changeWave flattened. When everyone who was brash enough to buy an Internet stock had bought all they could buy, the market for Internet stocks was saturated and peaked, too. There are no endless waves.

The flattening curve is the equivalent of the surfer ending his ride on a wave. As all surfers know, you ride the wave as it grows and you kick out before it reaches its crest and starts to crash. In surfing, hanging on too long is called “going over the falls? In invest­ing, riding a winning wave too long is called snatching defeat from the jaws of victory.

[thefirstimmortal]

As an change analyst, you would have seen the flattening curve of oil prices in the early ‘80s and concluded we had reached an anchored point of overestimation and gone short on oil. You would have made a fortune as oil returned to $20 two years later.

[thefirstimmortal]

If you looked at the growth rate of the Nasdaq or of infotech spending, you would have seen the almost-exponential upward
slope start to flatten in March and April of 2000-everyone who could have bought tech stocks had bought tech stocks.

Extreme visions of grandeur during every transformational change mean newly minted beliefs cause people (especially “experts”) to over-project current growth rates to unreachable horizons. Sooner or later, transformation, even the most wide-scale, falls under the weight of its own success. The market becomes saturated and demand levels off. In short, everyone who could buy did buy.

We saw this saturation point in the PC industry in early 2000. Heavi­ly saturated markets for PCs and the slowing of PC growth should have told us to sell Dell, Microsoft, and Intel many months before the general pub­lic got wind of slowing demand. Ditto optical networking.

It’s at the flattening part of the curve when the experts are most prone to overestimating growth and demand