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New Nonsensical Stock Trading Idea: Someone Else Paid A Lot More For It

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[Note: This is an article idea that I had outlined for a week and a half now. I'm going to continue with it, because:

  1. I think it's interesting
  2. it can show one (in this case myself) can be reactionary to a short term.

Something that can seem like a great idea might not be.]

A little more than a couple of months ago, I wrote about the Facebook IPO giving my thoughts and predictions. I had thought that 38 was too high and predicted that it fall to around $30 a share. Surprisingly, I was actually pretty close to right. This is where I executed the strategy that you read in the title. Since institutional investors had paid a lot more for Facebook, I figured I was getting a better deal than those smart guys. Better yet, they'd probably do whatever they can to try to push the stock up so that they can break even. With this in mind, I ended up buying some FB at around 30.50 and as it continued to drop some more at around 26.50. Facebook stock recovered to around $33 and I implemented a strategy a friend at college had mentioned... selling most of the stock and playing with much of the "house's" money.

I sold off 75% of the Facebook stock and kept 25%. My friend in college suggested that it might be wise to do this to leave behind a trail of your investments. It's not like Facebook is going to be worth 36 trillion dollars any time soon, but it could certainly be worth something significant in 10, 20 or even 40 years from now.

I executed a similar strategy with Groupon recently. I saw that they hit an all-time low at around $7.30 and picked up 100 shares. My theory was that once again, there are a lot of people who paid more than $15 and even $20 for the stock, so it could go up there. Admittedly, this ignores a lot of important analyis such as why the stock went down. With Facebook, there were no earnings misses or anything that I saw as a significant change in their business from the $38 price. With Groupon, there is significant worry about their exposure to Europe's financial problems. However, I stil saw it as worth taking a shot at something at such a discount. Within hours of buying it, it jumped up to $7.90 and I had once again showed the stock market who was boss. The funny thing is that when you only buy 100 shares and things move up 60 cents, you only made $60... and trading commissions takes away some of that. This time I didn't sell... I didn't have much of the house's money to play with like I did with Facebook.

If you've looked at the stock market today, you'll have noticed that Groupon has gone down and created some new lows. As I write this, Groupon is down to $6.70 and I'm on the wrong side of losing an entire $60. (I'm emphasizing how insignificant this is for a reason.) I clearly have not solved the stock market riddle (and we know that it isn't possible to solve). I'm reminded of the time a dozen years ago where I bought Worldcom on a similar thought process. That didn't work out either. At least I'm now a little wiser and looking at the growth, potential earnings, and other metrics. I'm still feeling comfortable with Groupon.

The third stock that I had been looking at with Groupon was Zynga. When they went public at a valuation of nearly 10 billion dollars I laughed. I'm sorry, but people throwing digital cows at me or whatever Farmville is can't be a 10 billion business. It simply can't compare to Netflix which put most of the video rental stores out of business was worth around 4 billion. However, as Zynga fell and fell, my through process of "someone else paid a lot more for this" started to take over. However, it still seemed very expensive compared to other businesses, so I didn't pull the trigger. If you've seen the news today you know that it was a wise decision as Zynga got slaughtered on its earnings miss losing 40% of it's value over night. Now at $3.10 it might be worth considering a few shares, but I don't see anything significant moving the stock until the next earnings.

That Zynga miss affected Facebook, because a good chunk (I think 10%) comes from Zynga. So to bring this all back around to Facebook, it is trading at 27.50 and announcing earnings in a few hours. Almost everyone is expecting it to be bad. I am expecting Facebook stock to go even lower. Over the next 6 months or so, employees of Facebook will be able to sell significant chunks of their stock options as the lock-up period expires in a few stages. I expect this to drive the stock further. I'll be keeping an eye on Facebook to buy in cheaper. It's amazing to me that Facebook started out with about twice the market capitalization of Ebay and is now neck and neck with Ebay posed to pass it. Even though their businesses are separate with nothing other the Internet in common, I am keeping my eye on them because they are similar priced right now.

Have any thoughts on this, or am I just nuts trying to trade these tech stocks like it was 1999? Hit me up in the comments as usual.

Final Note: Something that I should have mentioned earlier is that I am doing these trades with a very small amount of my IRA account (Some 90% of it of is well-diversified in index funds and cash waiting for a buying opportunity). I'm not trading anything that should have any great impact on my financial future (unless these small moves really add up over time as I hope). Trading stock like this bears some risk, so I make sure that I have a good amount of money in buy and hold, diversified areas.

Posted on July 26, 2012.

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Investing

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16 Responses to “New Nonsensical Stock Trading Idea: Someone Else Paid A Lot More For It”

  1. Jim says:

    Sounds like you’re doing the “Greater fool theory” in reverse. Instead of hoping for a greater fool to come in behind you and push the price higher, there seems to be justification because a greater fool already had bought it higher previously. This could be one of the silliest reasons to invest in something. Wait, this isn’t investing it’s speculating, which is very different.

    At least you have 90% in a well diversified portfolio of index funds. Holding the cash waiting for a buying opportunity is closet market timing.. good luck with that.

    It’s fun to have a small percentage to play with in more aggressive securities which could provide a significant payoff, but it still should be based on a sound investment idea not because some other fool had paid more for it.

    The average investor will throw more than half of their returns away trying to time the market, avoid downturns, chasing fads, and all kinds of destructive behavior, all with the best of intentions. Not sure if you’re familiar with the annual Dalbar studies. Here’s an easy to read page illustrating the findings.
    http://davisfunds.com/document/read/the_wisdom_of_great_investors/#page_2

    Remember, trading is hazardous to your wealth.
    http://faculty.haas.berkeley.edu/odean/papers%20current%20versions/Individual_Investor_Performance_Final.pdf
    While boring and requiring patience, a diversified portfolio, periodically rebalanced (regardless of the headlines)has always treated long term investors well. It’s really quite simple. Not always easy, but simple.

    • Lazy Man says:

      Yeah, it is simply speculative trading. However, it is at least buying at a very good value. Also the “Greater fools” are often not fools in the traditional sense, but institutional investors with direct relationships with the companies they invest in.

      I realize the point with the market timing, but those fully invested in the market for about a dozen years and have seen no gains during that time. We are just starting to see some gains this year. However, with multiple rounds of quantitative easing, a really high national debt, and a bunch of other unfavorable factors (Euro problems for example), the market doesn’t look particularly promising going forward.

      I hate to be all gloom and doom. With regard to the set it and forget it (except for rebalancing) investing, I remember everyone saying that real estate always went up over the long term too. and the condo I bought in 2004 is still down some 35% from where I bought it. I realize that 8 years may not be “long term” for some, but it will still likely be a lot of years before that it recovers to where I paid for it. Had I applied my value method for buying, I wouldn’t have bought the condo at the height of the market.

      You covered some of this in the Dalbar study, but I found this interesting:
      “Driven by emotions like fear and greed, they engaged in such negative behaviors as chasing the hot manager or asset class, avoiding areas of the market that were out of favor, attempting to time the market, or otherwise abandoning their investment plan.”

      I’m doing the exact opposite of some of these things. People chased Groupon at $20 and $25 as a hot fad. I’m charging into it (instead of avoiding it) now that it is out of favor at around $7. Of course that may be still valuing Groupon pretty high at nearly 5 billion dollars – though they turned down $6 billion from Google awhile back.

      The problem I see with the Dalbar studies is that it is taking the “average” investor philosophy.

      As for the keeping cash on hand, in 2002 and 2008, I wanted to shift more into cash so that I could buy if there was a big dip. I didn’t because these studies say to buy and hold. Each time, I had called almost the perfect bottom. I created a fake portfolio in Yahoo in early 2003 that was based on indexed funds that is up huge today. In 2008, I was able to cobble a couple thousand in cash and buy some cheap shares of Vanguard Total Market Index (VTI), but it’s impact on my portfolio was next to nothing. If I had engaged in destructive behavior like putting more in cash, I would have gained some 50%+ on that money.

      Finally, I think the past history of investing isn’t necessary going to reflect the future. Much of that data is from a time when America made product and there was much less of a global economy. It would be almost like not getting an iPad now because you used a Mac Classic and didn’t like it. I’m not sure if the past is relevant to today.

  2. Jim says:

    Lazy,

    Thanks for the reply, I’d like to address a few things you said as I belive they are leading you down the wrong path which is followed by most people.

    First, I suggested that a well diversified periodically rebalanced portfolio always has treated the long term investor well. I would contend that you are incorrect stating “I realize the point with the market timing, but those fully invested in the market for about a dozen years and have seen no gains during that time.” This would be correct if all you bought was the S&P as it is still below it’s highs of 2000 (not including dividends of course). But if you had bonds of all varieties, large growth and value, small growth and value and developed and emerging international and had rebalanced, you did quite well. You would have been selling along the way in the late 90s from your large and small growth buying bonds as well as large and small value. Of course this would have been very unpopular and you would have looked back year after year feeling foolish for having trimmed areas that continued to produce outlandish returns.

    But when the bear struck (as it will every 5-6 years on average to the tune of about 30% on average), you had already loaded up on the areas that would produce double digit gains during 2000-2002 while they were cheap. Now you could sell them at better prices to accumulate the discounted out of favor growth assets, which of course everybody was now cursing.

    Rebalancing would have forced you to sell equities during the run up between 2003-2007, buying discounted bonds, so that you had ammo for the big panic of 2008-2009, which appears to have been the greatest buying opportunity of my lifetime (so far at least). It is important to realize that you make your money during bear markets, it just doesn’t feel like it at the time. If you have the time, run the numbers on historically rebalancing, it’s worked like a champ… if you can be disiplined and patient.

    You stated “The problem I see with the Dalbar studies is that it is taking the “average” investor philosophy.” Yes, the study takes into consideration the returns earned by ALL investors in all large cap funds over a 20 year period. The average investor, the aggregate of all investors, not only under perform the market, they significantly under perform their own investments. I think this is one of the most important studies. It is performed every year and every 20 year period the investor under performs his own investments, sacrificing over 50% of his return.

    You also stated “As for the keeping cash on hand, in 2002 and 2008, I wanted to shift more into cash so that I could buy if there was a big dip. I didn’t because these studies say to buy and hold. Each time, I had called almost the perfect bottom.” If you were able to consistantly call the bottom, you would be the first person I am aware of able to perform such a feat. Even if you did call the bottom correctly the last half dozen times, there is no guarantee that you will call even one of the next half dozen. Peter Lynch is famous for saying that more money has been lost in anticipation of bear markets than in bear markets themselves. I would go ever farther and say that there are no losses in bear markets, only volatility experienced, unless you lock in those low prices by making the big mistake of capitulating.

    Finally, you said “Finally, I think the past history of investing isn’t necessary going to reflect the future. “. Ahhh, the four most expensive words in investing… This time is different. Become a student of history and realize how many times, over and over, this attitude has led to euphoric tops like 2000 when the business cycle had been repealed, trees were going to grow to the sky, and earnings didn’t matter. Or 1982 when rampant inflation, voodoo economics, and Japan inc spelled ruin for the US economy. As Mark Twain once said “history may not repeat itself, but it sure does ryhme”. Yes the problems of today may be different than 2000, or 1982, or 1974 etc. but the problems of the moment while frightening have always proved to be surmountable.

    The facts are that in 2000, when the S&P traded at 35 times earnings, there was every rational why it was justified and stocks would continue higher, the appetite was insatiable. Today, stocks trade at 12 times earnings, with the ten year paying just 1.5%. Balance sheets are flush with cash, earnings are highest ever, with 2/3 beating earnings this past quarter and noboy wants to buy them. To quote Buffett “be fearful when others are greed, be greedy when others are fearful” and today is a most fearful time.

    • Lazy Man says:

      That’s a good point with the bonds. As I’m 35, and was 25 ten years ago, I had limited bonds as the expert recommendation is to be more aggressive with the stock market to get the alleged 10-12% annual growth (though it seems like the experts have reduced that recently to 8%). Perhaps this is a failure in my portfolio, but again it matches the expert recommendation. Even so, the appreciation of the bond fund I would get, Vanguard’s BND is about 13.5% total over the last 5 years (it’s entire existence), minus dividends, which of course would raise things a bit.

      My Vanguard FTSE All-World ex-US ETF is down 20% over the last 5 years. It hasn’t been around for 12 years, but my international funds are similarly down over the last 12 years. I have some Fidelity Spartan which hasn’t done well either.

      I guess I see a wide difference between the average investor chasing performance vs. my plan of buying value. I would like to see a study that eliminates those “negative behaviors” that the Dalbar studies mention. I think that 50% return that the studies say people are sacrificing are those who are chasing performance, which is the exact opposite of my “buy low, sell high” plan.

      Note the part that I mentioned about the “almost perfect bottom.” I made a hypothetical portfolio of $100,000 on Yahoo Finance in July 31st, 2002: http://static.lazymanandmoney.com/images/2012/07/yahooFinanceGame.png. I didn’t have real money to play with so this is the best I could do. It looks like the Dow was 8000. On February 26th, 2009 the Dow was 7700 (not the quick bottom of 6600 or so a week later), but still close. I wrote Lesson 2: People Want to Sell When It’s the Best Time to Buy and made the mention of how my wife and I had talked about buy more stock, saying “it was a good time to buy at the lowest point we’ve seen in years.” Again, this isn’t calling the very bottom, but calling a great time to buy. I don’t claim to be able to call the bottom, but this is recognizing that I’d rather buy at Dow 8000 than Dow 12,000.

      I understand the point that Peter Lynch is trying to make. He would have been very right from 1983 to around 1999. I think he would have been wrong from 2000 to 2012. This is using the Dow as a benchmark as it is easier than trying to compare a diversified portfolio at this time.

      I think you underestimate the difference in the global economy now vs. say 1970. “This time is different” is true for almost any given time. The 1990s were different than the 1970s and the 2000s were different than the 1990s. I’m not suggesting that the problems in the US are not insurmountable, but I’m suggesting there’s a lot of risk right now. I think you can only live in debt so long before you have pay the piper and the United States is in that tough situation. The Federal Reserve has done just about everything it can do by lowering interest rates, where they can almost only go up.

      It looks to me that others are being greedy with the Dow being so high given these economic factors. This makes me fearful. I’m expecting people to get more fearful of the manipulation by the Fed (quantitative easing, low interest rates) and high national debt, creating an opportunity to get greedy.

      • Lazy Man says:

        I should add that I bought some more Facebook on Friday at $22.97. Even though I felt that Facebook would go down with earnings as I said, I didn’t sell the shares I had. While it is speculation, it is also something that I’m comfortable owning for years. If it shoots up to $30 soon I’ll sell and take my gains. If the lock-up expires and it gets even cheaper, I’ll probably use it an opportunity to buy even more.

        I realize that the P/Es are very high with Facebook, but I think they have a lot of room to ramp up earnings.

  3. DTM says:

    Good conversation. I absolutely agree with you that people want to sell when it’s the best time to buy. That is the point of the Dalbar study. You asked ” I would like to see a study that eliminates those “negative behaviors” that the Dalbar studies mention. I think that 50% return that the studies say people are sacrificing are those who are chasing performance, which is the exact opposite of my “buy low, sell high” plan.” The study shows that if you had just bought the average run of the mill large cap fund, and forgot about it, 20 years later you would have averaged 8.8%. 8.8% would turn $100,000 into around $500,000. Instead the average investor in those same exact funds earned only 3.5%, in which $100,000 would grow to only around $200,000. They sacrificed $300,000 not just by chasing hot investments, but more importantly I think due to selling out at those low prices when it was the best times to buy. So that is the cost of these “negative behaviors”.

    The idea of buying low is clearly a good strategy, especially when it comes to indexes because entire indexes do not go out of business. Buying an individual security solely because it is less than others paid, even if they are institutional investors, would not be a good idea. Remember, just about all of these institutions, the suppossed smart money, just about put themselves into bankruptcy and had to be joined with commercial banks to avoid it.

    I believe if you are going to have a speculative portion of your portfolio, which is fine and keeps it more interesting, the speculative buys should be based on understanding the business and believing in it’s future. You seem to believe in Facebooks future and are willing to hold it. That is an investment, buying it just because it’s down and you believe someone paid more for it prior so they’ll pay more again is speculation and a poor reason to speculate in my opinion. Remember all the dot coms that got cheaper and cheaper before they eventually went to zero.

    A couple other comments. You said “I’m suggesting there’s a lot of risk right now. I think you can only live in debt so long before you have pay the piper and the United States is in that tough situation.” I’m suggesting at 12x earnings, there is not a lot of risk in owning the quality companies of America and the world. There will always be risks, when you don’t feel there are risks are when you should be nervous (2000). Markets climb a wall of worry. Yes there is alot of debt and it is concerning, but what better to own than quality companies? Would you rather lend money to them than own them if interest rates are going up? Inflation is one way out, and that is horrible for bonds especially at these rates. Equities are one of the best hedges against inflation.

    You also said “It looks to me that others are being greedy with the Dow being so high given these economic factors.” The market is not “so high”, it’s so cheap. The absolute number is meaningless, it’s how much earnings are you getting for your investment dollar and today you get the most earnings for your investment dollar since the early 80s, when you had to compete with double digit interest rates offered by Government bonds. Everything else is noise. Noise that has undermined the average investor to thier detrement as illustrated in the Dalbar study.

    Finally, you said “I’m expecting people to get more fearful of the manipulation by the Fed (quantitative easing, low interest rates) and high national debt, creating an opportunity to get greedy.” This is market timing. This is “bad behavior”. There is no way to do this consistantly. This is a fools game. While it can work, it generally ends worse than just accepting that volatility is part of the deal. In fact, volatility is your friend…. if you’ll let it be.

    It is the “bad behavior” that is the determinant factor in how an investor will fare over the long term, more than anything else. This is clear as we can see in the finding of the last 20 years where the average investor made $100k in my exaple vs. $300k where all one had to do was close thier eyes and ignore the noise.

  4. Jim says:

    Don’t mind me as I babble on.

    Regarding your point “I understand the point that Peter Lynch is trying to make. He would have been very right from 1983 to around 1999. I think he would have been wrong from 2000 to 2012. ” I think you’re probably correct, people may have gotten out and missed big runs trying to aviod bear markets that never occurred in the 80s and 90s.

    The net equity flows of the past decade would indicate that a good percentage of the losses were actually sustained in the bear markets. But why do people continuously sell at bottoms? Because they think it’s going to get worse. Nobody would sell if they honestly believed they are at or near bottom. Most know they can’t abandon equities forever, but rather want to sit on the side lines until things are less uncertain. They are selling on anticipation of a worsening bear market that never comes and they miss the meteoric rise that has historically been the case when the capitulation is complete.

    How many people have missed out on a 100% return over the last three years waiting for the economy to fall apart? People are missing out right now and have been for 3 years anticipating a bear market ( I think they were calling a double dip up until about a year or so ago). Unfortunately, many of them will give up fighting the up market just in time to buy at the top and experience another cyclical bear market.

    I’m not saying the market is going up, I have no clue. I think it’s cheap, but the fact is nobody knows…ever. And I can live with that.

    • Lazy Man says:

      I agree this is a good conversation.

      I’m not sure you can say the difference between buy low and sell high is the difference between buying an average large cap fund and chasing hot stocks. After all, buying the average large cap fund could be done at a high time.

      You make a good point about indexes not going out of business while individual companies do. That’s why I try not to buy individual companies that often. I don’t want to get Enron’d. At the same time, I feel pretty good that Facebook isn’t going away any time soon. Groupon, I feel less sure about, but after reading about their international presence, I more confidence in Groupon hitting $13 before it hits $0. I probably should have qualified that I have great confidence in the companies not going out of business. Facebook is profitable, which is more than could be said for Amazon for a number of years. I see some parallels to them in that they are investing in growing the network, their basic infrastructure rather than making decisions for short-term monetary gains.

      While I believe in these companies’ future, if in the short term I see them go up for a quick profit as I did with Facebook previously, I’m going to lock it in and sell off a majority of the shares. This strategy would have been very bad with investing in Apple that only seems to go up forever, but for almost anything else, if you can make 20% in month, cash out and move onto another company that you believe now represents a better buying opportunity, it seems like a good thing.

      It’s true that the institutions also nearly put themselves out of business with bad decisions, but a key was that they were able to protect their interests where the average person would not be afforded this benefit (the whole, “where’s my bailout” question that many justifiably had). Unlike repackaging of mortgages and such, if they pay $38 for a share of Facebook, that’s pretty much what it is… they can’t package and spin it off as something else. It also seems better to buy below what the institutions are paying rather than the logical alternative buying above what they are paying, right?

      You made a great point about the markets actually not being high on a price/earnings ratio. That’s something that I hadn’t considered. I had just been looking at the bad news and the indexes going up, which didn’t make sense to me. I was so trained to look at major indexes that I hadn’t factored in earnings into the equation. That makes as much sense as buying Facebook because it is $22 a share and avoiding Apple at $600 a share… saying that Apple is expensive (in other words, it makes no sense at all).

      So I did a little looking into the S&P P/E and I found some interesting things. According to this it seems to be 15.93, not 12. I would like to use a more reliable source, but I couldn’t find one. However, this article made points that S&P P/E is deceiving. Their examples are that if you look at the last decade the P/E was highest at the two best buying points the 2003 and 2009 crashes. The article makes a case for the Shiller P/E to be a better measure as it accurately shows bottoms during those buying opportunities. This site has the current Shiller P/E at 22.25, which is higher than the historic mean of 16.43 going back to 1880. I think the S&P 500 looks cheap by this measure. Also, there’s been concerns about earnings due to the Euro not being worth as much. Some bellweathers such as Intel didn’t in earnings recently if memory serves.

      You’ve got a point about the competition of double-digit interest rates in the 1980s. If we just see a return to 4-5% interest rates, I think many will sell off equities and put more money in the “competition.” This makes me see the low interest rates as a negative. They can only go up. When it will happen, I don’t know, but it seems like it will only push the market down when it does.

      Jim said,

      Finally, you said “I’m expecting people to get more fearful of the manipulation by the Fed (quantitative easing, low interest rates) and high national debt, creating an opportunity to get greedy.” This is market timing. This is “bad behavior”. There is no way to do this consistently. This is a fools game. While it can work, it generally ends worse than just accepting that volatility is part of the deal. In fact, volatility is your friend…. if you’ll let it be.

      Yep, I admit that it is market timing, but I’m not convinced it is a “bad behavior” like chasing a hot stock (i.e. buying high) or selling a poor performer (i.e. selling low). I would like to see some analysis of market timing independent of these factors. I also question the wisdom of buy and hold without respecting economic warning signs.

      The flip side of everything that I said is that the US could slowly dig it’s way out of the debt and interest rates could raise so moderately during the next 10 years that they don’t adversely affect the market. This situation, along with a stabilizing Euro, could lead to steady gains in the US indexes as these concerns are alleviated. This ties into the point that you made with regard to Peter Lynch about people getting out to try to avoid a bear market that never happened in 80s and 90s.

      Jim said,

      “How many people have missed out on a 100% return over the last three years waiting for the economy to fall apart? People are missing out right now and have been for 3 years anticipating a bear market ( I think they were calling a double dip up until about a year or so ago). Unfortunately, many of them will give up fighting the up market just in time to buy at the top and experience another cyclical bear market.”

      I think this is kind of my point. These people have missed out on the great return, because they sold at Dow 8000 or so. Now they are thinking about buy in at Dow 13000? That’s clearly bad behavior. I’d rather sell some at 13000 and look to buy more at 12000 and more at 10000. This presumes that the Dow doesn’t go to 15000. However, in these economic conditions I just see the 10000 as much more likely than the 15000.

  5. Evan says:

    Why not take both sides and short until it goes down?

    • Lazy Man says:

      I don’t have the guts to short a stock that I view as cheap in the long term even though the employee lock-up expiring could make it even cheaper.

  6. Jim says:

    I agree that we are in agreement on many points, including it is better to buy things cheaper. I just would not give to much credit to the “smart money” of institutions, my experience has been that they are not neccessarliy so smart.

    It’s funny that finding something that should be so simple as the PE of the S&P would yield so many variable answers, it’s just simple division. Since we’re talking about the S&P though, I’m going to reference S&Ps site.
    http://www.standardandpoors.com/products-services/articles/en/us/?articleType=HTML&assetID=1245337082864
    The last time I had looked it was around 12, with the recent run, I’ll concede it appears to be more like 13.

    I suppose my point is that market timing in all of its forms have rarely worked and is one of the bad behaviors that results in investors leaving the lion’s share of returns on the table. Of course being able to time the market, buy low and sell high, is a spectacular approach, if only it could be done and my stance is it can’t. I’m not saying you can’t, I’m saying nobody can consistantly so it’s better off not being attempted.
    http://www.cbsnews.com/8301-505123_162-37841089/the-smartest-things-ever-said-about-market-timing/

    You stated “I also question the wisdom of buy and hold without respecting economic warning signs.” I don’t. The prediction business is a lousy business. The Wall St. Journal has surveyed economist regarding something as basic as the direction of interest rate changes for the next six months since 1982. They have been wrong 64% of the time. You would have been better off flipping a coin. I love the quote of John Kenneth Galbraith “The function of economic forcasting is to make astrology look respecable”. There are other jokes about the ability of economists to have predicted 12 out of the last 6 recessions.
    http://davisfunds.com/document/read/the_wisdom_of_great_investors/#page_8

    I stated that what matters is how much earnings you are getting for your investment dollar and today you are getting more earnings since the early 80s. This can be seen in the earnings yeild in this chart. 1988 was temporarily higher due to the crash of 1987 2 months prior. Since 1960 the S&P has increased from 58 to 1380, an increase of roughly 24 times not including dividends. During that same time earnings have increased 33 times. Over this period the 10 year bond averaged over 6%, I can’t find a link, you’ll just have to trust me on this one.
    http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/spearn.htm

    How can one argue with the historical facts? Jeremy Seigal has tracked the markets back 200 years and the data is very similar. The declines are temporary, the gains are permanent. Does anyone think the S&P is going back to 58? I meant that rhetorically, but the pessimism is so great today, I wouldn’t be surprise to find a large percentage of the population thinking it just might. By the way, this incredible negative bearish sentiment is one of the most positive signs. Remember, the crowd is almost always wrong.

    • Lazy Man says:

      I’ll take that S&P link as the definitive source on S&P P/E ;-). I was looking for a link on their site for some time and came up empty.

      I don’t think that by holding cash and waiting for a buying opportunity it is getting into the prediction business. It’s not like I’m trying to figure out the interest rate change 6 months from now. During the last 30 years that would be a coin flip. However, what if the question was, “Do you think that at some point in the next five years from now it is likely that interest rates will be higher because they are historic lows now?” I think economics would generally say that they will be higher and I have 100% confidence that they would be right.

      I guess my point here is that I’m not betting on a red or black of a roulette wheel guessing if the market is going to go up this week or down. I’m keeping some cash available to capitalize on buying opportunities because I think there’s going to be some point where it drops. I could be wrong as we may never have a dip or the next dip could be in 2040. However, I see having cash as being prepared to a capitalize on an opportunity, which is something that I didn’t have in 2003 or 2009 when there were dips.

      Maybe I haven’t been following the market sentiment because I don’t watch CNBC any more, but I didn’t realize that it was “incredibly negative bearish.” I mean the bad always makes 6 o’clock news like high unemployment, rising national debt, slowing GDP growth, etc.

      I would consider the bearish sentiment to be a more positive sign if I saw the markets moving in a bearish direction.

      As for arguing with historical facts, I think I said it before, I’m not sure if the economy back before the car was invented is truly relevant today. There were tons of historical facts that showed that real estate always went up, until they didn’t.

      The link you sent with the earnings yield of the S&P 500 was pretty convincing.

  7. Jim says:

    Hey Lazy,

    To continue our conversation, which I’m enjoying, you said “I don’t think that by holding cash and waiting for a buying opportunity it is getting into the prediction business.” First, I understand you are mostly invested and just holding a small percentage in cash. Unfortunately, I think many people are fully in cash. But your quote above is to some extent a prediction that the market will be going down some time soon.

    My statement about the prediction business being a lousy business was in reference to relying on economic forcasting. Sir John Templeton when asked why they did not have an economist on staff said “If we did, we’d probably have to pay them and if we paid them we’d probably have to listen to them”. My point was similar, since we can not rely on forcasting it may be best to disregard it.

    You said “I see having cash as being prepared to a capitalize on an opportunity, which is something that I didn’t have in 2003 or 2009 when there were dips.” It seems to me that you are saying that you have learned from experience that this is the best course. Mark Twain said “A cat who has walked on a hot stove will never walk on a hot stove again.. nor a cold one” The point being to not make too much of an assumption from a limited set of experiences. In your lifetime, you’ve seen the S&P increase from less than 100 to over 1,300 and that’s not including dividends being reinvested. Over this 35 year period there do you know how many times there have been calander year declines of over 10%? 3 and they have all been in since 2000. To be fair, there were bear markets in 1981 and 1990, but they were so short lived they hardly appear as blips on the long term chart of S&P earnings I referenced earlier. So to include them, for 30 out of your 35 years the market has moved up.

    You said “Maybe I haven’t been following the market sentiment because I don’t watch CNBC any more, but I didn’t realize that it was “incredibly negative bearish.” ” I’m glad you don’t watch CNBC, worst channel ever for wealth accumulation. If you would like to see an example of the general bearish attitude go to Yahoofinance and read the comments after any article. I would bet that 95%+ of the comments will be negative. Not just negative, wildly unrational, angry, eomonic collapse type pessimism. Again, I find this so encouraging. Little else gives me more optimism than a pessimistic crowd as they are almost always wrong.

    Again you said “I’m not sure if the economy back before the car was invented is truly relevant today.” Again I say the four most expensive words in investing are “this time is different”. What matters is despite the cyclical temporary pull backs for the last 200 years the quality companies of this country have managed to fairly consistantly outpace inflation by 6.6%. All along this way there has been the chant of this time is different.

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  9. Lazy Man says:

    Jim good points here. I’m enjoying the conversation as well, but getting a little caught up in some other projects… hence the delay.

    I guess I can see how holding cash could be perceived as predicting the market will go down. I do think the market will go down for the reasons that I stated above. At the same time, there’s preparation for negative occurances to take into account. If you were fuly invested and you thought the market would go down, I don’t think you prepared yourself very well. It would almost be like thinking that you might get in a car accident and not buying car insurance. I don’t think buying car insurance constitutes predicting a car accident in the same way that I don’t think having some cash constitutes predicting a market drop.

    Your Sir Templeton story reminded me of a story from my high school calculus teacher. He would say that economists always predict the best economy. If you graph the four possibilities (good economy/good prediction, good ecomony/bad prediction, bad economy/good prediction, bad economy/bad prediction) it is wise for them to so. In a bad economy they going to lose their job anyway (no money for them) even if they are right. So they might as well predict a good economy, because if they are right they’ll get rewarded.

    Part of the point here is that if you know what they are likely to predict ahead of time, their prediction isn’t that helpful.

    I see your point about not making too much of an assumption from a limited set of experiences. Thinking about Twain’s cat and stove analogy one could say that walking on stove is being invested in the market. A market crash is the rare time that stove is turned on. So for the anaology to really be accurate, someone would have to competely avoid the market forever after getting involved in a couple crashes. This would be very difference than realizing, “Hey, when that stove heats up, I drag my mouse over there and make myself a tasty cat dinner.” By that I mean, recognizing the signs and turning a negative into a positive.

    It is true that I’ve seen a lot of the gains in the S&P in my lifetime. I’m not sure if a lot of the gains from the pre-Internet era matter as much in the post-Internet era. I’m not talking about Internet stocks, but more the move to the information age… the increased globalization of everything. In those early days of S&P growth I had products that were made in the USA. Now I don’t. That too me is fundamentally different. I’m not saying that USA is going down the tubes or anything like that… far from it. I just see globalization and economies elsewhere affecting the US more than in the past. That could be a good or bad thing, I don’t know. I do know that it is different. History does show us that there are indeed pockets of eras that are different… industrial revolution… the development of the PC in 1980’s that created fortunes like Gates/Jobs, etc. I can’t buy in that the history of 1960 applies to today’s world. Maybe some parts of do, but a lot does not.

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