Saturday, January 27, 2018

Bullshit or Bearshit?

Is the stock market poised to take off even further?  Or are people getting ahead of themselves with giddiness?

One thing that puzzles me again and again, is that throughout history, whenever something has gone up in value dramatically, the average man on the street buys in only after it has gone up.   Buy high, sell low - the sure recipe for disaster.

And this goes back centuries.   During the 1800's, railroad stocks took off, and the small investors jumped on at the end of the bubble - often pouring money into sketchy johnny-come-lately railroads that went from nowhere to nowhere and were the first to go bankrupt.  Why did they do this?

In a way, it is similar to Bitcoin or other sketchy investments today.   People see Bitcoin shoot way up in value.   So they think, "I will buy this and it will go up further in value!" and of course, it "corrects" and goes down in value.   The small investor then panics and sells for less than they paid, and goes on to look for some other "next big thing!"

Or they might look at Bitcoin and think, "Well, that's already gone up in value to the point that I can't afford it!" so they buy some other "crypto" which they think may be poised to shoot up in value like Bitcoin.   This is akin to buying the Durango Railroad or some other small, narrow-gauge line that will surely go belly-up when the market collapses (and the mines it serves peter out).

Now, what is interesting about this, is there is a predictable pattern of human behavior at work here.   And it doesn't matter if the "thing" they are investing in is railroads, cryptocurrencies, real estate, precious metals (hey, silver is almost as good as gold, right?), dot-com stocks, or even tulip bulbs.   People behave in a predictable quantum pattern.   You can't predict the behavior of the individual, but you can predict the behavior of the crowd.

And since a new crop of young investors comes along about every ten years or so, you can predict this pattern will repeat, again and again - and again.

When I was in my 20's and 30's, I did the same sort of thing - trying to divine what was "a good investment" based on the price history of a stock.   The market was going nuts under the Clinton administration, and I thought, "Gee, I should get in on this too!"   Grocery clerks swapping stock tips - it happens to every generation.

The reality was, of course, that  I was already in the market in the form of my 401(k) at work - as well as Mark's.   And the money I squandered trying to "beat the market" would have been better spent just parking it in that 401(k) and letting it grow organically over time.   And like every generation before me, and every generation since (and every generation to come) I had to learn this lesson after losing a few thousand dollars - money I could ill-afford to lose in my income bracket at that point in my life.

Why do young people think this way?   Or even some older people?   My finances at the time were a clue.   At that age, I had a recurring balance on my credit card - intractable credit card debt that I could never seem to pay off.   I didn't balance my checking account, other than to look at the monthly statements and perhaps try to write down the checks I wrote in the "register" of the checkbook.  Those little carbon-copy checks helped a bit, but not much.

What changed?   Well, starting my own business forced me to learn about accounting methods.  I had no idea what "Accounts Receivable" and "Accounts Payable" meant when I started.   I got paid and deposited the money to my bank and then I wrote checks to buy things I thought I needed.   I was pretty stupid.

After a year, I took an adult education course in Arlington on how to use Quickbooks, and I learned a bit about accounting methods and also how to keep track of what was owed to me, what I was spending, and moreover, how much I had in the bank.   This got my business accounts in order - but it took several years before I applied this to my personal life.

Run your personal life like you would a business - and that might mean learning how to run a business first.  Sadly, basic accounting and finance are not taught in school - not high school, not college - unless you plan on majoring in accounting.   So most folks are as ignorant as I was for half my life, about "where all the money goes".

But getting back to investing, my pattern there mirrored the pattern in most people's lives - and the pattern we are seeing today.   It isn't shocking that people today are throwing money at things and hoping it sticks - that is human nature.   It is just like this "Tide Pod Challenge" nonsense - people used to swallow goldfish and do other stupid things.   Just look at the haircuts we used to have in the 1970's - it makes you cringe.

Today, in addition to sketchy investments like cryptocurrency, people are just throwing money into the stock market.   This started after the election, based on the premise that Trump would slash regulations and American businesses would take off.   And when the new tax law was passed, it went into overdrive.   Surely this big cut in corporate taxes would unleash a new era of growth and prosperity, right?

Maybe, maybe not.   As I noted in another posting, while the old corporate rate was indeed 35%, there were so many loopholes in the law that many if not most corporations never paid close to that rate.   In fact, it was a constant rant on the Left how such-and-such a corporation "didn't pay its fair share of taxes!" - a charge often leveled at General Electric, which given recent events, seems like a quaint notion today.

To younger investors, who haven't seen the downside of the Bull market before, this seems like a great time to invest.   A 24-year-old today was 14 when the economy melted down in late 2008 and the banks and auto companies were bailed out.  What he remembers about the market back then - and the signs of the coming meltdown (which happened when he was 10-12 years old) might not have made much of an impression on him.   When you don't have money in the game, what the market does is sort of irrelevant.

For example, I am often surprised to read about market meltdowns in the past, when I was younger, as I failed to notice them - not having anything invested in the market.   When I was 18-22 years old, we had high inflation, high unemployment, and rationed gasoline.   These were things I remember from the consumer side of things as that's what I was.   I remember the peanut butter and coffee shortages in 1979.   I could not tell you how the stock market was doing at the time, as I had no stocks back then.

But the more I was invested in things, the more I noticed - and started piecing together pieces of the puzzle and realizing the patterns in the market were there - and had been there before, but I just failed to notice them.   I was stung in the real estate crash of 1989, but not by much.   I just had to grin-and-bear-it and wait a few years for our house to be worth what we paid for it.  It wasn't much of a crash, compared to 2007 or thereabouts.   Some people who bought houses at the peak of the market then are still underwater on their homes.   Indeed, the home we own today is worth, on a good day, maybe what we paid for it.   It's a good thing we don't have a mortgage - or worse yet, a funny-money mortgage.

But we did OK in the last go-around because we sold most of our investment real estate before things got really bad.   And since we held most of it for a decade or more, even when we sold one property after the peak, we still sold it for almost three times the purchase price.

Now the stock market meltdown, which peaked (or valleyed) in February 2009 (Black President!  Sell Everything!) was something we didn't really anticipate or time very well - but then again, timing the market is hard to do.   We had to grin-and-bear-it and within a year, we were back on track, although if we had sold in December of 2008 and bought everything back in March of 2009, we could have easily have double the amount of money we have today.

Timing the market is difficult to do.   But what seems odd to me is that the novices seem to have a knack for reverse-timing the market.   When the market goes up, they buy, buy, buy.   And when it crashes, they sell, sell, sell.   I recounted how an oldster here on the island "sold it all" in February of 2009, so he "wouldn't lose even more!"   As it turns out, he sold at the bottom of the market and locked in his losses.  Greed and Fear drive the market, it is said, and if you give into these two emotions you will end up screwed.

The Greed part is easy to understand.   Everyone is making money, why shouldn't I?   So people buy things they don't understand and end up broke.   And it is a hard impulse to suppress.   If you see someone doing well at something, you want to copy their behavior.   But oftentimes, it is impossible to copy other's behavior without a working time machine.

The Fear part is a little more complex, and we'll get to that later.  Suffice it to say, when people see they are losing money they often panic and try to "do something" about it - but the only thing they can do is to sell at the bottom of the market, which is not a smart choice.

But getting back to Greed, when I was doing well in Real Estate, some friends decided that, seeing me make money at it, they should buy investment properties, too.   I kept reminding them that the reason I was doing well was that I bought a decade earlier when prices were low and banks were desperate to give properties away.  I bought when fear ruled.  They bought during the greed cycle.   A decade after my friends bought, the same pattern repeated, only worse - banks were desperate to give properties away, and because of fear, no one was buying.

Today, the hot thing is the stock market, and many folks are sounding the alarm - just as people did in the past regarding real estate, dot-com stocks, and today with "cryptocurrency".   And just as in the past - and as is happening today - these warnings are shouted down.   Obviously they are wrong!  Look how far the market has shot up!  Look how much Bitcoin has gained!

But things shooting up in value is the one sure sign that they may correct over time.   Markets are unstable and undamped systems - many times - and as a result, prices tend to overshoot and undershoot their real values.   The idea that "market value" for something reflects a real value is a myth.   Market value is a perceived value of things, and perceptions can be radically skewed.

In a recent CNBC article (disclaimer:  This is the same network that employs the shouting guy, who says "now is the time to invest!") they note that an index calculated by Bank of America indicates that the market may already be overheated:

While the inflows have helped push the market higher, they also can be seen as a contrary indicator when they flash signs of excess. BofAML uses a proprietary "Bull & Bear" indicator that gauges when inflows or outflows point to investors moving too far to either side. 
The current reading on the indicator of 7.9 is the most bullish since a reading above 8 in March 2013 — a sell signal. Michael Hartnett, BofAML's chief investment strategist, said the Bull & Bear indicator has shown 11 previous sell signals since 2002 and has been correct each time. 
In the near term, around February and March, that suggests a technical pullback for the S&P 500 to 2,686, which would represent a drop of close to 6 percent, Hartnett said.
This is not to say the market will crash, only that it may be ahead of itself and a correction is due.  If you are investing for the long-haul - a horizon decades away - then this should not concern you.  After all, a 6% pullback after a 7% gain in a month is not that bad a deal.   That still represents an annualized 12% gain for the year.   You may see your investments go down, but they should recover, provided you are not investing in crazy things like crypto, gold, or some new dot-com IPO bullshit.

If you are invested in rational things, for the most part, they survive these pullbacks.  Companies that are making money and selling things will turn around the fastest.   The market may go down, but then people realize that ACME company now has a P/E ratio of 10, and pays a regular dividend and just reported decent profits.

Of course, there could be a bigger pullback on the horizon.   There is a lot of systemic rot in our system today, and the recent debacle at GE is a case in point.   It seems management has been hiding the real extent of the company's troubles.  Gone are the days when they could afford to own their own vacation island.  They have a huge pension and health care liability, and their insurance division over-sold long-term care policies without properly funding them.   In fact, most of GE financial has a net worth of zero these days.   Only the divisions making things like jet engines and turbines and medical equipment appear to be worth much - and they may be spun off.   Of course, this raises the question, how many other companies are hollowed out from the inside like this?

We hear about the bankruptcy of Toys 'R Us, and the Amazon Washington Post claims that it was Amazon that done it - driving them out of business with Amazon's low-low prices.  Sign up for Prime today!   The real reason wasn't Bezos' relentless pursuit of market share (at the expense of profits) but that Toys 'R Us was loaded to the gills with debt, due to a private equity buyout.   It was a classic bust-out scheme, but unlike what Tony Soprano does, perfectly legal.

But you have to wonder, how many other companies are in a similar situation - loaded down with debt, but getting by, because interest rates are at an all-time low.   Those corporate bonds are coming due and interest rates could be up at least a point or two - enough to wipe out the modest profits these companies are eking out.

The problem for the small investor, of course, is that life circumstances often dictate when you buy or sell investments, far more often than market timing.   We buy stocks when we are younger, to save for retirement.  When we are older, we sell these investments and live on the money - often forced to do so at age 70-1/2 by the IRS.  So for me, I am at a stage in life where I am selling more than buying.  You may be in a different position.

I am not Bullish or Bearish, but a Realist.   The market goes up over time more than it goes down.  Being Bullish is nonsense - the market doesn't need cheerleaders.  But if you can detect the signs of rot, decay, and over-enthusiasm, that's where you can make money.   People don't get rich from spotting things that have went up in value.   But folks who can spot when something is going down - or is undervalued - can make a mint.  The folks who "spotted" the real estate crises cleaned up.  Warren Buffet doesn't make money buying things that are hyped by Jim Cramer - quite the opposite.  He finds "diamonds in the rough" and polishes them up - often buying things that the "smart" people laugh at.

But if I had to guess, I'd say this present exuberance will be short-lived, in part simply because things are going up too fast, too soon.   But there are other factors to consider as well:
  1. Real Estate is again overpriced in many markets.
  2. Interest rates are climbing, which will make refinancing debts more costly.
  3. Corporations are heavily in debt (see #2) which will cut into profits.
  4. Individuals are heavily into debt, limiting their ability to buy things.
  5. A tariff war will raise prices domestically and reduce exports
  6. Farm income is off by half.  The tariff war could bankrupt many farmers.
  7. When bubbles burst, it creates uncertainty in the market.  Bitcoin.
  8. Too many amateurs are getting into investing.
  9. Amateurs are looking for huge short-term returns. 
  10. World Politics. 
 The list goes on an on - maybe you have some factors as well.  And maybe I am wrong about this.  But a decade-long bull market has to end sometime, and let's just hope this one ends well - with a gentle, "pffffft!" and not an explosive "Bang!"