Readers will recall from what we said last week at New Orleans that rules are what we turn to when we don’t know what to do. And most often we don’t know what to do. Hence, our investment approach – like our philosophy of life – is founded on a bedrock of ignorance. Sure. Constant. Unyielding. Ignorance is something you can count on. A man is wise, and here you may quote us, only to the extent that he is aware of his own ignorance. The wiser he is, the more he sees himself as an ignorant fool. The real fool, on the other hand, thinks himself wise; he thinks he knows things he cannot possibly know.
It is not given to man to know his fate, said the ancients. We can never know what the future will bring – neither in our investments nor in our private lives. Since we cannot know the future, we cannot hope to improve it…except in the most marginal, modest ways. “We will be better off,” we say to ourselves, peeking ahead just a few seconds, “if we don’t step off the kerb quite yet; let us let the bus pass first.” But will we be better off next year if we buy Google today? Will the world be a safer, better place in ten years if we bomb Tehran today?
The gift of clairvoyance is not something you can give at Christmas. But what an awful gift it would be. Yes, we could read tomorrow’s newspapers today. And yes, we could see what direction the gold price was going, for example, and adjust our investments accordingly. We could read about natural disasters, strikes, revolutions and make sure we were somewhere else! But what a boring life it would be. There would be no pleasant surprises. And no chance to improve or achieve. You might win a Nobel Prize, but so what? It was foreordained. All of your striving, sweating and stretching would make no difference; the whole thing was in the bag even before you began.
And imagine the tediousness of it. Day after day, going through the motions of life without the serendipity, the sheer chanciness of it. Every action, every word, every event, already written out for you in bold relief. And you, just muttering your lines like a brain-damaged celebrity, not even bothering to think about what they mean; for what does it matter? The whole show would go on anyway with our without you; you are just playing a bit part in it.
You could look ahead, too, and foresee your last gasp. You hope for, at least, a small crowd of weeping friends and woebegone relatives gathered round your bed as you bid them farewell. Perhaps you will even get to do a grand death bed oration: “The evil that men do lives after them,” you will remember from Julius Ceasar, “the good is oft interred with their bones.” You will look at your children, grandchildren, your wife, your mistress, your creditors, your drinking buddies, and say: “Please remember the good that I was, the good that I did and the affection I have had for all of you. And remember; I’ll be waiting for you all, with open arms on the other side.”
At this suggestion, the grandchildren will get quizzical looks on their faces. They won’t know where the “other side” is…but they have no intention of getting there any time soon and the thought of grandpa’s hairy arms waiting for them will not make them want to hurry.
But what’s this; you turn to the future, you look ahead and see yourself crushed by the same cross-town bus you avoided today! Or done-in by a jealous husband in Santa Monica. Darn, no deathbed scene! “I never get good scenes,” you complain to yourself. And at that moment, you will be tempted to do a little rewriting. “Ah,” you will say to yourself, “I think I’ll stay out of Santa Monica.”
But could you? Even if we could know what the future will bring, we probably still could not reach ahead and improve it before it happened. There are simply too many possibilities. Change one today, and tomorrow’s lines don’t make any sense. Soon, the whole performance changes in ways even the fortune teller cannot foretell.
Even if you could look into the future as it will be you couldn’t possibly look into all the futures that could be. In other words, as soon as you departed from the script, the ending would change in a way you couldn’t predict. You would have lost the power of clairvoyance and will pop right back into the same impromptu low comedy you’re in now, ad libbing from one day to next, ignorant of how thing will turn out, but hoping they sort themselves out better than you have any right to expect. You will have your appointment in Samara, no matter how far you think you are from fate.
If you look at the many mistakes and bamboozles of history, what you find is that the leading characters were misled not by ignorance, but by knowledge. What they thought was so turned out to be not so. Hannibal knew the Gallic and Lombard tribes would rally against Rome. Hitler knew his master-race could beat all the rest of Europe. Investors in 1929, 1966 and 2000 knew that stocks always went up in the long run.
No one has ever been let down by ignorance, on the other hand. Because ignorance forces upon a man a kind of modesty that rarely fails him. He has to retreat to the few things he really does know best and follow rules that keep him from getting into too much trouble.
“I always tell the truth,” Congressman Andy Jacobs once told us. “That way I don’t have to remember what I said.”
Likewise, a man who follows rules neither has to remember what he did, nor wonder about the consequences.
“Did you kill John Brown?” the prosecutor asks him. “I don’t think so,” says our modest hero, “it’s not something I would do.”
“Why not?” the lawyer follows up.
“Because I would never know how it might turn out.”
If you knew that you would be better off by telling lies or killing people, you would go ahead and do so. If you could look into the future – and if you had the power to improve it before it happened – why wouldn’t you? Imagine that it was 1920 and you, for some unexplained reason, had the entire history of the 20th century in your brain. You are travelling in Bohemia and happen to be sitting in a railway car when a young man, recently discharged from the German army, enters the car. His name, you discover, is Adolph Hitler and you have a loaded gun in your pocket. Pull the trigger. Why not? Whatever happens, it is not likely to be worse than what did happen.
Alas, we have no histories of the future. Ignorance is all we can count on and rules are all we have to go on. We do not kill, we do not steal and we do not lie. We follow rules because we are ignorant. Nor do we buy investments that are overpriced. They might go up, of course. But we can’t know that. So, we stick to the rules.
So, here is a general rule for you:
If someone wants to sell you an investment, you don’t want to buy it.
Investments are different from other things you might buy. You could expect to buy a good used car, for example, simply because the previous owner needed a bigger one or wanted a snappy convertible. So too might you get a good deal on a watermelon, if the farmer had an especially bountiful crop. A nice house might be offered to you, if the previous owners’ children had grown up and moved away; he might feel it was time to ‘downsize.’
But nobody ever voluntarily downsizes an investment portfolio. Nobody ever has too many shares of a good stock, or trades in a good investment just because he’s had a hair transplant and is looking for a little action. Barring a forced sale, serious investors hold good investments until they believe they are no longer so good. Which means that buyers must realize: whenever they buy a share, they take it off the hands of someone who probably knows it better than they do and who judges it no longer worth holding onto.
And there’s another reason to look askance at what people sell you: selling costs money. Every investment that is packaged and sold requires lawyers, accountants, secretaries – not to mention advertising costs and sales commissions. Just look in any financial magazine or newspaper. What do you see advertised? Mutual funds. Insurance programs. Managed accounts. Private banking. All the things that have such wide margins that they can afford to advertise. You will find ads for funds, funds of funds and maybe even funds of funds of funds. Because each layer carries an extra little bit of grease. The investor who buys a fund of funds of funds is practically walking down a dark street in a bad neighbourhood with a sign on his back: I’m Carrying $500 in Cash!
“But the professional will get a better rate of return,” you might protest. “So it’s worth paying a little bit in commissions.”
Is that so? It is probably so that a little grease will ensure that a professional will not do anything patently absurd and foolish. He has no incentive to do so. And he’s usually learned enough about investing to avoid the obvious mistakes. In this sense, the rank amateur – if he is too lazy to read a book or think about it for a few hours – is better off paying the commission. But between the serious professional and the serious amateur, the returns will be about the same. Both have available to them the same information and the same theories.
The best investments are those no one wants to sell. They are the investments that pay no commissions or fees, that have no managers, that give no press conferences, that issue no quarterly reports and that you have to work hard to find. These are the kind of investments private investors look for…and often wait years to buy at a good price.
Who do we all know – at least by reputation – who invests this way? Guess who? Warren Buffett, the most successful investor of all time. Buffett famously disdains the gaudy baubles of the modern investment world. He uses no computers to do his research, preferring a yellow note pad and a Number 2 lead pencil. He waits on no brokers to provide hot tips. He is his own fund manager, a service for which he charges no fee. And he searches out companies – often over the course of many years – as a private buyer would, focusing on the earnings yield the company will bring, not on a speculative capital gain.
That is to say, in investing as in everything else, you don’t get something for nothing. The investors who succeed are those who work hard at it and avoid the public spectacle of the markets. In fact, only lazy investors are ever ‘in the market.’ Instead, the more serious they are, the more they are out of the market and into specific companies that they know inside out.
For in investments, as elsewhere, it is the ‘insiders’ who generally do better than the outsiders. This should come as a surprise to no one. The insider is the person who has eliminated the most unknowns – by actually knowing what is going on in the business. In this sense, he is the most private of investors; in Nietzschean terms, his knowledge is far more private erfahrung – actual experience – than it is public wissen – what everybody thinks he knows.
The ordinary investor cannot be an insider in the stocks he buys. But he can come very close. He can work hard to learn the industry, study the business and get to know, in detail, both the numbers and the management. If he does his work well, he will choose an industry he likes close to home and stick to it for a number of years and gradually come to know the business better than the real ‘insiders.’ That’s what Buffett tries to do.
What you’re doing, of course, is lessening the likelihood that your own ignorance of the future will hurt your investment performance. The more you study, the more you know, the more familiar you are with the business – the fewer unknowns there are.
Of course, you can never entirely eliminate the unknown unknowns. That is why you must also have rules, principles and theories, they allow you to make decisions even when you don’t know the facts.
Our most deeply held theory here at the Markets and Money is that everything that lives also dies. It is just an observation, but it seems to apply to everything – trees, governments, financial systems, bubbles, empires, and people themselves. There is a life cycle to all things – institutions, insects, and insurrections. They begin small, they grow, they mature, they get taken over by parasites and they die. Tout casse et tout passe, as the French say. Everything breaks up…and everything goes away.
In the stock market there is a life cycle of from 30-40 years from one peak to the next. In the last century, the big peak in ’29 was followed by another peak in ’66 to ’68, almost 40 years later. The most recent peak is still in question.
We believe it came in January 2000. The Dow is now higher than it was then, but only in nominal terms. Adjusted for inflation, the Dow is actually about 20% lower. Adjusted to euros, the Dow is still a bit lower. But it is in terms of gold that the Dow has really been hacked down. Since 2000, it has been cut in half. In that year, it took more than 40 ounces of gold to buy the Dow stocks. Now, it takes only 20 ounces. And if we’re right about these cyclical patterns, the next major bull market in stocks may not come until the year 2040.
One little insight into how these cycles work: In the 1970s you could buy a seat on the New York Stock Exchange for about the same price as you could buy a New York taxi medallion. You needed a seat on the NYSE if you wanted to sell shares. You needed a taxi medallion if you wanted to operate a cab. Investor sentiment was so negative on equities at the time, they seemed to think you’d make as much from driving a cab as selling stocks.
But in the bullish trend that began in 1982, shares – and seats on the NYSE – sprouted wings. Now, they’re flying. You can buy a taxi medallion for about $400,000 today. But if you want a seat on the stock exchange it will cost you 12 times as much – $5 million.
We have no way of knowing, but if the patterns of the past repeat themselves, seats on the NYSE – and shares generally – are now a bad bet. You want to buy investments after they come back down to earth. And if the bear market trend really did begin in January 2000, it will probably take another 10 or 15 years to run for shares to hit the ground!
The bond market, too, may have peaked out in June of 2003…we’re still waiting to find out for sure.
And US housing, the mother of all markets, now seems to have topped out. We don’t know any more than you, mind you, just what we read in the paper.
“Record Inventories,” says one headline. “Sales falling in 39 States,” says last week’s AP report. “Sellers Offering Free Cars, Other Incentives,” say the local news stories.
These cycles of up and down, bull and bear, are well known. What you can never know for sure is where you are in the cycle. “Markets always do what they’re supposed to do,” say the oldtimers, “but never when they’re supposed to do it.
While the Dow, US bonds, and US housing are probably going down, some things are probably going up. Japan has been in a slump for 16 years; it now looks like a good bet to change direction.
And gold suffered a bear market that lasted for the last two decades of the 20th century. Since George Bush entered the Oval Office, gold has more than doubled. It seems to be in a long-term bull market.
But there’s nothing like a 20-year bear market in his favourite metal to give a man a sense of modesty. As your author’s gold coins fell in value; his stock of modesty increased. Now, at least, he knows what he doesn’t know.
That still leaves the things about which he knows nothing at all: Unknown unknowns
Here we are in terra incognita. Since 1971, for example, the world financial system has looked to dollars to store and measure its wealth. But to what does the dollar look? Nothing at all. It merely floats on its full faith in empty promises and the credit of the biggest debtor in the world – the USA. We’ve never seen anything like it. People work all their lives to lay in a store of a pure-paper money that lost half its value in the last 20 years and could lose the other half any time. Foreign governments, pension plans, insurance companies, hedge funds too stake their financial futures on this same paper money, whose value is uncertain and whose future is unknown.
Never before have so many people had so much wealth tied up in so many dubious propositions. During the 20 years from 1980 to 2000, the capital value of America’s stocks rose more than 1000% and the value of America’s residential housing approximately doubled. Meanwhile, so has the American government’s ‘financing gap’ gotten so large it will likely never be bridged. Between the financial obligations of the US federal government and its anticipated revenues is a canyon of $65 trillion, in present US dollars. No nation ever faced such a huge economic challenge.
Nor have the western economies – including Japan – ever been threatened by the competition they’re now getting from 3 billion Asians. Nor has any country ever run a trade deficit on the scale of the current US shortfall of $800 billion. Nor has any country had anything like the dollar reserves now in the hands of the Chinese – more than $1 trillion of them.
Also unprecedented is the derivatives market. As recently as 10 years ago it barely existed. Now, the latest news tells us it has swollen to more than $300 trillion. What kind of shock would it take to bring it down? Even if it only shivers and shakes, what will happen to the financial system when it does?
Against all this kudzu of dollar-based wealth, debt and delusions is a solid, slow-growing oak of gold – man’s traditional way of keeping score in financial affairs – getting larger at the almost invisible rate of 1.7% per year.
How will it all turn out? We don’t know. All we do know is that every previous monetary system has washed up. And every paper currency every previous experiment with paper money has ended in regret and recrimination. All bubbles end. All of them. And when a bubble in paper money comes to end, typically people abandon the paper and rush back to gold.
Sooner or later a day of reckoning must come for the dollar, America’s trade deficit, and the world’s faith-based monetary system. We don’t know how. We don’t know when. But it is a pretty good bet that it will happen.
Of course, if you knew how it would turn out, if you could look into the future, you could take just the right action at just the right moment to take advantage of it. But we are profoundly ignorant. All we know is that, however it ends, it would probably be a good idea to have a few gold coins in your pocket when it does.
Markets and Money