Editor’s note: I want you to go and check out Shae Russell’s new report on gold if you haven’t already. Shae, over at The Daily Reckoning Australia, is one of the country’s smartest gold analysts…and she has a take on the market I know you’ll find interesting. It may even tempt you to buy some…go HERE.
Life is full of irony.
The 1970s game show Great Temptation hosted by the popular Tony Barber was axed in 1975 because people gave into an even greater temptation…sex.
A raunchy TV series, Number 96, based on the lives of those who resided at 96 Lindsay St Paddington, made rem actress Bev Houghton who played Abigail famous.
For the first time in Australian television history, full frontal nudity and sex scenes were beamed into our lounge rooms.
Ratings boomed as viewers switched channels…preferring the physical to the mental.
After a five-year break, the format of Great Temptation was revived in 1980.
Same host, but a different title…Sale of the Century.
Ah, the irony.
Over the past decade, the Great Temptation of low interest rates, an abundant supply of dollars (courtesy of QE) and meteoric asset prices has created (what’s widely recognised as) the ‘everything bubble’.
How ironic that the Great Temptation of the past decade will lead to the Sale of the Century in the next decade.
And the warning signs of that Sale are there for those who care to look…especially the signals coming from the insiders.
The headlines proclaim strong employment numbers out of the US.
The mainstream interpretation of this data is ‘the economy is strong and therefore positive for the market’.
Well, that’s not how the people who do the hiring and firing see it.
CEO confidence (orange line referenced to LHS) has fallen into a range that has previously coincided with a US recession (grey bars).
The fall in confidence from those providing the jobs occurs around the same time as jobless claims hit a low (meaning more people employed and less people looking for work).
After the recession, the trend reverses.
CEO confidence rises and so does the jobless claims (people seeking work).
Source: Real Investment Advice
Are you prepared to bet against the insiders and this established pattern?
Sooner or later a US recession is coming and when it does it will extract a heavy price from those who believed ‘it’s different this time’.
To take advantage of the forthcoming Sale of the Century we have to keep our heads while others are losing theirs.
When it comes to matters of capital, the head must overrule the heart.
Having a set of rules to assist in making considered decisions is what sets the winners apart from the losers.
When the crowd is reacting irrationally, it’s imperative to act rationally…understanding why the mob is panicking; knowing when bargains are on offer; applying a disciplined approach to gradually buying into a falling market.
I can tell you from experience, when it happens, you’ll be surrounded by doubt and uncertainty.
What if the market falls further? Perhaps it’s different this time and the market doesn’t recover?
The negative self-talk generates the emotion of fear.
Crazy as it sounds, when the social mood is dark, disruptive and downcast, it’s difficult to fight the trend.
That’s precisely when clear minded investors need a set of rules to remain focused.
Guiding principles that help avoid the distraction of fear and uncertainty that makes others react illogically.
Bob Farrell, who commenced his career with Merrill Lynch in 1957, developed the timeless ‘10 Rules of Investing’.
It’s an invaluable guide for all investors who want to act on reason and not impulse.
For anyone interested in Farrell’s background, this is the link to his Hall of Fame page with the Institutional Investor.
Here’s some of Farrell’s rules that I think people should heed today…especially as the US share market has enjoyed the longest bull run in history.
1. Markets tend to return to the mean (average price) over time.
‘Reversion to the mean’ is a time honoured mathematical principle. Extremes in either direction eventually get corrected. That’s the logic.
But when it comes to markets, emotions (greed and fear) are never far from the action.
Perhaps it’s different this time is a pitiful attempt at trying to apply some (flawed) logic to a highly emotional situation.
This banal reasoning is always applied to rationalise away the irrational.
But it’s never different. The one absolute certainty is that markets always ‘mean revert’.
The big unknown is, when?
The longer a market takes to reach its point of absolute extreme (in either direction), the more convinced investors become that the trend is permanent…extrapolating the present into the future.
No market goes in a straight line indefinitely. Every chart is dot pointed with peaks and troughs.
Knowing markets always mean revert, but not knowing when that’ll happen is why it’s prudent to employ a ‘dollar-cost average’ strategy to buy or sell.
Gradually buy into a market that’s below the mean and gradually sell out of one that’s above the mean. The actual timing of these actions is down to individual choice and risk tolerance.
2. Excesses in one direction will lead to an opposite excess in the other direction.
Over 300 years ago, Sir Isaac Newton discovered ‘for every action, there is an equal and opposite reaction’.
Rule number 2 is hardly a new concept.
But, even Sir Isaac ignored his own logic when he made his ill-fated investment in the South Sea Bubble.
Emotion got the better of him.
According to Business Insider:
‘Back in the spring of 1720, Sir Isaac Newton owned shares in the South Sea Company, the hottest stock in England. Sensing that the market was getting out of hand, the great physicist muttered that he ‘could calculate the motions of the heavenly bodies, but not the madness of the people.’ Newton dumped his South Sea shares, pocketing a 100% profit totaling £7,000. But just months later, swept up in the wild enthusiasm of the market, Newton jumped back in at a much higher price — and lost £20,000 (or more than $3 million in [2002-2003’s] money. For the rest of his life, he forbade anyone to speak the words ‘South Sea’ in his presence.’
It’s not just the strong who weaken, the smartest can also allow the heart to overrule the head.
The Shiller P/E 10 is a good proxy for gauging social mood.
Source: Guru Focus
In good times (like the peak of the Roaring Twenties) enthusiasm (driven by emotions) drove the P/E multiple up to 32…well above the historical mean of 17.
In the bad times (the trough of the Great Depression) the multiple shrank to a low of 5.
The reason excesses in one direction rebound with equal force, is due to the emotional drivers of greed (euphoria) and fear (panic).
In recent times, excesses have reverted to the mean, but not beyond.
Central banks — with increasing amounts of intervention — have managed to contain the emotional response before it reached full blown panic.
Should future Central Bank intervention efforts fail to arrest the emotional slide, then we’ll see the social mood barometer (P/E 10) fall into the single digit range.
An equal and opposite force is like a coiled spring…just waiting to be released.
3. There are no new eras — excesses are never permanent.
‘A lesson I learned early is that there is nothing new in Wall Street. There can’t be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again.’
Jesse Livermore, legendary Wall Street trader
The list of ‘new eras’ is a long one.
- Tulip Bubble — 1600
- Mississippi Bubble — 1720
- South Sea Bubble — 1730
- Railroads — 1845
- The Gilded Age — 1907
- Commodities — 1973
- Entrepreneurs — 1987
- Long Term Capital Management — 1997
- Technology — 2000
- Real estate/ Subprime Lending — 2007
- The ‘everything’ bubble — ????
Each one of these new eras was proclaimed as ‘it’s different this time’.
It never is.
The new era, like railroads and technology, can produce much value to society. But there’s a big difference between value and price.
Investors place too high of a price on the new era…rampant speculation takes over. People fall for the Great Temptation.
Eventually, Rules 1 and 2 prevail and prove that excesses are never permanent.
There is money to be made in the ‘euphoric trend’. The trick is to not believe in the permanency of the trend. The smart money knows that eventually the queue of ‘bigger fools’ does run out.
If the fall in CEO confidence is any guide, then investors should avoid The Great Temptation of staying too long in a market that’s primed to deliver prudent investors The Sale of the Century.
PS: Here is the simplest way to save money in a low interest rate economy. Click here to watch.