Thursday, May 16, 2013
The Four Most Dangerous Words
“The four most dangerous words in investing are, it’s different this time.” Sir John Templeton As the market moves past old record highs fueled by unusually high profit margins, a huge increase in the money supply, as well as the usual suspects; greed and fear, I am once again hearing the four most dangerous words in investing. Yesterday I read an article suggesting that it was too dangerous to stay in conservative dividend paying stocks. Did the author suggest that we should pull some of our profits off the table and wait for a better time to buy? No. He suggested that this time it was different. He suggested that we discard the basic principles of investing, dumping those conservative positions now overvalued by retirement dollars seeking income. He suggested now was the time to take a more aggressive position in cyclicals and technologies because this time it was different. He may be correct in the short run. Fast money may well shoot stocks with high betas into the stratosphere. However the same beta that predicts these stocks will move faster during a bull market also predict that these stocks will move faster once the bear gets out of his cage. Sometimes the bear moves so fast you will not have time to react until it is too late. For New Readers from Wikipedia: “In finance, the Beta (β) of a stock or portfolio is a number describing the correlated volatility of an asset in relation to the volatility of the benchmark that said asset is being compared to. This benchmark is generally the overall financial market and is often estimated via the use of representative indices, such as the S&P 500.” For example, Johnson and Johnson, a classic widow and orphan stock has a beta of 0.55 much less than that of the general market which by definition is 1.00. Cyclacel Pharmaceuticals Inc, a small development-stage biopharmaceutical company has a beta of 1.99, much higher than that of the general market. If something goes up too fast and too far, it will come down, there is no escaping gravity of the business cycle as it turns, and it will turn. The roaring 20s were fueled by new technology; radios and automobiles. Everyone believed that this time it was different, stock prices would continue to go up forever. Here is one quote typical of that era, "Stock prices have reached what looks like a permanently high plateau. I do not feel there will be soon if ever a 50 or 60 point break from present levels, such as (bears) have predicted. I expect to see the stock market a good deal higher within a few months." - Irving Fisher, Ph.D. in economics, Oct. 17, 1929 I was too young to enjoy the bull run of the nifty fifty in the late 1960s and early 1970s. Once again it was widely believed that you couldn’t lose money on stocks like Polaroid, Xerox, and ITT. Things went fine until the first oil crisis of 1973. Then we lost a full decade to stagflation. I am old enough to remember the first gold rush of 1970s. I was too young and broke to participate. I watched gold go from $35.00 an ounce in 1971 to $1,000 an ounce in 1980. Then it fell to around $250 an ounce and stayed there until it was rediscovered about eight years ago. Gold once again peaked in 2011 around $1,900 an ounce. The gold bugs screamed, “This time is different.” It wasn’t different in 1980. It wasn’t different in 2011. I am not selling my gold shares neither will I be buying any more in the foreseeable future. I view gold as a sort of insurance policy that is hedging my position in treasuries. I still believe that gold is an integral component to my portfolio, but I will never believe that it will go up forever. I remind my gold bug friends who sometimes start to think a little like survivalists that if we really face a Road Warrior scenario shotgun shells and gasoline will be the best investments. The big this time is different disaster that I remember only too well was the dotcom boom of the late nineties. My coworkers abused me for paying off my mortgage early. They told me to borrow more money against my house so that I could invest in the Internet boom. I quite literally remember a conversation in which a coworker who was making more money in the market than as a fulltime Government high grade flat out told me in so many words that this time it was different. He told me I could not lose money on the dotcom revolution. If I remember correctly, he lost over $300,000 in 2000. I remember joking with him, “Come down off the roof. Don’t jump. Things will get better,” and they did get better. Please! Please! Please! Let’s be careful out there today.