How to Make Cents in Today’s Senseless Market
Knowing quantifiable, measurable stats can help you make money year in and year out – But NOT in Stocks!
On Friday, August 10th, 2018, an otherwise well behaved Airline ground worker named Richard Russel climbed into the cockpit of a Horizon Air Q400 aircraft at his workplace.
Mr. Russel, not a licensed pilot, taxied out to the runway, ignored commands from Air Traffic Controllers at Seattle-Tacoma International Airport, throttled the engines and took off.
What followed was a dramatic and puzzling flight that included several acrobatic dives and rolls out over the gleaming waters of Washington’s Puget Sound. The flight maneuvers were so advanced they stunned experts on the ground.
Flight to Oblivion: Not everything in life, or investing, makes sense.
Mr. Russel carried on a matter of fact, whimsical conversation with air traffic controllers – never explaining how or why he was flying the plane. He claimed he got his flight training from “videogames.”
Then, about an hour after takeoff, flanked by two F-15 fighter jets scrambled from a nearly Portland air force base, Russel crashed the Q400 into an all but deserted island off the coast of Washington. His body was found amongst the wreckage the following day.
Aside from the obvious concerns this story raises about airline security, the primary take away is that it makes absolutely no sense . Why would a seemingly normal individual with no criminal record, no history of mental illness, a stable job and described by his friends as a “warm, compassionate man,” suddenly steal a commercial aircraft, joyride it for 60 minutes and then crash it into the ground?
Does Investment “Common Knowledge” Make Sense?
It brought to mind a recent dinner conversation I had with a financial advisor friend of mind a few weeks ago. During a discussion we were having about our respective industries, he said “I know that’s your thing. But commodities never made any sense to me.”
“Really?” I replied. “Because stocks never made any sense to me!”
He laughed. But deep down, I wonder if equities really make any sense to him.
The US trade dispute with Turkey and the ensuing collapse of the Lira, has thus far had a muted effect on the DOW.
It is given as “common knowledge” in the financial industry that everybody should buy stocks because over time, they always go up.
And this may be true – if you’re willing to ride out the Russel-like rolls and dives that come along with long term holding.
But I always had a hard time taking it on faith that something will “always” eventually go up just because that’s what its always done. Past performance is not indicative of future results, right?
You see, of all of the stock books, analysis methods, PE ratios, and earnings reports, it never really added up for me.
You can pick the best stock in the world. But if the index cracks up like Russel’s Q400, your stock is going with it. It’s just a little piece of the bigger airplane. You can do everything right and still lose because of an outside event.
But you can also lose just because nobody else likes your stock.
A Keynesian Beauty Contest
My beef with stocks need look no further than revered economist John Maynard Keynes. In an effort to explain the stock market, Keynes created an example that came to be known as a Keynesian Beauty Contest. This contest is actually an analogy based on a fictional newspaper contest, in which entrants are asked to choose the six most attractive faces from a hundred photographs. Those who picked the most popular faces are then eligible for a prize.
…the public prices stocks not on their their fundamental value, but what they perceive others fundamental value of them is.
Keynes states that a naïve entrant would pick the 6 faces he felt were most attractive. But a more sophisticated entrant would select faces that he felt other people would think are most attractive. Consequently, as others caught onto the strategy, everyone would eventually be trying to guess everyone else’s perceptions, rather than the faces they actually found most attractive.
Keynes believed the stock market worked the same way . His theory was that the public prices stocks not on their their fundamental value, but what they perceive others fundamental value of them is.
2018: Making Sense?
Could this explain why everyone kept piling into tech back in 1999, even as values soared into the stratosphere? Could it explain why even while facing a potential globaltrade war, an apparent economic dumpster fire starting in Turkey, an historic mid-term election that could potentially result in attempted impeachment of a sitting US president, a soaring US currency,rising US interest rates and a national debt topping $21 trillion, the US stock market hops along giddily higher?
January (or worse) is what happens when the herd gets spooked.
Taking the Stairway up and Elevator Down. What will spook the herd next?
It is true the economy is soaring. Consumers are jubilant. Tax cuts and lower regulation have indeed supercharged the economy. Good for the US. And Good for US Stocks. But how long is this sustainable?
CNBC pundits rave as equities drive ever higher. What they tend not to mention is that stocks are merely clawing back the losses the market handed out during the January train wreck . Stocks take the stairway up and elevator down, remember?
Did January’s fiasco having anything to do with the fundamental value of the underlying stocks?
The public prices stocks not on their fundamental value, but what they perceive others fundamental value of them is.
Fundamental value or popularity contest?
Thus, stock values move on the mood of the herd. January (or worse) is what happens when the herd gets spooked . And despite the roaring economy (which we whole heartedly applaud) there just seems to be a bit too many things orbiting right now to spook the herd – especially as September rolls around and people start paying attention to their portfolios again.
You can measure, analyze, and calculate all you want. In the end, it’s a v oting contest based not on numbers or reason, but emotion.
Thus to my dinner friend, I explained that trying to make money by guessing at moods or emotions doesn’t make sense to me.
But numbers do.
I don’t need a beauty contest. I need something I can measure.
The Lira can fall to zero tomorrow. People won’t stop eating cornflakes.
Commodities – A Quantifiable Investment
Commodities on the other hand, have not the luxury of waiting for public moods. Food manufacturers, farmers, airlines, builders – these entities don’t have the luxury of waiting for popularity voting . They need raw materials, or to hedge their raw materials, NOW. Their entire business depends on it. And with MUCH less public participation in the commodities markets, prices tend to take their cues from measurable, quantifiable aspects of old fashioned supply and demand.
As mentioned earlier, you can pick the best stock in the world. But if the currency of a third world country collapses, if a political story explodes, if the second largest economy in the world slaps tariffs on US goods – I have NO IDEA how it will impact stocks. Do you?
It all depends on how the public votes. Do they like the index as a whole? Do they like your individual stock?
Turning Sense into Cents in Commodities
You can however, garner a fairly good idea of how these type of things are affecting commodities. Supply and demand can be measured. Supply/demand trends are typically slow moving and gradual. But you can SEE it. How many bushels of soybeans were bought last month is concrete, real, and inarguable. It’s not how somebody feels.
In addition, the demand curve for physical commodities is a bit more inelastic than the demand for shares. The Lira can fall to zero tomorrow. People won’t stop eating cornflakes. And you better believe, they’re not going to forgo their morning coffee.
A commodity’s supply and demand is concrete. It can be measured.
Like Richard Russel’s flight to oblivion, not everything in life or investing makes sense. And while commodities prices are never 100% predictable, at least they make sense. And with a little elbow grease, you can turn that common sense intobankable cents. For you, that can meanstability through long term, predictable growth or income, safety by diversifying assets, and security through preserving wealth for you and your heirs.
If you think that makes more sense than a beauty contest, then you’ll enjoy this month’s newsletter.
Have a great month of premium collection!