Wednesday, March 3, 2010

Value Investors, Santa Clause and the Easter Bunny

There are 3 types of investors. The first type would be people that only see one dimension of their investments. They rely on a salesperson to make their decisions for them. The salesperson in turn wants to take the biggest portion of your investment principle without having repercussions coming back upon themselves later. One dimensional investing is the easiest but unfortunately the most costly way to invest.

I can always pick out a one dimensional investor. When I try to explain two dimensional value investing I get the "bovine stare". Their eyes become black vacuous holes as brain neurons immediately stop functioning. Go down to the stockyard and look in the eyes of livestock. The same far off stare. This is the herd behavior of our ancestors. This is the same behavior that is making Wall Street huge profits today.

The salespeople that are advising the one dimensional investor can be real estate agents, financial advisers, the media, Wall Street and our government. But they are also friends, family members and neighbors. If your friend bought a house in 2007 then our course they will try to sway you into thinking that house prices are a good value. You can call it a defense mechanism but in the end it is just a sales pitch to validate their bad decision.

The second dimension of investing would be thinking about the investment yourself instead of letting someone else do it for you. This approach works best using mathematics and historical trends to determine if investments are priced appropriately. Most importantly one would have to ignore the sales pitch and get information directly from a reliable source. An almost insurmountable task.

This two dimensional investing can have complications. There is a group of people that think they are value investors as they use data from tainted sources. So in the end, they are no better off than the one dimensional investor. This creates more useless data and more static for the true two dimensional investor. If there really is such an animal. I have never really seen one.

Suppose that there was a true two dimensional investor. Their performance would have to tie to real events. The larger the event the more credible the performance indicator. The fact is that no one saw the 2004 housing bubble. No one saw the 2007 credit crisis. No one saw the 2008 recession. These were huge events that where basically, "no brainers". Our best and brightest not only ignored all variables to predict these events but they belittled anyone that suggested these almost certain outcomes as even a possibility.

The last type of investor sees in all three dimensions, up, down and to each side. It is impossible to teach or learn. It is breed by circumstance. The only way to be a three dimensional investor is to live through a period of extreme economic hardship.

This is why I tell people that The Great Depression was a wonderful event. It created two generations of fiercely independant, hard working, family oriented individuals. This country had two generations of three dimensional investors. These people understood value, hard work and sound government.

The last 15 years has seen a three tiered collapse. The collapse of the Interest Rate Mega Bubble rewarded a generation of one dimensional investors that have lived far beyond their means. This has collapsed our savings rate and turned our nation from a creditor to a debtor. These one dimensional investors are dismantaling the constitution to maintain this profligate lifestyle. This is the collapse of sound government.

This collapse should have seen an outcry that was heard around the world. Our grandparents would have thrown out the lawyers, economists and politicians that have forced the most powerful nation on earth to mortgage our children's future to hostile foreign nations with the sole intention of creating economic bubbles and making government bigger. It would not have made sense to our grandparents but oddly we are unable to see what is right in front of our eyes.

We have tainted investment DNA. Kind of like the 3 eyed chickens that live next to Chernobyl. Only the Chernobyl chickens aren't sacrificing their chick's future to live decadently in the present.

Our country has changed from a nation of 3 dimensional hard working savers to mindless debt producing consumers. We have become one dimensional thinkers.

For myself I would rather read a memoir about the Great Depression than today's paper. There is so much more honesty in people working together in overcoming a period of extreme hardship than what we are going through today. The excess and avarice of today's pampered populace. Everyone listening as salespeople tell us to create stifling debt for our children so we can create another housing bubble and consume more Chinese junk.

I have wanted to write a post comparing our current plight to the movie Starwars. Paul Volcker would be Obe wan Kenobi. Elizabeth Warren could be Princess Leia. Of course our government would be Jabba the Hut. Darth Vader would be played by Wall Street with Giethner and Bernanke piloting the Death Star. But the story would be incomplete because there are no Luke Skywalker or Han Solo characters yet. You can't put Krugman, Roubini, Shiller or Taleb in these roles. They are profit driven and are just motivated by book and speaking fees. Some day we will have a young Volcker that will save our economy but that is far in the future.

Presently the only way for me to describe our present situation is as an Orwellian drama. Animal Farm but with just pigs. Our population has become pigs at a trough with the most favored pigs being at the opening of where the government pork comes out. The rest of us less favored pigs are in line to pick up the leftovers. Our piglets are in the pen next door as we hear wild squeals. Later the young pigs exit with the same blank stares as the adults. Their future has been chopped off and sold to the Chinese. Scraps come back to the feedlot and are ground up for the soylent pork that the government feeds us.

It seems to fit current events pretty closely.

So you think you are a two dimensional value investor.

Here are some questions:

Do you think the economy is growing?

If you said "yes" then you are being led by salespeople which makes you a one dimensional investor. Our economy is contracting. Presently we do have a positive GDP number but it is only positive as our government uses massive debt to borrow resources from the future to pay for votes in the next election.

Are you investing with an eye toward inflation in the future?

If you said "yes" then you are being led by salespeople which makes you a one dimensional investor. There is no way that our government can create "magic inflation" that will not raise interest rates. As interest rates rise it will collapse long term asset values. We are in a contractionary period and will stay there until we get halfway up the slope of the next interest rate mega bubble that our Federal Reserve is creating. Then and only then can we have real inflation. Yes our government can create a new bubble but hopefully you have learned by now that this in not inflation. Look back in history, there has never been "magic inflation" that brings prosperity to a country after a period of wild excess and stifling debt.

Do you like dividend paying stocks?

If you said "yes" then you are being led by salespeople. There is no long term tie between dividends and long term stock performance. Increased dividends are a sales tool by a company to sway investors to buy their stock. Actually dividends could be a drag on company's performance as they take productive resources from the company to be taxed twice and given out to shareholders. Historically mature slow growth companies have higher dividends. Young high growth companies don't issue dividends because they are able to invest their profits in future growth instead of dividend payments that entice short term thinking investors to buy their stock. If you own high dividend producing stocks you are sacrificing long term gains to replace your lack of long term investment planning. It is ironic that our financial salespeople are selling unwary investors on this scheme after our country has lost 30% of your retirement account.

Do you own any long term bonds?

If you said "yes" then you are being led by salespeople. The only way you should be holding any long term bonds is as a short term hedge. These of course would have to be sold long before interest rates start to rise. Presently long term bonds are a terrible long term investment.

Do you feel that real estate will make more than 1 1/2% real gains in the future?

You have to be honest here. This is part of the DNA change that has festered over the last 15 years. A house has become a speculative high priced rent payment. Contrast this to how our grandparents treated their homes. Back then real estate was something to be paid off as soon as possible. Our grandparents had memories of the Great Depression and how housing debt ruined families in a contracting economy. Our next generation will have these same memories. Presently, you know in your bones that real estate will pay for your retirement, even though it is mathematically impossible. Over the past 100 years real estate gains were 1 1/2% above inflation and stocks 6 1/2%. You will favor real estate as an investment over stocks because it is part of your DNA.

Do you have a vast understanding of the interest rate mega bubble?

This is the deal breaker. The interest rate mega bubble is the biggest single economic event in the last 50 years. 187% of the last 300% profit from real estate was driven by this event. Over half the profits from long term bonds since 1988 have come from this government created bubble. This event that you have never heard about and definitely don't understand changed your investment DNA. You will never be the same.

Our present generation only has memories of the "financial geniuses" that through no ingenuity of their own, rode the collapse of the interest rate mega bubble and the easy money of the Federal Reserve to a once in a hundred year profit. This is an event that is mathematically impossible to recreate and will never happen again. Except in the minds of present day speculators. Our generation is tainted, financially illiterate and totally dependent on salespeople to make our investment decisions.

You are not a value investor because like Santa Clause and The Easter Bunny they presently don't exist. You are a product of your environment. We will not have value investors until the next generation takes over the helm. They will be able to see very clearly what a value investor looks like. The exact opposite of our generation.

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