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History Teaches Four Important Lessons about Investing

Posted by Claus Vogt - Safe Money

on Wednesday, 27 April 2011 13:10

Just look

It is impossible to draw a universal conclusion from a single observation — or even from a myriad of observations. This method is called induction, and logic proves it’s impossible.

So the correct statement should be something less ambitious. It goes like this: “Since the early 1900s, stocks have risen strongly in the U.S.”

And I want to add an important point: There was a very good reason for them to do so.

You see, during that relatively long period the U.S. rose from a very low starting point to the most powerful and wealthy nation the world has ever harbored. It’s actually one of the most amazing success stories of all time.

If there was ever a country whose economic path seemingly went straight up, it has been the U.S. The very country we Europeans used tat the long-term chart of the Dow Jones Industrial Average below. The first thing you’ll probably notice is that it starts at the bottom left and rises strongly to the top right of the chart. So the message is clear: U.S. stocks have risen over this period.

And that’s why many pundits keep claiming that stocks always rise in the long term.

Unfortunately this conclusion is not only somewhat naïve; it is even false, because it makes some hidden assumptions about our future.

Dow Historical

Growth Miracles Aren’t
Miracles at All

Of course we would all like to extrapolate this impressive trend into the future. But history teaches us that we have to be somewhat cautious in doing so — the next 100 years will not necessarily resemble the past 100 years. If they did, we could expect a similar satisfying outcome for the stock market.

But even if this ambitious assumption turned out to be right, we’d have to allow for major drawbacks on the way up. Drawbacks like the Great Depression and World War II. In the bigger picture they both turned out to be mere bumps in the road. Yet for millions of people living through those times it was much, much more.

But how about the assumption of a continuation of the American success story?

I think there is a very important point to be made, a point of utmost importance to all of us living in the U.S. or in Europe today. The U.S. success story was not just happenstance. Far from it. Growth miracles aren’t miracles at all, never. They are always the logical outcome of capitalism, free market and pro-growth oriented policies.

Unfortunately the U.S. and Europe have strayed away from this concept … even far away recently. Instead of letting the free market take care of our economy and wellbeing, we are on a path to ever more government regulation and intervention.

We have allowed our central banks to become extremely powerful central planning agencies. And we have allowed our governments to run up surreal deficits, mountains of government debts and cockamamie promises.

Therefore we have to be skeptical about the next chapters of the U.S. success story. Without a major shift back to prudent monetary and fiscal policies, which are the cornerstones of free market oriented success stories, there will be no success … but demise.

History’s Four Valuable Lessons

It’s definitely possible to learn from history. And the history of mankind tells an interesting story of the rise and fall of nations. So there is still hope.

And for you as an investor this is very important …

First, it leads to some humility and humbleness. All of us who have been born into the wealthy and relatively free western societies are blessed without our own doing.

Second, nothing outside the law of nature is for sure and accepted as unchangeable. We were lucky enough to witness the sea of change that freed huge parts of the world from communism and made the world a better place for hundreds of millions of people. Other generations lived in much more demanding times.

 

Third, it’s your responsibility to take precautions to make sure you will not be swept away by major changes and impositions. Diversification — even geographically — can do a lot to achieve this goal, at least financially.

Fourth, history teaches us that we better keep an open mind. If you think outside the box, will you be flexible enough to cope with major changes unthinkable to a vast majority — and even anticipate them to some degree.

image

The fall of the Berlin Wall in 1989 gave a burst of freedom that led to the collapse of communism in Europe.

We Are in the Midst of
a Tide Change

Decades of monetary and fiscal mismanagement in the U.S., Europe and Japan are driving the current financial system to a tipping point.

Unfortunately it is unclear how the endgame will turn out. If market forces were allowed to take over, a huge wave of debt deflation and a deflationary depression would likely follow. But if the ubiquitous inflationists were to get their way, the world would be heading to an inflationary crisis.

Both scenarios involve huge losses of wealth and welfare. Both imply severe social and political risks as well. Due to the mechanics of politics in our social welfare democracies I rate the inflationary scenario at a much higher probability than the deflationary one. Therefore I continue to suggest gold as insurance.

You can conveniently buy it as an ETF, like SPDR Gold Shares (symbol GLD). Or you could buy the real thing, that is bullion or coins.

Best wishes,

Claus

 

Claus Vogt is the editor of the German edition of Safe Money. He is the co-author of the German bestseller, Das Greenspan Dossier, where he predicted, well ahead of time, the sequence of events that have unfolded since, including the U.S. housing bust, the U.S. recession, the demise of Fannie Mae and Freddie Mac, as well as the financial system crisis. Claus is currently the editor of Million-Dollar Contrarian Portfolio and has just completed his book The Global Debt Trap.

The below update was sent out to subscribers of Money Matters on 26 April 2011

On Monday, the silver market experienced a key intra-day reversal.  During Asian trading, the price of silver surged to almost US$50 per ounce (+5% intra-day), however during European trade, selling came in and the metal struggled to stay firm.  Thereafter, when the US market opened, the price of silver plunged to below its previous close.  In other words, the silver market experienced a classic intra-day reversal, which usually markets the end of a parabolic move.

As you know, we were expecting a serious pullback in the price of silver and it seems as though the medium-term correction is now underway.  A dispassionate review of silver’s weekly chart shows the metal’s parabolic rise, which always ends with an equally spectacular reversal. Although the silver bugs will argue with our assessment, we want to make it clear that there is no shortage of physical silver and the world is not running out of the metal. Anybody who says otherwise is only engaging in propaganda and trying to separate you from your money.

At this stage of the game, there is no way of knowing how long silver’s correction will last but when you take into account the fact that less than a year ago, silver was trading at US$17 per ounce, you can be sure that the pullback will not be mild.  Accordingly, if you are a trader and/or have significant exposure to physical silver of the related mining stocks, now may be a good time to book profits.

Remember, precious metals are still in a secular bull market but no item goes up in a straight line.  Every bull market goes through periodic corrections and whenever any commodity rises in a parabolic fashion, it always undergoes a severe correction. Thus, this is the time to control your emotions and take some money off the table.

Finally, as far as gold is concerned, since it did not zoom up like silver, we expect any correction to be muted. Thus, there is no urgent need to liquidate one’s gold related holdings

Puru Saxena publishes Money Matters, a monthly economic report, which highlights extraordinary investment opportunities in all major markets.  In addition to the monthly report, subscribers also receive “Weekly Updates” covering the recent market action. Money Matters is available by subscription from www.purusaxena.com.

Puru Saxena
Website – www.purusaxena.com

Puru Saxena is the founder of Puru Saxena Wealth Management, his Hong Kong based firm which manages investment portfolios for individuals and corporate clients.  He is a highly showcased investment manager and a regular guest on CNN, BBC World, CNBC, Bloomberg, NDTV and various radio programs.

Having risen from an average price of $5.00 to $46.05 an ounce, it is only reasonable that one question what may be occurring in the silver market. A well read Investor will certainly have considered many explanations as to why the price of silver has increased over the past 7 years. The most common argument for this, is an extreme shortage of the metal. Without a doubt, if there is a shortage of silver in the market, one would expect the price to rise. Let’s take a look.

Market Buzz – U.S. Risk Free Credit Rating Receives Negative Outlook from S & P’s and March Inflation Surprises in Canada
Canada’s leading index closed the four day work week of April 21st at 13,975 points, up 266 points, or 1.9 per cent, since the start of the week.

The market opened the week in rough waters on Monday when debt ratings giant Standard & Poor’s announced that it had reduced its outlook on the U.S. government’s credit rating to negative. The credit rating of the United States has historically been considered the global community’s risk-free benchmark. Experts debate the actual ramifications that the outlook change may potentially have on the U.S. debt market and bond yields, but it is clear that the move by Standard & Poor’s was a simple ‘cause-effect’ response to the country’s increasingly deteriorating balance sheet and the lack of political will to improve it. Under the current plan, the government proposes to cut $4 trillion off the deficit over the next 12 years. That rather large number still seems somewhat of a pittance considering that the U.S. federal deficit is estimated to be in the range of $1.56 trillion for 2011 alone. Another 12 years of amassing debt can only further increase the risk perceived in holding U.S. government debt and further threaten its declining position as the world’s safe haven of fixed income. Higher risk only increases the interest rates that investors will demand, which puts further pressure on the federal deficit and struggling economy.

Fortunately for the world’s largest economy the weekly news was not all negative. Throughout the later portion of the week, U.S. companies reported first quarter earnings with a surprisingly large number of key large-cap names confirming beats of analyst estimates. Many have pointed to the solid quarter of corporate earnings as a clear sign that the U.S. economy is indeed in recovery. The positive news had the S&P500 up 34 points, or 2.6 per cent, since the start of the week.

In Canada, inflation numbers for March hit the market with overall-CPI rising 3.3 per cent, the largest year-over-year increase since September 2008. The Bank of Canada (BOC) uses its influence over short term rates to keep annual price inflation within a healthy band of 1 per cent to 3 per cent. The overall-CPI numbers were a surprise to most economists and have many forecasting that the BOC will start raising rates again sometime this summer. Although we agree that rates will have to start moving up soon, the strong performance in overall-CPI was feed primarily by energy and food inflation. These commodities are excluded from core-CPI, which is the measure BOC uses when determining monetary policy. Core-CPI was 1.7 per cent over the past year, which although within the target band, is a level that the BOC did not expect to see until the third quarter.

Looniversity – Why Wall Street “Sells” are So Rare

One of the main reasons there are so few sells is that it is not economical to follow a stock with a sell rating. Providing research coverage requires a large investment of time and money. In order to remain profitable and cover the cost of providing research, brokerage firms need to be able to make money on transactions made by customers trading the stock or get investment banking business. A stock that is going up has the potential to generate profit for researchers because investors may buy the stock many times and will need more information throughout the time they own the stock. The sad truth is, a sell rating results in just one trade and it can lead to a less favourable relationships between the firm and the public company, which could lead to less investment banking business (it is rare for a public company to raise money through a brokerage which has a sell rating on their stock).

Historically, it is a rare occurrence to find research initiated on a company with a sell or hold rating because the cost of initiating coverage is not justified by the potential revenue of that research coverage. Coverage is usually initiated and maintained on companies that have the potential to be long-term winners, thereby generating income for a longer period than it took the brokerage to initiate coverage. Of course, investors want to buy stocks that are expected to rise, sometimes several times, which generates fee income that (hopefully) more than offsets the brokerage’s cost of providing that research.

Put it to Us?

Q. What is the most important factor to consider when valuing a stock?

– Fran Wilkensen; Edmonton, Alberta

A. Without question, the current spot price of pork bellies. But seriously, there are a multitude of factors that can influence the price of a stock. Indeed, the multiple relationships that form between each factor conspire to complicate valuations even more. That aside, most experts would agree the most important factor is related to earnings.

We often think about stocks, or a stock, as something apart from business. But, when you invest in a stock, you invest in a business. In a very real sense, you become a business owner – and business is about products, profits, and customers.

As a business owner, you must pay attention to the fundamentals of running a business. What’s the inventory situation? How much capital is needed to run the business, and how much does that capital cost? The bottom line or corporate earnings are the bottom line. As such, they are the most important consideration.

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Knowing when to sell is one of the four things that you need to master if you are to trade the market successfully. Selling is challenging because we get wrapped up in the emotions of taking a loss or not maximizing our profit. Ultimately, it is fear and greed working against us to hurt our trading performance.

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