The same thought process for 30+ years

One of the most important factors of investment success, and one of the most overlooked, is the thought process that governs the portfolio management itself. Ultimately, this thought process resides in the brain of a single individual for any given portfolio, and yet most investors have never met that individual or had any opportunity to learn the outlines of the thought process that governs his investments on their behalf.

We have explained the reason for this ignorance before, implicating the intermediary system common in the financial service industry, whereby a "financial advisor" or "wealth manager" sends his investors money literally all over the world to be managed by people the investors never meet and whose process they cannot possibly know.

While many complacently accepted this system during the past twenty or thirty years in which it spread throughout the investment world, after the events of 2008 investors (and their financial advisors or wealth managers) are reexamining what they believed to be true about investing.

How many of the investors who had significant sums of money being managed by Bernard Madoff knew what his process was? Obviously, none of them had any idea what his process was and did not understand it whatsoever. Neither did their advisors.

While that is a particularly egregious example, involving a confessed criminal who was actively trying to harm his clients, millions of other investors send money off to be managed by people they never meet, without much more understanding of the process being used.

Even if they do take the time to meet the manager and understand his thought process, that manager will probably be someone else five or ten years later. The investment approach followed by the new manager may share some common elements with the previous process, but unless there has been a long and close association between the predecessor and the successor, the more common result is that the investor will have a new process for the next five or ten years, until the next change of command.

The history of the management of the well-known Fidelity Magellan fund illustrates this reality quite clearly:

1963 - 1977.......Ned Johnson....14 years
1977 - 1990.......Peter Lynch.....13 years
1990 - 1992.......Morris Smith......2 years
1992 - 1996.......Jeffrey Vinik.......4 years
1996 - 2005......Robert Stansky...9 years
2005 - present..Harry Lange....will be 4 years in October 2009

When you consider that the investment journey of an individual or family may span many decades, from their 20s or 30s into their 80s or 90s -- and when you take children into consideration the span of time becomes even longer -- this kind of manager turnover is akin to taking a long plane trip and seeing a new captain walk into the cockpit to take over the controls every forty minutes!

It may be argued that no manager can be expected to work for seventy years or more, so arguing over turnover is all relative, but the real issue here is that these changes of managers were specifically seen as a way of "setting a new course" for the fund, as the 2005 article referenced above makes clear.

There is a clear distinction to be made between bringing in a manager who is long and carefully trained in the thought process and discipline that governs an investment portfolio (a process that we would argue takes over ten years to fully inculcate), and bringing in a completely new manager with the intention of "setting a new course." Unfortunately for investors, it is this second type of manager change that is more typical in the investment world.

Less well-known funds with less prominent managers often have even higher rates of manager turnover and shorter manager tenure than the above example. Many funds today will obscure their rate of turnover by claiming that their funds are managed "by committee." While a fund may indeed have an investment committee, ultimately someone must be in charge of deciding differences and making the ultimate decision, just as a military staff may have many different individuals giving input, but one commander must ultimately make the final decision.

Also, this problem is not isolated within the world of mutual funds -- the management histories of separate portfolios tell a similar story, as do the records of the strategists at large brokerage firms who are hired to provide "model portfolios" which brokers can then replicate in their clients' accounts.

The sad reality is that the possibility of having the same thought process governing their investments for thirty years or more is very remote for the vast majority of investors.

This is a huge problem for investors, because an individual's or a family's wealth is not determined over one year or even five years, but rather over a period of thirty, forty or even fifty or more years of investing. Research has shown that over these long periods of time, the haphazard process that is practically guaranteed by the intermediary arrangement in the financial services world today has served investors very poorly.

We urge investors to consider the central importance of basing their investment upon a consistent thought process for many decades. We have previously referred to the document written by Mr. Thomas Rowe Price in which he emphasized this critical point, while emphasizing that this does not mean holding the same companies forever.

What we are advocating is consistency of the principles which underlie the selection of the investments. The investments themselves can and must change over the years. Furthermore, Mr. Price himself always emphasized the need for flexibility in dealing with "new eras" of political and economic reality, without abandoning the core process. In fact, we would argue that operating from a consistent foundation of well-tested core principles enables greater flexibility in the face of change -- indeed, it may well be necessary for true flexibility.

Where can an investor today obtain a consistent thought process to govern his investments for thirty years or more?

One sure way is to use one's own process, without farming his investment decisions out to mutual fund managers or anyone else. This is a valid option, and one we touched on at the beginning of 2009 in this post.

For those who do not want to become their own portfolio manager, we would advise looking for an investment firm that does adhere to a consistent process, and can demonstrate that they have been doing so for a reasonably long period of years and that they have a system in place for reasonably ensuring that will continue to be the case for many decades into the future. We have discussed some of the criteria investors should examine in this previous post.

Being able to have the same thought process of investing for thirty-plus years is such a rare situation that today most investors don't even think about it or know how important it is. It is an idea that simply gets no discussion in the traditional financial media. Nevertheless, it is an idea with which all investors should become familiar, and one whose importance to investing has never been greater.

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Paying yourself first

As investors survey the damage caused by the financial panic of 2008 and the ferocious bear market which accompanied it, the question of what they should do differently going forward is a very significant one.

There are plenty of areas that can yield valuable insights, and we have visited this subject several times before, in posts discussing some of the problems with "modern portfolio theory," the dominant intermediary structure of the financial services industry, and the rush to "diversify" into financial products such as commodities funds, international funds, and investments tied to foreign exchange speculation.

One important area we have not directly addressed, however, is the importance of establishing a systematic mechanism for ploughing capital into savings on a regular basis.

It has been our experience over the years that this is an area in which investors -- even very wealthy investors -- often have good intentions but haphazard execution.

Systematically putting money into building real estate equity is fairly automatic -- most real estate owners establish a system for having their monthly mortgage payment happen every month without much thought. Similarly, building cash value inside a permanent insurance vehicle is also automatic -- the insurance company ensures that you make your payments in a regular and automated way, a sort of "forced savings."

But investments in the capital markets are not generally automated in the same way. We firmly believe that establishing an automatic mechanism for moving income into an account that is not used for consumption is a critical component of long-term success. That "savings" account can earn interest on its own, and be a source of funds for investment in long term capital market assets such as stocks and bonds. This has been expressed in the advice, "Pay yourself first."

We have written before about the important distinction between production and consumption, and linked to an excellent essay by economist George Reisman on the subject. Professor Reisman has also written that "Capital is accumulated on a foundation of saving," and this is exactly what we are talking about in this post.

This is especially important in light of the fact that we believe that ownership of well-run, growing businesses should be the real foundation of any long-term preservation and growth of wealth.

Ploughing money into a home remodel, for instance, can be a valid investment, and one that increases the market value of a real estate asset. However, it is our belief that investors cannot rely on real estate values to grow at a faster rate than businesses grow over a long period of years. Ultimately, real estate is either bought by businesses or by people who are paid by businesses, so it does not make sense for its value to outpace the rate of business growth for long periods of time -- a river cannot rise higher than its source, so to speak.

There have been areas and periods in which real estate values have outpaced business growth, but that cannot go on forever, and may indicate the likelihood of correction in the future.

There are many lessons to be learned from this recent bear market experience, but also important is the concept of creating an automatic system for ploughing some money into savings regularly, particularly for investors who are still actively working.

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Dent vs. Schumpeter . . . and Kurzweil

The feverishly anti-business tone coming out of Washington, as well as the promise of greatly expanded government intrusion into industries from health care to energy, the prospect of significantly higher taxes in years ahead, and the threat of tremendously expanded government spending and budget deficits, has many investors wondering if we are heading for an economic re-run of the 1970s, or worse.

A new book out from demographic prognosticator Harry S. Dent, entitled The Great Depression Ahead, paints a grim picture of deflation, depression and economic decline in the US and advises readers to invest in China and India. In a recent interview about the book, Dent declared, "stocks have to go back to about 3800" (presumably he means 3800 on the Dow, which Dent uses for most of his predictions, such as his statement in 2004 that "we are still predicting a Dow as high as 38,000 to 40,000 by 2010" -- see The Next Great Bubble Boom by the same author).

Dire scenarios like Dent's are getting plenty of traction these days, and the economic mis-steps in government make it easy to fall into despair about the road ahead. However, as we have written before, even in times of excessive government intrusion and economic malaise, such as the 1970s in this country, there are well-run companies that are creating new fields of growth or taking advantage of major paradigm shifts, and investors would be wise to seek them out rather than just owning the "entire market" as often counseled by "wealth managers".

Those who believe, like Harry Dent, that economic prosperity is governed by blind cycles outside of human control miss the central role that innovation plays in economic progress. In his most recent book, Dent states: "The truth is that Newton was right in his theory of simple and clock-like cycles. [. . .] Our economy has peaked every forty years, like clockwork-- and commodity prices have peaked every thirty years. The early part of most decades starts off weak, even in boom times. Every four years the stock market tends to take a significant correction, and about every four months it often does so again on a more minor scale" (pages 3-4).

If Dent indeed holds this position, it would be interesting to ask him how his predictions could swing so wildly between his 2004 call for a Dow of 38,000 to 40,000 by 2010 and his 2009 interview calling for the Dow to drop to 3,800.

Noted Austrian economist Joseph Schumpeter held almost the opposite view from Dent's deterministic model. He held that free enterprise continues to create greater and greater progress, not by choice but by necessity. He wrote that the free operation of individuals and businesses within any given industry "incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one" -- that business in a capitalistic system "not only never is but never can be stationary."

This is an incredibly important truth for investors to understand, and it is why we are confident that innovation will be the engine that continues to drive prosperity, even in spite of the clumsy and unnecessary government intrusions which will probably be on the rise for the near future.

The scenarios of extreme pessimists, like Harry Dent (who were recently extreme optimists), generally ignore innovation altogether or predict that innovation has basically come to an end. In an interview just a month ago in the Minneapolis-St. Paul StarTribune, Mr. Dent ended by saying that innovation will not have much impact in the next couple of decades, because new innovation from here will just be incremental, not revolutionary.

He said "The iPhone's going to get better, broadband is going to get better, but you don't get the same impact from those improvements that you do from the adoptions of computers and cell phones." In other words, he sees only "sustaining innovation," not truly "disruptive innovation," in the terminology developed by Clayton Christensen. Harry Dent basically believes that innovation is tied to impersonal cycles just like everything else, and when the innovation cycle is on the way down, innovation will not make much impact.

This is as foolish as the apocryphal story of the Patent Office Commissioner who supposedly suggested to President McKinley that the US close the Patent Office in 1899, because "everything that could be invented had already been invented."

Not only do we not believe that innovation is bound up by multi-decade cycles as Dent argues, but we believe that the evidence shows that the pace of innovation increases over time. In fact, inventor and entrepreneur Ray Kurzweil, whom the Wall Street Journal calls "the restless genius" and Forbes magazine calls "the ultimate thinking machine," has observed that the pace of innovation increases not in a linear fashion but rather in an exponential fashion (see graph below).

In his 2005 book The Singularity is Near, Kurzweil says: "The future is widely misunderstood. Our forebears expected it to be pretty much like their present, which had been pretty much like their past. Exponential trends did exist one thousand years ago, but they were at that very early stage in which they were so flat and so slow that they looked like no trend at all. As a result, observers' expectations of an unchanged future were fulfilled. Today, we anticipate continuous technological progress and the social repercussions that follow. But the future will be far more surprising than most people realize, because few observers have truly internalized the implications of the fact that the rate of change itself is accelerating" (pages 10-11).

In fact, there are many innovations that are going to be quite revolutionary in the years ahead, and we have discussed some of them in previous posts such as this one and this one.

We have often stated that we do not make predictions about the next move of the overall market, and we don't suggest that investors try to time economic cycles. We do believe that the prospect of less economic freedom should give investors cause for concern, but we also believe that there will be innovation that will drive growth, and that investors who put forth the effort to seek it out have cause for continued optimism.

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Don't despair

These days, it is easy to believe that the entire American system is doomed to collapse into an economic swamp of no return. The headlines give us a daily overdose of politicians railing against profits, bonuses, Wall Street, greed, and incompetence, and Americans for the most part are overwhelmingly sick of bailouts and TARP money and Washington solutions that seem to lead to more problems, more headlines, and more incompetence.

In times like this, it might be helpful to step back and consider where America was at the time of the above television interview from December 07, 1975 with economist Milton Friedman (1912 - 2006), and to draw some encouragement and wisdom from the late professor.

At the time of the interview in 1975, Professor Friedman (who would later win the Nobel Prize in Economics) was very concerned about the massive growth of government in the United States and its interference with economic liberty.

In fact, he was so pessimistic that he put the chances at "a good deal less than 50%" that the slide towards greater and greater government could be corrected. In the above interview, if you advance the progress bar to about 24 minutes and 14 seconds into the clip (24:14), you will find the following exchange between interviewer Richard D. Heffner and Milt Friedman:

Richard Heffner: "Where are we going, in your estimation? Quite honestly, quite directly."

Milton Friedman: "Sure. There is a balance, you're quite right: I am not in favor of eliminating government entirely. I think government has grown all out of proportion to its scope. Where are we going? I believe that that depends on us, that that's not in the cards -- we are masters of our own destiny. But IF we take the road we have been on, we are heading toward a destruction of our free society and toward a totalitarian society. We are, unfortunately, headed down the route which Chile has already taken essentially to its end, which Britain has taken much farther than we have. Now, I hope -- we still have time to avoid it, but we will not avoid it unless the people of this country recognize the danger and take very difficult and important steps to set a limit on the extent to which they are going to permit government to interfere with their lives."

Richard Heffner: "If you thought that we would not avoid it, that we were going to continue down the present paths -- the path to serfdom, perhaps -- would you then try to develop some different kind of philosophy, some different kind of approach, that might enable us to make the jump from the freedom that you embrace and the near-serfdom that seems likely in the future?"

Milton Friedman: "I don't believe so, because I think that if you go down that road, I don't believe there is any philosophy in the world which will enable you to avoid it. I believe -- I would -- my own reaction is very different. It is to say we don't have to go down that road. I may think the chance -- I really DO think -- that the chance is a good deal less than 50% that we'll be able to avoid it. We may well be fighting a losing battle, but if it's the right battle, if it's the only alternative to serfdom, then we ought to fight it, and try to convert that fifteen, twenty-five, thirty percent chance, whatever it is, into a certainty. There are some sources of support on our side, fortunately."

Richard Heffner: "Tell me, give me the name of two, please!"

Milton Friedman: "I will be glad to. Number one is the extraordinary ability and ingenuity of the American people in finding ways to get around laws. That's a major source of strength for freedom. And number two is the inefficiency of government. People go around complaining about waste in government. I am always reminded of a favorite -- of a wonderful saying of an old teacher of mine, he was a teacher of statistics, and he made this statement about statistics, in which he said, 'Pedagogical ability is a vice, rather than a virtue, if it is devoted to teaching error.' Well I say, 'Thank God for government waste.' If government is doing bad things, it's only the waste that prevents the harm from being greater. And the waste of government has two very important elements. Number one, if government were now spending the amount it spends, which is 40% of our income -- governments federal, state and local in the United States have total spending which equals 40% of total national income -- if they were spending that efficiently, we'd be slaves now. And in the second place, the waste is so obvious that it arouses a counter-movement in the population at large, people are disillusioned with government, and it increases the chance that they will recognize where this road is taking them, and get off that train before it goes all the way."

From the perspective of history, we can see that as dark as the middle of the 1970s were for the economy, Friedman's pessimism about the chances of turning the situation around were too pessimistic.

His two sources of support that he mentioned turned out to be more than enough to prevent America from sinking forever into the morass of government oppression and stagnation that he feared.

Those two sources of hope identified in the interview are, firstly, the ingenuity of the American people, as we've discussed in previous blog posts such as this one, and secondly the inefficiency of government and the tendency of government solutions to alienate and disillusion people to the point that they realize the folly of the path to greater and greater government interference with their property and their lives.

As discouraging as the massive increase in government interference in the private sector over the past months has been, this previous history of the irrepressible ingenuity of the American people, and their ultimate distrust and disillusionment with government intrusion and control, is a sign of hope.

We would like to sound a note of optimism, even amidst the disturbing panic of the moment. We believe that America will remain a seedbed of innovation and the creation of new value into the future. As we expressed in previous posts on the work of Joseph Schumpeter and Clayton Christensen, innovation and ingenuity are the most important component of future economic growth.

Government intrusion may be on the rise, but we believe as Milton Friedman did in 1975 that there are important elements in the American economy and the American character that will prevent government from growing to the point that it destroys the entire system. However, we may have to endure some painful and unnecessary periods of inefficiency and waste before people become disillusioned and "recognize where this road is taking them."

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Big news on mark-to-market accounting

Yesterday was a momentous day. The press chose to focus more on the emotionally-charged story of Bernie Madoff pleading guilty to a Ponzi scheme and being sent (at last) to his new jail cell, but the bigger story was about an accounting rule that few Americans really find interesting or understand completely. This accounting rule has caused far more havoc in their lives than Bernie Madoff, however.

Yesterday, Congress finally revealed bipartisan willingness to remove the mark-to-market accounting rules that have played a pivotal role in choking the financial system to a point that the entire economy was thrown into an unnecessary recession. See the video clip above.

It's been a long time in coming. In fact, we have been warning for exactly a year that this misguided rule could cause firms to go under -- see this post from Friday, March 14, 2008. The weekend after that was published, Bear Stearns collapsed.

Some will argue that the mark-to-market rule, which is part of a type of accounting called "Fair Value" accounting, is necessary for bringing transparency to the market. In fact, it is a relatively recent accounting development, with its final phase being implemented in November 2007 -- which all by itself helps to reveal the role it played in causing the financial panic of 2008. We have discussed why the events of 2008 should be seen as a financial panic that led to a recession in previous posts, such as this one and this video.

In the above video clip, economist Brian Wesbury explains very clearly that mark-to-market accounting forces banks and other financial institutions to bring forward potential future losses and book them immediately, because the market price to which they are being marked right now is irrational, or nonexistent. Far from creating transparency, this actually prevents a sober assessment of the value of assets.

It is as if, because of an unusual situation such as a forest fire in the adjacent county, someone came up to you and offered you $5 for your house. Knowing that your house is worth far more than that, and realizing that even if the house does burn down the land is worth more than that, you would be wise to tell that person "no, thanks" -- especially since it is not certain that the fire will even reach your house. But mark-t0-market forces you to write your house down to that price (since that is the only "market offer" you can get right at the moment), and then to use your new lower "net worth" as the benchmark for evaluating your credit rating.

Mr. Wesbury has been tireless and articulate in his efforts to educate investors and politicians about the dangers of this misguided accounting rule. See for example his videos explaining the problem in greater depth here, here and here.

Former FDIC head William Isaac has also been an articulate advocate of removing the mark-to-market rule. We linked to one of his explanations of the issue in this post from November 2008. Yesterday he went before Congress and explained the problem again, which he also explained in an interview yesterday available here.

The removal of these misguided accounting standards will be a very positive sign. The leadership of the Financial Accounting Standards Board, under pressure from Congress, said yesterday that it will be able to address the issue within three weeks. Let's hope they come up with a wise solution.

While accounting rules are not very exciting to most members of the general public, this is a significant issue that we would urge everyone to examine and understand. If this problem can be fixed and the banking system allowed to begin to return to healthy operation, we believe the economy -- and the markets -- can recover much faster than most investors realize.

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The Bottoming Process

The markets turned decidedly ugly again in the last couple of weeks and the major market averages have reached new bear market lows. Is this the bottom? That is the question being asked in just about every financial market conversation either in media or around the water cooler. The answer is simply: we don't know, nor does anybody else. It should be noted that the bottoming process is simply that, a process, and as noted in the chart of the S&P 500 above, we have witnessed what may be a second bottom on Monday, March 9, 2009. Only time will tell if this one will hold up in further tests.

What we did observe in this recent new leg down was that many companies did not reach the November 20, 2008 lows. In fact, in our own experience, our portfolio did not reach new lows, in the aggregate. We strongly believe this is a sign that the market has started to more seriously focus on placing value in those companies with real businesses which are creating economic value-add for their customers and ultimately their shareholders. We have discussed the concept of investing in real businesses in previous posts , such as this one, and this one.

We clearly recognize how difficult it is in times like these to view investing in terms of ownership of businesses over multiple market and economic cycles, but it may truly be the solution for most market participants to adopt this way of thinking. Granted, some may suggest there is no other alternative but to be "long term" now since everything has been so beaten up. Yet it is consistently our belief that the proper way to invest in the stock market is to think of it like owning a group of businesses. This allows one to set aside the often irrational and emotional swings of the market prices themselves and focus on what makes business sense.

However, let us make something very clear about what is required in order for us to maintain this view and where there are potential signs of danger. As long as companies are able to operate in a relatively "free enterprise" environment, we can feel comfortable being owners. We discussed the dangers of intrusive government regulation and intervention in private enterprise in our November 2007 post "What's Really Troubling the Market". We wrote then that the prospect of tighter regulation and higher taxes was weighing on the market and would suggest that the barrage of such talk from those in government today is equally responsible for much of the selloff that we have witnessed. The question is whether the actual policies will be so harmful as to turn a relatively free enterprise system into one which businesses cannot operate and provide the economic value-add that is necessary for shareholders' long term success. At this time we believe that is highly unlikely and, in fact, the more talk there is of intrusive government, the more the markets will act as a self-correcting mechanism keeping the powers that be at bay and allowing the wonders of freedom and innovation to lead us out of this crisis and on to greater accomplishments.

This current market is a shot across the bow, so to speak. We, and the rest of the marketplace, will be watching closely.

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If portfolios were parachutes

If investors thought about the assembly of their investment portfolios as if they were packing a parachute, there would be several helpful lessons that they might learn from that mental exercise.

First, while some investors may have been somewhat cavalier about who was packing their portfolio "parachute" prior to the current bear market, 2008 probably changed all that for just about everyone. Naval aviation hero and Vietnam veteran Captain Charlie Plumb has written about his experience of being shot down over North Vietnam on his seventy-fifth combat mission, and of later meeting the rigger who packed the parachute that saved his life.

After meeting him, he reflected on "how many times I might have passed him on board the Kitty Hawk" and"how many times I might have seen him and not even said 'good morning,' 'how are you,' or anything because, you see, I was a fighter pilot and he was just a sailor." But after having to actually use his parachute, ejecting "at a high rate of speed, close to the ground" he was overwhelmingly grateful to that rigger.

Having experienced a bear market more ferocious than any since before World War II, and having seen some portfolio "parachutes" that were not packed in a way that would enable their users to live to fight another day, investors should now be much more concerned with who is packing their portfolios and what method that rigger is using.

One good option is to learn how to pack your own parachute. We have written about this option in various previous posts, such as this one. Needless to say, if you keep in mind the analogy of packing your own parachute, it would behoove anyone who chooses this option to take the time to learn how to do it properly, and to exercise a high level of diligence in the process.

Many investors actually think they are packing their own parachute, because they assemble the contents of their account by themselves, but they are actually using portfolios that are being managed by someone else. If you use mutual funds or other vehicles that are managed by someone else, then the actual portfolio management is being done by a professional manager.

We have discussed some of the drawbacks of using mutual funds, such as in this previous post. One of the biggest drawbacks, which is easily understood using the parachute-packing analogy, is the fact that most people who are using mutual funds or other "mass-produced" financial products have never met the people who are actually packing the parachute. In normal times, most people don't give that a second thought, as illustrated by the reflections of Captain Plumb. But, when there is a serious situation like the events of 2008, who that person is becomes more than a minor detail.

We believe that investors should pay very close attention to who that parachute packer is. They should, if at all possible, meet that person, look into their eyes, and understand the method they use -- before they invest with them (before jumping out of the plane, in other words).

Sadly, the current structure of the financial industry is geared towards the mass-distribution of parachutes by individuals who do not actually pack parachutes themselves. They are not qualified riggers, nor do they really have much interest in ever becoming qualified at it. They enable investors to feel like they have met and examined the character of someone involved with their parachute, but in fact the investor is only meeting with the person who is handing them a parachute packed by someone else (we have visited this topic in previous posts such as this one and this one).

Finally, we believe the parachute analogy is helpful in dispelling some of the academic theories that have infiltrated the investing world far too much in the past thirty years or so. As discussed in "Beware of the witch doctors of modern finance," a famous article in 1975 made an unfavorable comparison between "the world of practical operators in the stock and bond markets [. . .] and the new world of the academics with their mathematical stochastic processes." He suggested that the practical operators were inferior to the "academics with their mathematical stochastic processes," and the financial world was only too happy to agree.

In retrospect, and in light of the parachute analogy, it is astonishing that anyone would abandon the experience of men who had spent their lives packing parachutes (and jumping them -- entrusting their own fortunes to their handiwork) and instead put their trust in the theories of academics who had in fact never jumped in their lives!

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Don't get off the train

We used to say "You have to stay on the train." As you can see from the video above of a Caltrain "baby bullet" going by, when it gets moving you can't jump on very easily!

The same is true of markets.

We have argued several times before that this is where investors make their most damaging mistakes. Research bears this out.

As unbelievable as it seems now, there will be a turn in what seems to be a never-ending bear market cycle. When the markets will turn back up is anybody's guess. However, when it moves, it can move very rapidly. Try stepping on to the baby bullet train in the video above as it blows past the station.

Of course, an analogy is never perfect. Obviously, trains do give you an opportunity to get onto them, even bullet trains. However, history shows that market moves are concentrated into a few big days and weeks. Unlike a train, the market does not print a schedule and tell you when those will be.

This is why we have always emphasized focusing on the business and not the market prices, as we discussed in this previous post, as difficult as it might be in this environment.

There are some indicators that the economy may be turning around, although the markets are not. For example, look at this chart below (from of the Baltic Dry Shipping Index, which measures the price of shipping dry goods (as opposed to shipping oil), and indicates the demand for raw materials used in manufacturing.

Note that the S&P 500 Index generally tracks along with the Baltic Dry Index fairly closely (they are somewhat correlated). For example, after the 2000-2002 bear market, the blue Baltic Dry Index line is clearly seen moving up, and shortly after that the green S&P Index line begins its rebound.

In the chart above, you can see that the Baltic Dry Index at the far right has moved up sharply in 2009. The green S&P line is still plunging.

When will it turn around? We don't know. However, investors may be wiser to "stay on the train" rather than to jump off now and try to jump back on. The train is currently backing up and moving forward, backing up and moving forward, and if it does take off in a big way forward, as it did in 2003 and 1975 after those major bear markets, jumping on is a lot harder than people think it is.

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