by
Michael S. Rozeff
I recently ran across an article somewhere, since lost, in which several successful investors revealed that they do not invest in the same way that they advise others to invest. The same is true of me. I’ve been meaning for some time to retract what I wrote a year ago about passive investing. Now is as good a time as any to set the record straight. I feel guilty over having published that article. I will atone for it by outlining my actual investment strategy, for what that is worth. A year ago, I published two articles on buying a diversified portfolio and holding it. That portfolio has since gone down by 34 percent. This is better than having bought a good many other stock portfolios that are down 40 percent, but it is really lousy performance in an absolute sense. At the same time, in other articles I stated that stocks were in a bear market and should be avoided. In fact, I warned about that as early as 2006. Will the real me stand up? The real me owned no such portfolio at that time and does not own one now. The real me has been out of stocks for years and has suffered no losses in this bear market. The real me does not give out investment advice as a rule, although I weaken sometimes. Giving opinions and interpretations of financial markets and economic matters is not the same as giving investment advice. I am constitutionally incapable of advising others on what to do in their investment portfolios. My confession is that I have never invested in the diversified world market portfolio that I wrote about a year ago. That policy is what finance theory and some evidence suggests may be good, but I haven’t done it. Also, that policy seems to be about as good as a passive (know-nothing) investor might follow, but it can be pretty awful as the last year has shown. What I do is opportunistic investing. I did that instinctively when I first began investing in 1962. By 1968 I had read Gerald Loeb’s The Battle for Investment Survival, at which point I could put a name on it and understand it better. Loeb’s basic idea was to think of one’s capital as a liquid pool of cash. One would stay in cash, maybe for long periods of time, and only invest when the opportunities arose that made it worthwhile. In inflationary times, one would buy stocks. In deflationary times, one would buy bonds. In times when currencies were being ravaged, one would seek hard assets. I oversimplify, of course. One’s basic attitude would be speculative or opportunistic. The idea of buying and holding, or "investment," as it is ordinarily thought of, was not his cup of tea. The problem with that approach was and is government. Government alters currency values, and this alters the value of different kinds of investments. Government creates booms and busts, and that alters investment values. The presence of government forces us to speculate. My actual investments over the years have been very simple. It seems I’ve followed Buffett’s advice of making only a few decisions. I didn’t know I was following this advice, however. Between 1962 and 1968, I speculated on a few individual stocks. I plunged. I did not diversify at all. I was fortunate to make very good gains. Starting from very little, I made enough to buy a car and help finance further education. The basic approach was to buy stocks whose value (in my estimation) exceeded their price. The market does not hand out free lunches. One has to search for these opportunities. I have a tendency to concentrate wealth on one of these if I can find one. That is Loeb’s strategy. But if I am wrong, I cut the losses quickly, which is also his strategy. My biggest fault in doing this has been impatience, or selling too soon. My second biggest fault has been too much risk aversion, or not taking on some opportunities that came up. In 1974 the market got to a very low point. Opportunity was knocking, but I had little money. The pension plan offered choices like 100% stocks, 75% stocks and 25% bonds, 50% of each, 25% stocks and 75 % bonds, and 100% bonds. That was it. Only 2 people out of 100 were choosing all stocks. I chose all stocks, because stocks were cheap and because over 20-year periods, stocks almost always had outperformed bonds. The environment happened to be inflationary, but it didn’t affect my thinking. Meanwhile I studied the matter and found out better how to evaluate when stocks are low and when they are high. I published a paper on dividend yields in this regard. There are other measures, such as price to book value. Yields stayed within reason for many years, and I stayed in stocks for many years, all the way until 1994. At that point, the yields got to a point that in the past meant that stocks were too high. I went into cash. Cash actually paid a decent 5 percent in those days. Stocks proceeded to go into a heady bull market, eventually reaching unheard of levels of overpricing. If I had not sold earlier, I surely would have sold by the year 2000. My decision sure looked bad for five years. However, I am not greedy. Meanwhile my pension plan started a new investment in 1996, which was commercial real estate. This asset class is not difficult to evaluate. It has what is called a "cap" rate, which is the income return on investment. When this is high and when the real estate markets are not overbuilt, real estate becomes attractive. The cap rates were 9–10 percent. Let us not be too greedy about these things and hope for 15 percent in an overpriced stock market. Let us take 9 percent with far lower risk. This was opportunity knocking. I plunged. No diversification. Everything in commercial real estate, because I was reasonably sure that the values exceeded the prices. Office buildings can get to very low prices in depressions and recessions and when there is excess capacity. With patience, the oversupply goes away and one has a decent investment. I held this investment until January of 2008 at which point I sold out at what turned out to be one percent below its high price. By then the cap rate had gotten down to 4.5 percent and the price per unit had tripled. I advised the fund to liquidate itself in 2007 because U.S. treasury bonds offered a higher yield at lower risk. Needless to say, they didn’t listen. The fund is still going down. It is faced with redemptions and has had to turn to its parent for liquidity to meet these redemptions. At some point, it will have to sell property into an illiquid market at low prices. The professionals running the fund did a superb job of starting it up at the right time and adding properties over the years. I am not so sure they did such a great job at the other end. They could not really act opportunistically and I knew that. A bureaucracy is not going to fold the fund at the top and sell it out. What will those managers do for an encore? Stocks are now back to where they were in mid-1997. My premature decision to sell stocks and go into commercial real estate now looks good. Value tells, but sometimes it only tells in the long run. My current portfolio is secret. I find that talking about my current portfolio harms my objectivity. Along the way, I’ve dabbled on occasion in stocks that presented opportunities. I’ve always used what is called "technical analysis" of stock prices in conjunction with the analysis of value versus price. I am an avid chart reader and interpreter. If I have made opportunistic investing sound easy, I assure you it is not. And perhaps that is why I wrote about passive investing. Maybe I should not feel so guilty. I studied and looked constantly. I still do. I knew nothing about real estate. I read as many journal articles as I could. One article that was quite helpful is here. It outlines some thoughts about the relative merits of stocks, bonds, and real estate. I discovered that I cannot understand the bond market. I can’t forecast interest rates, but I never speculated in bonds. For a while, I speculated in some commodities. I lost at that. Not big, fortunately. I cut losses. I have no means of detecting the value versus the price for many commodities. Without that guide, I was lost. Last year, on this site, I suggested that oil would go to $35–$50, not $200. That was based on some notion of the value of oil. That may be the first and last time I am able to forecast a commodity price. I didn’t make a dime on it. At no time did I go for a world market portfolio. It's what the research in finance suggests, but it really does not appeal to me as the way to go about the battle for investment survival. My actual behavior is opportunism. Evaluate the opportunities that you find around you. You want things that have value greater than price, and avoid things with value lower than price. I've always followed that rule. By the way, opportunities can occur in your neighborhood or region in business opportunities, timber, land, and other kinds of things. The opportunity mind-set applies in much more than stock investing. My mother bought antiques during the Great Depression with what little she could afford. They were really out of favor and unknown to the general population. She simply bought what she liked that had good workmanship. She didn’t read books about antiques. It was evident that price was less than value. It took many, many years, but eventually antiques became so popular that books were written on every conceivable type. Prices caught up to values. She taught me to buy antiques, and for quite awhile from 1963 onwards I found opportunities in that area. My rule when young was to avoid bonds, but if you can evaluate value in bonds, then you may find that useful. I cannot. I can't evaluate interest rates.
Gold is volatile. I cannot read that market, although I am gaining some knowledge. My articles on that are feeble attempts to understand gold. The Gold Council has some good research papers on gold. I am sure that gold is a good proxy for the prices of consumer goods and an excellent choice in the case of dollar depreciation. I’ll have some further comments about that soon. Good luck. Study and search if you intend to invest opportunistically. You cannot make money consistently at investing without knowledge and a significant investment in your time. January 26, 2009 Michael S. Rozeff [send him mail] is a retired Professor of Finance living in East Amherst, New York. Copyright © 2009 LewRockwell.com
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When
stocks yield over 6%, then think about buying them. Look at the
prospects, however. Another tool that is sometimes useful is contrary
thinking. It helps get away from thinking what everyone else is
thinking. At the moment, many commentators are looking for a stock
market bottom or simply a decent rally, even though the major trend
is down. Others point out that stocks rally before recessions end.
The contrary view is that stocks will not make a bottom at all.
That’s pretty extreme. What it means is that a bottom may not occur
for such a long time that it is tantamount to no bottom satisfying
all those who now expect it. A real bottom should be such that a
new bull market is launched. A real bear market bottom will see
prices go up by a factor of 5 to 10 in the bull market that then
occurs. (My investing horizon is long.) If many people are expecting
that, then the contrary view is that we will not see such a bottom
and such a bull market for a very long time. How about 10 years?
How about 20 years? How about 50 years? I have seen a stock price
series for 1720 to 1780 in which prices did not advance for a 60-year
period! 