Sitting Tight


“If you don’t know who you are, this is an expensive place to find out.”

Adam Smith, The Money Game


On Thursday, the Dow slid 106 points, or 0.6%. Gold rose $30, or 2.5%, to settle at $1,264 an ounce – its highest level in four months. As commodities and energy fall, gold goes up. Hmmm ….

Today, we continue our series on investing. Our lunch yesterday was enjoyed in the company of Dr. Richard Smith, the mathematician behind He reminded us that investing is more than just numbers; it is flesh and blood… nerves and gut instincts.

“Guess who are the world’s best investors?” he asked.

“Rich people. And it’s not because they have more information or better advisers. It’s because they are calmer. They are not like the little guy who is worried about losing his retirement money.

“They can take the long view. They can follow the best old-timer advice on Wall Street: ‘Get right and sit tight.’”


Gold-commoditiesGold relative to commodities: a strong uptrend is underway – click to enlarge.


Right Place, Right Time

To rehearse what we know already: You get most of your investment gains simply by being in the right place at the right time. At Bonner & Partners Family Office, our little family wealth advisory service, we call this “beta.”

For the last 100 years, stocks have been the place to be. You just had to get right into stocks… reinvest your dividends… and sit tight. An investment of $10,000 in 1915 would have turned into $1,754,401.41 today.

Most people don’t get right or sit tight. Instead, they buy this and sell that… fidgeting around, following whatever whims and fads the marketplace produces. They get excited at market tops and buy trash. They lose heart at market bottoms and sell treasures. The average investor consistently does much worse than “buy and hold”.

Richard has developed tools to help investors protect themselves from their worst enemy – themselves. But since most do worse … some must do better. How?


SPX long term-finalFor quite some time, “buy and hold” worked – provided you mimicked the changes in the composition of the index (failing companies are regularly weeded out, so this index does not represent the true return of “the stock market”. It is largely an illusion). It has become a bit less easy in the “bubble era”, as volatility has increased sharply. It will likely become even more challenging in the future – click to enlarge.


How to Be a Value Investor

We have already given you our flimsy understanding of value investing. In a nutshell, you turn off the TV and cancel your subscription to the newspaper. Instead, you do your homework to find out what a company is likely to produce in earnings over the years ahead. Then you discount that future stream of revenue to its “net present value.”

This accounts for the fact that a dollar earned tomorrow won’t be worth a dollar earned today. (A dollar earned today, after all, can accrue interest.) You buy when the market price is substantially below your estimate of fair value… allowing yourself what Benjamin Graham called a “margin of error” in case you added the figures wrong.

It is long, hard work. That’s why most people don’t do it. And it’s why most people don’t get Warren Buffett’s returns. We also should remind you that just because stocks were the place to be for the last 100 years doesn’t mean they will be a good place to be for the next 100… or even the next 10.

You see, in the investment world there is always “more to the story.” Most of the stock market gains of the last 100 years have come in the years since 1982. And the back story of those years is the tale of a credit expansion gone wild …


Credit bubble and WilshireThe credit bubble (indexed) and the Wilshire total market cap index – click to enlarge.


Cat and Mouse

Of all the things twisted and perverted by the great credit expansion, investors’ perceptions are at the top of the list. The money poured in; almost all assets rose in price. And investors – watching this over three decades – came to the conclusion it was just the way it works.

It’s not. The problem with credit expansions is that they are always followed by credit contractions. And the bubbly stock prices you see at the end of the expansion phase turn into the flattened-out prices seen in a depression.

So, don’t count on a rerun of the last 100 years. Our own indicator – the DAMA system (more about that anon) – tells us that the most likely return rate on US stocks over the next 10 years is MINUS 7% a year.

Another important comment is that the long-term returns on any investment always seem best just before the investment collapses. That’s the way the financial world works: Like a cat with a mouse, Mr. Market plays with his prey before killing it.

Investments go up. At the top, they look like winners. At the bottom, the picture is completely different. Then the line on the graph is pointing down, not up. And the record clearly shows that this investment is a big loser. Long-term investors see that this is something to stay away from, not something to buy.

The ups and downs of a market are as natural as the change of seasons. They should be expected. Instead, investors are shocked and appalled every time the temperature falls.

That’s why it is so important to know more about the investing world than just about investing itself. You also have to “know thyself.” As Richard Smith pointed out, if you don’t, the markets will teach you. And it will be a very expensive tuition.


SocratesInvestment advice handed down by ancient Greeks


Charts by: StockCharts, St. Louis Federal Reserve Research


The above article is taken from the Diary of a Rogue Economist originally written for Bonner & Partners. Bill Bonner founded Agora, Inc in 1978. It has since grown into one of the largest independent newsletter publishing companies in the world. He has also written three New York Times bestselling books, Financial Reckoning Day, Empire of Debt and Mobs, Messiahs and Markets.




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