Tall Trees can't grow to the sky ...

It is often said that "Tall trees can't grow to the sky", meaning that things cannot continue past their natural boundaries.

Although current stock market bull commentators often act as if this doesn't apply to today's stock market, the fact is, is that natural "rules" apply. And the two key rules remain impenetrable as always and they relate to PE ratios and interest rates: when PEs are above historical norms, and interest rates are on the way up - then stocks will inevitably fall (exact timing is, as always, the only question).

Nevertheless, as small investors today, we don't simply have to hope for a bull market to make money - we can use quasi-shorting techniques, even in tax-protected accounts. Given that this is one of the longest bull markets in the past fifty years, the direction of interest rates is up, and PEs are above averages, it doesn't take a rocket scientist to prepare for the worst.

That doesn't mean pulling everything from the market - the market often proves people foolish, by adding a few more points than expected. But it does mean doing a balancing act, that might produce a more stable portfolio over the mid-term. For some investors who agree with the thesis that we are in the prelude to a bear plunge, this means retaining solid core positions, and raising some cash, and perhaps using inverse leveraged positions to gain alpha on the downside.

Given that the last major bear market lasted 16 years, and produced numerous plunges (and subsequent near recoveries), a correction (at the minimum) seems in order - fairly soon. So, by investing 5%, 15% or 25% into a levered bear position, such as that available from ProFunds.com, this can allow you to profit while the market is in decline, and then allows you to throw it into the market, when it's hit what you consider to be the bottom.

The risk is that you dampen your return should the bull continue on longer than you thought, but the reward side is the potential to significantly mitigate the downside damage, and be ready to put more funds into the market when it's "on sale".

Just be sure that you aren't risking an excessive amount on the "downside" bet. Remember, it's having a well-reasoned approach - often contrary to popular thinking - that produces the best investment returns. Something to ponder (but not for too long), while this aging bull looks for a face-lift.


JW

The Confused Capitalist

The Tortoise and Hare Portfolios

Back in mid-March, I profiled two model portfolios, based on aggregate analyst recommendations. One, nicknamed "The Tortoise" portfolio, was designated by analysts as an "avoid" situation, while analysts were universally effusive in their praise of "The Hare" portfolio.

At the time, I suggested that those rankings could well be reversed in the real world: that is, the Tortoise Portfolio could well outperform the Hare Portfolio.

I recently checked in on them, and as of May 24, here's how they've been doing:

• The US Tortoise portfolio: -5.5% (Benchmark S&P500 [via SPY] -3.7%).

• The US Hare portfolio: -10.9% (Benchmark Nasdaq Index [via QQQQ] -6.1%)

I guess I'd have to give this one to the Tortoise to date; although both lost against their respective benchmarks, because while the Tortoise lost 48% more than the benchmark, the Hare lost 78% more than it's respective benchmark.

• The Canadian Tortoise portfolio lost 1.1% over the same time frame, compared to it's benchmark, the TSX/SP60 index (via XIU) which had a loss of 6.2%.

So, to date, the Tortoise portfolios are beating the Hare portfolio. We'll check in again later to see how they're all doing.


JW

The Confused Capitalist

All right, who has been kissing the investors?

From the almost too bizarre to believe, this just in:

" A
group of Yale researchers studying the origin of irrational decision-making found that choosing impractically isn't a behavior exhibited only by humans. Our evolutionary cousins, capuchin monkeys, exhibit the same tendency with respect to loss aversion, or the tendency to strongly prefer avoiding losses rather than acquiring gains.

The findings, published in the Journal of Political Economy, indicate these biases are innate in primates and have existed since before capuchins and humans split 40 million years ago.

'Some of the most deeply ingrained economic behaviors turn out to be very, very ancient and hardwired parts of our decision-making processes,' said Yale economics professor and the study's lead author, Keith Chen. 'If I showed a string of capuchin monkey data to an economist, he couldn't, with any statistical test, tell the difference between a capuchin monkey and your average American stock market investor.'
................................................................................"

The rest of the story can be read here and, apparently, this isn't the only time that these same capuchin monkeys have exhibited human traits.

This is an interesting adjunct to a recent post I made on considering "regret" before investing.


JW

The Confused Capitalist

Commodities - Which way? (updated)

The recent direction of the stock markets seem fairly clear, and for anyone who's got any doubts, these two (one, two) recent postings by Barry Ritholtz over at The Big Picture should help clarify things. The market, overall, seems poised to continue moving down - or at best - sideways. Yet, as always, even in soft markets, some stocks - or groups thereof - will continue to make gains.

The largest seemingly identifiable group that is likely to continue significantly differentiating itself from the broader market is commodities - mainly minerals, and oil & gas.

The only question is - which way?

Goldman Sachs analysts Arjun Murti and Brian Singer surprised the markets in March 2005 by calling for $100/barrel oil. While it may have been headline surprise, it was only a reiteration of similar calls for continued oil prices at increasingly elevated levels. More recently, pundits on both sides have pointed to a myriad of evidence supporting both higher and lower prices - pointing to things like increased demand from rapidly industrializing China and India, and potential for disruption from Iran, etc. - and on the other side - speculators keeping the price high. Seemingly authoritative sources on both sides make compelling arguments for both directions.

Other commodities too, had well known prognosticators on both sides of the fence point to imbalances. A recent letter from investment guru Bill Miller of Legg Mason suggests that the boom is more likely to be nearing the end, than in the middle of a tear. Superinvestor Warren Buffett also suggested in verbal comments (use browser tool to search for "commodities" within the article) made at the 2006 annual weekend conflab in Omaha, that commodities were subject to some speculative excesses although the comments were somewhat vague in nature.

Surveying the scene, it's possible to become utterly confused as to which way commodities might move. Investment guru and commodities expert Jim Rogers (co-founder of the Quantum Fund with billionaire George Soros) says that while commodities may in the midst of a "big correction" lasting anywhere from three months to two years, that this is a secular (commodities) bull market with another 15 years to run, "because supply and demand are so out of whack".

One can never be certain of course, and it's difficult to see exactly who's right: well-known conservative investors (i.e. Miller, Buffett, etc.), or other renowned experts like Rogers.

Me, I just keep thinking China and India growing economically at 7-10% a year, with their two and a half billion citizens. That, my friends, is a lot of demand. Are prices out of whack? Frankly, I don't know, but I very much doubt we are in the seventh inning in this particular game.

On the other hand, it's important to remember that even favorable long-term investment winds can't rescue an investor if he/she paid a wild price for their asset. Just ask anyone in the "NASDAQ 5000" club.

N.B. 7:22AM PST May 25 Update:

One thing I personally would NOT do, is to invest directly in the underlying commodity index, as seems so popular these days, by the roll-out of various commodity-indexed ETFs. As CIBC World Markets chief economist Jeffrey Rubin pointed out in some market commentary, the stocks of commodity companies typically lag the leading indicator (the spot price, usually) in a commodity rally for a long period of time.

Both the imputed price of the underlying commodity is much lower (in 2005, Mr. Rubin said most oil companies had a value which imputed oil in the high $20s or low $30s per barrel, for instance). The longer the rally goes on, the more the stock price begins to close the gap, AND begins to experience multiple (i.e. PE ratio) expansion.

This suggests that the best way to invest in a commodity bull market, is in the early phases invest directly in the commodities themselves, and later, through stocks. I personally feel that we're into the second part of that investment thesis, and the best days of the first portion are already behind us.


JW

The Confused Capitalist

Anticipate "regret" in your investing, and you'll do better

I've now finished a decent book relating to risk management, Upside Downside: Simple Rules of Risk Management for the Smart Investor. It's a light read and a rather small book - nevertheless, it has some good ideas.

The book makes the point that we need to take more into consideration than just the risk of the investment (or risk of an insufficient return). We need to consider our emotional make up and how we react to a potential loss (or lack of what we consider a sufficient return). The book uses the apparently true life example of a 32 Englishman who sold everything, went to Vegas and bet his entire life savings ($135,000) on the spin of the roulette wheel. Having doubled his money, he left the table and returned to his homeland.

The book points out that although this is a poor investment (odds are less than 50% of doubling your money, due to "00"), he probably considered how much regret he'd have if he never took this chance, against the potential to double his money. His regret would obviously be quite different than a 75 year old betting a similar life savings.

So in addition to considering the actual risk/reward profile of the investment, we need to consider how we feel about each of the possibilities - then to decide whether to invest, based investing an amount that won't exceed the maximum amount of regret we can handle. For some people, regret is the possibility of missing the next Microsoft, while for most investors it involves a perceived loss of capital. Some studies have suggested that the average investor experiences regret at a 2:1 ratio. That is, a loss of 10% produces about twice the regret that a gain of 10% produces happiness.

The main point is, is that if we structure our investments to reduce the possibility of regret, we'll stay in the market longer and increase our chances of long-term success.

All-in-all, a useful book, but it has some limitations, that I'll talk about in a final review, later.


JW

The Confused Capitalist

Emerging Market Positions Getting Pounded

One of the things I think I try to do in this blog is look towards the longer-term, a position that's popular with all so-called "value" investors. It means being able to ignore seemingly unfavorable current issues (particular security price declines), and look towards a more long-term favorable future.

I have written about my belief that the emerging markets will continue to outperform over the longer term, given the improvements in the economies, currencies, governments in many of those countries, and their long-term growth profile. Add to that what I believe is a secular trend to a decline in the value of the US currency, the case for long-term emerging markets investing seems made - to me. Nevertheless, it's days like today that take a strong belief in that position and the ability to stand fast in the face of the storm.

Here's how some of the iShares ETFs are standing up (or falling down) today as of this writing (1PM Eastern time):

• Brazil -7.86% (EWZ)
  
• S. Korea -6.77% (EWY)
  
• Taiwan -6.21% (EWT)
• S. Africa -5.86% (EWA)
  
• Emerging Markets (general) -5.66% (EEM)

In contrast to some developed market iShares ETFs

• Japan -3.66% (EWJ)
• United Kingdom -2.59% (EWU)
• Germany -2.21% (EWG)
• S&P350 Europe -2.81% (IEV)

And finally, the US market:

• S&P500 -0.73% (SPY)

Yes, it's days like these that test one's fortitude when overweighted in a position.


JW

The Confused Capitalist

Stress test your portfolio

Well, I've been meaning to write this for about a month, but just haven't gotten around to it. So this is going to be a quick note, rather than a more detailed bloggering.

The past few days have suggested that perhaps the market was ringing a bell. However, one never quite knows exactly what the future holds, only that the risks of a market decline seem more elevated than in the past couple of years.

Against this, of course, is the thought that market timers are rarely successful - but on the other hand it doesn't take a genius to pull a little bit of funds out of a richly valued market, and/or to re-position some other higher-risk holdings into holdings with more conservative features - i.e better valuation metrics, and nice things like cash on the balance sheet.

I've been doing so over the past month or so, but still remain with some 70% in the market - but this is probably the lowest market penetration I've had in 15 years of investing.

Make sure you stress test your portfolio ... when I look at the number of charts that have arced skyward in the past three months, it tells me that market risk is unusually high ... as they used to say in Hill Street Blues ...

"be careful out there"

JW

The Confused Capitalist

Portfolio Management - Know what you own

I'm reading a very interesting book relating to risk management, Upside Downside: Simple Rules of Risk Management for the Smart Investor. As reported on another aspect of the book, over here, it's a light read and a rather small book - nevertheless, it has some good ideas.

This section of the book is pretty straightforward, simply telling investors that they should "know what they own". Advisors have often found that investors don't really "know what they own" - that is, they rarely deconstruct their portfolios to find out the overall composition. What this means is that you look at all the mutual funds/ETfs you own, you go to their web-sites and write down the 10 largest positions and also the sector orientations.

Do this for all your positions - begin to place them in a setting, the same way that you often see; Growth, Value, Small Cap, Large Cap and so on. Consider the weightings of your sector investments, and finally, consider the individual companies that are hidden within your funds, and also those as individual purchases.

In this way, you can begin to get some sense of how your portfolio might be exposed to the market, and you can consider scenario thinking, in analyzing its overall risk profile, so you can make sure you're happy with it.

Although it sounds simple, you might be surprised at the weightings or sector profile that your portfolio has "morphed" to, over time.



JW

The Confused Capitalist

It's different this time ...

It's different this time ... that's always the siren call when a market of any sort has gained on, and on, for longer than anyone thought possible.

It was heard at the NASDAQ peak in 2000, and I'm sure in the tulip bulb mania too. While it is a sensible thing to consider - and to remember that more often that not it is a siren song - it isn't always. And I think that the emerging markets phenomenon is one of those cases, where there's a fundamental shift going on, possibly a change or modification to the old world order.

I've made the point several times on this blog that I think the US market in particular appears extended and certainly leading indicators have suggested that the excess liquidity flowing around the world have led to global asset inflation.

A finger is often pointed at the emerging markets, saying that this is a particularly risky market, and it has experienced outsized gains over the past three years, placing its stock valuations on par - in many key ratios - with US markets. This, some pundits say, is clear evidence that the overall market is overvalued and that emerging markets in particular are poised to tumble, when sense returns to the market.

Overall, I agree that many markets are high: I just don't agree that the emerging markets are the clear sign of this. Stock markets are like a reputation: it takes a long time to get one, but once it's in place, many people stop thinking about the market, and consider only its reputation. They start only seeing what was once there. I think this currently provides a benefit to the US markets, and a disservice to many emerging markets.

Many emerging markets have, over the past decade, opened their economies, freed their currencies, and placed their public finances on sound footing. Their companies are more robust than ever before, with modern management (trained in the US in many cases), and robust internal key ratios - like return on capital and equity, earnings growth and cash-flow, and so on. They are, in many instances, true peers to some of the best global corporations - or very close to it.

In the US, on the other hand, there is a very fundamentally deteriorating situation in my view, which isn't properly being valued in the markets:

• Years of underfunding public schools/colleges to provide short-term tax relief;
• A huge overhanging unfunded Social Security liability;
• Fiscal and trade deficits that would make your hair stand on end;
• No one saving anymore - homes are seen as a huge ATM;
• Inflation, which isn't particularly going to benefit the US.
  

Frankly, when I consider all the variables - I see the house above as more emblematic of the current US situation, that I seeing it as an emerging market.

Many people however are conditioned by years when that was clearly an emerging market house, and still see it that way. Me, I'm noticing how nicely some of the other neighborhoods have been fixed up - so to speak - and this one, seems to be running down.

Just an observation - and it's a reason why I'd rather pay roughly equivalent multiples for emerging markets with their significantly faster growth, compared to US markets. Sometimes, some things are different - it just takes awhile for folks to notice it.


JW

The Confused Capitalist

The problem with forecasting - a call for scenario thinking

I'm reading a very interesting book relating to risk management, Upside Downside: Simple Rules of Risk Management for the Smart Investor. It's a light read and a rather small book - nevertheless, it has some good ideas.

In the section discussing why investors should lay out different possible scenarios, rather than simply forecasting, it makes the point that forecasts are too often simply the present extrapolated into the future. It uses some rather famous statements by prominent individuals and organizations to make the point:

• One day, there will be a telephone in every major city in the US - Alexander Graham Bell, circa 1880.
  
• There will never be more than 1,000 cars on Europe's roads, "because that is the limit on the number of chauffeurs available" - Daimler Benz spokesman.
  
• "Stocks have reached what looks like a permanently high plateau" - Irving Fisher, professor of economics, Yale University, 1929.
• "I think there is a world market for maybe five computers" - Thomas Watson, chairman, IBM, 1943.
• "There is no reason that anyone would want a computer in their home" - Ken Olsen, chairman, Digital Equipment, 1977.
• "... with over 50 foreign cars already on sale here, the Japanese automobile isn't likely to carve out a big slice of the U.S. market" - Business Week, 1979.
  
• "640K ought to be enough for anybody" - Bill Gates, Microsoft, 1981
  
• "Television won't be able to hold any market it captures after the first six months. People will get tired of staring at a plywood box every night." - Darryl F. Zanuck, 20th Century Fox, 1946.

or how about this one that I recalled ...

• Oil: Under the heading "Drowning in Oil", The Economist magazine predicted the world - then with $10 a barrel oil, was heading towards $5 a barrel oil - 1999. Today, forecasts here are quite different.
  

I hope you got a chuckle out of some of these - but as investors, we need to be diligent in thinking about both risks to our investments, but also potential opportunities that can arise - if the future turns out different from the past - i.e. one does not need a chauffeur to pilot an automobile around.

The book points out that laying out the possibility of a number of different scenarios, requires some thinking about the situation, and considering that differences in the future may arise. By laying out a number of different possibilities - some perhaps even seemingly far-fetched, it allows us to better consider the risk/reward potential of an investment.

By doing so, we avoid the blind reliance on the "most likely" forecast, and to therefore protect ourselves to some degree against other, seemingly obscure, possibilities.

Scenario thinking - worth considering in your own investing.



JW

The Confused Capitalist

Time is on my side ...

Time is on my side, yes it is ... (apologies to the Rolling Stones) ... or at least it's on my kid's side.

I was thinking about this today with my two teenagers, and thought how little money it would take, with decades of compounding ahead of them, to fashion a comfortable retirement, some 50 years hence. Of course, compounding within the confines of a tax-deferred account will make it all the better.

So with that thought in mind, I considered what $5,000 could be worth with a little leverage working for them for a long period of time. Recently, Horizons BetaPro Funds announced two leveraged index mutual funds. Both are levered to produced twice the change as their underlying indices; which are the Canadian S&P/TSX 60 (the largest companies in Canada); or the NASDAQ index. Both funds are designed to mimic their index, except with twice the upward and downward movements. The MER on the S&P/TSX 60 index is 1.5%.

To consider what could become of $5,000 in a tax-sheltered account (IRA or RRSP), compounded for 50 years, I used considered a long-term rate for large companies of 10.5% annual return as reasonable (about 10.5% is a widely quoted number). However, this might be slightly optimistic going forward, so I scaled this back to 8-9%, say 8.5% as a long-term rate. With a fund leveraged like this, it would mean an 17% return over the long haul, less the 1.5% MER charged by the fund. This would leave a net return of about 15.5% per annum.

I then went over here to use the financial calculator, and this indicated that the $5,000, compounded at 15.5% over 50 years (in other words, when my children turn 65), would be worth $6,703,839 at the end.

However, inflation has averaged 3.15% per annum over the past 90 years. Accounting for that 3.15% inflation factor suggests that the $6.7 million will be worth the equivalent of $1.42 million in today's dollars. More than enough to provide a very comfortable supplement to whatever else they have accumulated for their retirement.

Excuse me, I'd like to continue talking to you, but I have to go speak to my wife about an idea I have ...


JW

The Confused Capitalist

Proxy Investing

Great post over at Abnormal Returns relating to what he (she?) calls proxy investing. Essentially, it's finding a favorable trend, then figuring out what companies will benefit from that trend. Essentially, that company you invest in, is a "proxy" way to invest indirectly in the trend itself.

A checklist is provided so that you can analyze your chances of using this profitably.

I highly recommend you take a visit over there, and perhaps add this bit of wisdom to your investing scrapbook.


JW

The Confused Capitalist

Don't be dumb ...

and don't be dumb and dumber ...

Rick Konrad, over at a blog I enjoy reading, Value Discipline, had some kind words to say about the Confused Capitalist.

He went on to further discuss a point that mutual fund manager Tom Stanley had made that I relayed in a recent posting, the point being ...

Outperform by being different - if you really want to outperform the index, you have to strive to position yourself differently.

In his posting, Rick astutely points out that ...

The need to think differently just for the sake of being different is just as foolhardy. Have a rationale for your thinking, not just a bravado.

If you don't have this thought in your mind as well, well, then you are just being dumb and dumber. In his own portfolio management experience, Rick gives a good example of "what it takes" to outperform the index in this regard ...

I can recall one investment strategist telling me post 1987 crash how he still had faith in the consumer and was weighting the retail sector at 5% rather than the S&P's 3.5%. When I admitted that I had 25% of the portfolio in retail, he went ashen. He told me that I was reckless.

Rick further comments ...

The notion of long term horizons is also important. Almost every contrarian looks like an idiot for the near term.

Something to think about ... don't act dumb and dumber ... make sure you've well thought out why and how you want to position yourself differently than the index. Because underperformance is a very real possibility too.


JW

The Confused Capitalist

Outperformance - some key thoughts

Outperformance in the world of Resolute Growth Fund manager Tom Stanley (there since 1993 inception).

One year return, 91%, five year return 45% p.a., since inception, 26% p.a. Investing principles according to Mr. Stanley:

1. Be a long-term investor - it's easier to spot long-term trends than quarter-to-quarter movements;
2. Be flexible - use whatever works at a reasonable price;
3. Hunt for ideas;
4. Be skeptical of information sources - try to verify important information from a secondary source;
5. Buy your best ideas - last year, Resolute held only 14 stocks in it's fund ("we had 14 great ideas - I don't have 150 great ideas, so I'd rather just buy the 14");
6. Strive for effective rationality - filter out the noise;
7. Outperform by being different - if you really want to outperform the index, you have to strive to position yourself differently;
8. Stay humble - humility breeds an open mind that continually seeks good advice and is willing to listen to others (and is thus open to heeding good advice);
9. Stay in your circle of competence - define it, learn within it, stay in it;
10. Be a contrarian - some of the best opportunities are found in unloved sectors and stocks;
    
11. Be patient - being a contrarian means sometimes underperforming the index, while the long-term trend you've seen fully develops and is more generally realized;
    
12. Apply spiritual principles - a daily prayer for wisdom can help you avoid making investment mistakes.

JW

The Confused Capitalist

Zombies on the prowl for better investing

Well, it's all confirmed as true. Emotionless investors make better returns than us regular humans.

In a study by Professor George Loewenstein last year at Carnegie Mellon University in Pittsburgh, found that those who had suffered brain damage which impaired emotional responses, were better investors in a small study.

The participants, consisting of normal people and those with some neurological impairment, were tested on their ability to invest. Participants were given $20 to invest, and in each round they could either invest $1, or refrain from investing and pocket the $1. The study found that under the circumstances - consisting of roughly 20 rounds of investing - the impaired individuals ended up with an average of $25.70, vs. $22.80 for the non-impaired. They also invested more often, at 84% of rounds, versus 58% for non-impaired.

Prof. Loewenstein found that the non-impaired often became discouraged if they lost money and avoided investing too often after that. Conversely, those who won too often, often took to sitting out rounds, in the belief of not wanting to "press their luck". The emotionally impaired, it seems, were best able to figure out the odds and continued to press on.

Although this isn't really new information to most savvy investors, it does help to clarify my thinking around this point - please refer to my more recent photograph below.

"The needs of the many outweigh the needs of the few" - Spock


JW

The Confused Capitalist

Canada: Hiding out the market downturn in the land of rocks and trees

Canada's stock market has often been referred to as market of rocks and trees, a reference to it's reliance on commodities like minerals, lumber and oil to power its economic growth and stock markets.

I have written recently about the bell ringing in the US, my opinion that the market is near the top for the stock market, based on a number of signs I see, not the least of which is unrealistic expectations of capital gains (note, things have only gotten more speculative since this was written), rising interest rates, booming commodity prices (a harbinger of inflation, something particularly bad for the US market), risky assets becoming more popular (note, things have only gotten more speculative since this was written), while quality assets languish (i.e. big cap's continue to be available for bargain prices). All of this common sense information makes me also wonder if another 1972-1974 drop might be in the offing, and if so, can one "hide out" successfully in the Canadian hard asset climate, as Sir John Templeton is reported to have done in the secular bear market lasting from 1968 to 1981.

Culling through the TSE (Toronto Stock Exchange - Canada's largest stock exchange, now renamed as the TSX) statistics, if you were focused on avoiding the 1972-1974 bear market, the escape to Canada wouldn't have provided much comfort. The Dow fell by about 40-45% over that time, and the TSE also fell, by a somewhat similar amount. In 1972, the TSE index closed the year at 1226 (its monthly high close for the year), and by December 1974, closed at 835, a decline of 32%. So over the short term, the two markets were fairly similar.

However, over a slightly longer period, it was definitely favorable to be in the Canadian market, as by mid-1979 it had rallied to double in value over it's 1974 close, while the Dow took until 1982 to close above the 1000 level at year end; this was a level it (the Dow) first pierced in 1964 and closed at year end above that in 1972. Perhaps because inflation was such a factor, companies involved in hard assets (mining, lumber, oil) were the prime beneficiaries of hard asset inflation, and thus the Canadian market rallied through the mid-to-late 1970s. This is a scenario that I think is could again be replicated when the US market softens over the next while and struggles over the period thereafter.

I had always thought that the Canadian market had fared better than the US market during the brutal 1970s bear market. It turned out I was both right and wrong.


JW

The Confused Capitalist

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PS: Changes made, May 3 06, 3:20PM, to correct grammer and erroneous reference to 1972 TSE "low close", when it should have stated "high close".

Market outperformance - Is it all it's cracked up to be?

Is market outperformance all its' cracked up to be? This is a worthwhile question, as the markets go higher and higher.

I consider that market outperformance should be a reasonable benchmark for most investors who are in the active, self-managing, investing mode. By that, I mean investors who are dedicating a few hours per week (or more) reading about, or investigating, potential investments and markets. Even for those not spending a lot of time actively managing their investments, long-term portfolio outperformance should be possible, simply by constructing a simple portfolio that plays to both long established trends, and forward-looking trends (see recent sample portfolio over here).

But I only recommend attempting to beat the benchmark when you either have those favorable long-term trends running with you and are taking a diversified stance (see prior link), or you have a value-investing orientation, because either method (or combination thereof), will generally lower your long-term risk profile. Which is a good thing. As superinvestor Warren Buffett says, "Rule #1 is never lose your capital, and Rule #2 is never forget Rule #1".

However, I think that trying to outperform the market isn't necessarily a good thing if you are taking on risk that's significantly above what you should for your age and capital.

It's one thing for a 30 year old to invest in the high risk "latest and greatest" with some of his/her capital, but it's quite a different thing for a 60 year to speculate significant portions of capital in the hopes of beating the benchmark.

In that case, it's a particularly poor decision to try to beat the market. On the other hand, being the same 60 year old and trying to beat the market, while simultaneously achieving a lower risk profile, is a good thing.

For many investors however, given their particular temperment, retirement requirements, etc. standard market performance will do quite nicely. But for those not satisfied with the average then, market outperformance is, in my opinion, all it's cracked up to be, if done in a prudent way!


JW

The Confused Capitalist

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Long Term Investing and Fighting the Tape

Left: 7' 2", 450lbs, wrestler Andre the Giant. b.1946 d.1993

There's a saying in the stock world, that goes, "Don't fight the tape." What it means is that when there's powerful selling going on against a stock, only the foolish step in and start buying, because the price is likely to continue to decline.

While there's obviously some point at which the selling will stem, and the "tape" may turn (provided there's some underlying positives to the stock), the short-term investor is well-advised to take note. To some extent, it would be like trying to fight Andre the Giant.

While I generally pay very little attention to "fighting the tape" in my own investing over the short term (hey, if I'm willing to buy the stock at the price offered, I don't particularly care whether I've bought at the precise bottom anyway), it makes sense to pay attention to "fighting the tape" over the longer haul.

Where I think one has to be very careful "fighting the tape", is when powerful long-term forces are at work against your investment. In my opinion, an example of this includes things like the computer industry, where costs keep getting driven down, as do margins. Investing in businesses in the midst of commoditization are situations where above average caution is warranted. That's not to say don't do it, just be aware of the forces at work, and be cautious.

I think that this is something to particularly keep in mind these days, as commodities themselves have risen from the ashes, to become a very popular asset class - and commodity oriented companies - and their stock prices - have thrived.

One day this tide will turn (probably when inflation is seen as a benign future factor - unlike today), and commodities and commodity-oriented company's stock will "return to earth". In the interim, some careful thought is warranted, to ensure that you're happy with your level of exposure to any situation based on a commodity product.


JW

The Confused Capitalist

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