Quit Trying the Impossible. The Probable is much more Profitable

Imagine that back in January you were given an ironclad forecast of how the world and economy would shape up in the first half of 2014. You would have known in advance that the US GDP would have a negative print for the first quarter, that the Ukraine would explode into civil war with Russian involvement and that the much touted housing recovery would begin to show signs of slowing down. You would have known that Iraq would see sectarian violence and that Islamists separatists would successfully attack major cities and seriously destabilize the region. You would have had information showing you that the prices of important food items like coffee, hogs and cattle would experience double digit price surges. You would have foreseen the crushing new environmental regulations imposed on industry and utilities. The slowdown in retail profits and decline in consumer confidence would have been no surprise to you because you would already be in the know about these things. Now, given the fact that the economy never really picks up any steam, the global geopolitical situation is worsening dramatically, food and energy prices are up and the jobs situation is still lukewarm at best how would you placed your bets on the direction of the stock market? A rational person would have bet against higher prices and sold the market short. They would have been wrong as stock prices have hit new highs so far this year. Unless you had the foresight to realize that zero rates really do trump all in today's world the combination of factors would have made you very skeptical of any likelihood of a stock market advance. Even with perfect information you could not have predicted how the stock market would react to various events and most of us would have bet the wrong side of the trade. Predicting the stock market is a futile exercise for most investors. If the markets were rational it might be possible but the simple truth is that they are not. Human psychology plays as big a role in market behavior as economic numbers and corporate profits do in the short to intermediate term. The stock market tends to overshoot on the side of both fear and greed and is rarely priced to accurately reflect current conditions. Guessing what will happen and them how the market will react is a waste of time, and more importantly a waste of money the vast majority of the time. Research and reality has shown that investors can gain a huge edge on the market by focusing their attention to corporate valuations and adopting a longer time frame. Rather than worrying about and betting on what the market might do in the future most investor's time would be better spent looking for stocks and even sectors that are undervalued and have the potential for enormous long term price recovery. Ironically adopting this approach would force investors to be buying after large declines and selling rallies rather than the well documented tendency to buy exciting markets as they approach the top and selling scary ones as they begin the bottoming process. It seems that everyone wants to be the next George Soros or Ray Dalio making grand, spectacular bets on equities bonds and currencies. They want to be in the center of the action trading in and out of the market and racking up spectacular profits. Everyone is selling some get rich and quit your job day trading from home program and they sell pretty well apparently. The sad truth is that most people who try these trading programs are not going to get rich and will probably lose a good deal of money. The reality is that like great baseball players for every one that goes on to hit game winning home runs and make spectacular catches there are 99 who didn't make it. We can hope and dream all we want but most people who try to make a living guessing market direction fail. Instead of trying to emulate Jesse Livermore and Paul Tudor Jones investors should aspire to be the next Leon Black or David Rubenstein. These two private equity investors have and a fortune buying undervalued companies and asset, holding them for an extended period of time and selling them at a profit. Rather than search for penny stock profits they should try to act like Seth Klarman who has compiled a fortune by acting as the buyer of last resort in falling markets and insisting that every dollar invested has a large margin of safety. There is an enormous amount of money to be made in the market. However it is probably not going to come from guessing market direction and furious trading. The real money, especially for individuals, is in reacting to what the market does and buying when stocks are cheap and selling them when they are not. Cheap assets and long time frames are a much more reliable path to big profits than the seemingly more exciting trading and guessing approach to investing.