Hold up, wait a second

A friend of mine sent me an interesting article today, regarding a fellow who's managed to quit his job at the age of 34, not after making millions, but by living frugally and making some savvy if not spectacular investment choices. Of course, he's also written a book to explain how he's done it, because if there's anything people who've made money like to do, it's to share all their wisdom with others for the nominal cost of a book purchase -- "Lesson 1: Write a book about how to make money."

One of the things that struck me about this article is his terrifically mediocre advice about investing in the markets. It's not that he hasn't made money -- anyone who does and beats the indices as well as fixed income returns + inflation is already a leg up on the general population; it's that his strategy contains one of the major fallacies of investing (to me) that I think should be pointed out:

While living in Vancouver, for instance, he noticed a coffee chain called Starbucks that was popping up on every street corner. After studying the annual report, he bought the stock. It soared about 30 per cent in a matter of weeks. Then he sold -- a decision he regrets to this day.

"That was stupid. I should have just held on to it forever. It would have been worth about eight times as much now", he says.

One, the concept of "holding a stock forever" that is espoused by Buffett isn't borne up by Buffett's own actions. Buffett sells stock and keeps alert to the environment for equities and debt instruments much more so than he lets on. He speculated against the US currency in the past few years by selling it, and has been known to participate in somewhat exotic bond investments. So I often find the attempt to model oneself after Buffett, by buying "recession proof, value-oriented" businesses kind of funny. I don't think it's a bad attitude, but clearly this Derek Foster guy feels he has absorbed the key lessons from Buffett, or something.

Secondly, in that quote, Foster is clearly showing the symptoms of "missed opportunity regret" -- where a stock you once owned, and made a little money on (or lost a little money on, or maybe a lot of money on) suddenly skyrockets without a seat for you. I suffer from it, as does any other average person, but it's certainly not a reason to hold a stock forever. What Foster is forgetting is that he actually made a decent return (30%) and he's focussed on the could-have-been. In another scenario, which he conveniently forgets, he makes a 30% return, and then coming back a few years later, finds the stock no longer exists, the company shut down. Should he have then held forever? Obviously, the idea with holding less hyped companies in solid, stolid industries, is to avoid that ruinous scenario, but to me the concept of "forever" is naive.

Which reminds me of the saw that people bring out about now, that over a period of the last hundred years or so, common stock has on average given the highest return of all investments. This is pushed as the reason why you should buy and hold, and maybe so for the casual investor who doesn't want to think too much about what he or she's buying (which has its own problems, obviously). That's all well and good until you think about the fact that a hundred years is not really that long a period of time. What happened yesterday is no indication of what will happen tomorrow, even though this is a prime tenet of technical trading and prognostication, and it's also impossible to know where we are on the scale of things. It's quite possible we're at the beginning of a long, hundred-year long trend of underperforming or negatively performing stocks but who would know? How would you determine this were the case until after it happened?

Furthermore, the example of the ever-increasing stock market, I believe fails to account for the fact that companies that failed don't contribute, so there's a built-in confirmation bias to the numbers where it's only companies that continue as going concerns into the present day (already a test for a company's fitness) that factor into the stock market returns. I'm not sure about that, and will have to do some more research on it to be sure, but I think there's certainly room for doubt about the sure-fire methodology of buying and holding.

I do find it funny how coy the article is about his investment successes, carefully revealing only the "wins" he's made to make it seem like he's invested smartly -- it almost feels like he's paid off the newspaper! But what I find funnier is that even the positive investments he's made aren't particularly good: 30%, 33%, 25%. I don't know about you, but if the best stock investment I made returned 33%, I wouldn't be so quick to advertise my ability in stock picking, especially in a national newspaper. If, on the other hand, his entire portfolio was up 33% on the year, that would be something to crow about -- especially in this market.

A time for recuperating

As many of you have likely experienced this year, the equity markets have not been a kind and placid presence this year. Although most of the indices, including the DJIA and the TSX, are up a moderate percentage, it's not clear that investing in the markets was any better than socking your entire portfolio into a high interest savings account. In fact, for all the vaunted housing bubble talk, at least in the Canadian market there have been no major price declines and in some markets, including Vancouver, it still would have made a good momentum-style investment to be in real estate. However, real estate being a much longer term investment, with lower liquidity than stocks, I don't know how feasible it would have been to try to capture that move, when US markets have begun to feel the pinch and the possibility exists that the malaise will shift to Canada.

For me, it's been a lull year in total. Although I saw some fair early gains, I'm now considering this year a wash in my mind. One of the major stories this year was energy. Obviously the big news in energy investing is the giant dive the Amaranth hedge fund took based on big futures bets on natural gas -- the losses are purportedly around six billion, larger even than the LTCM meltdown. That said, energy in general has retreated significantly in the past month and it's become clear to me that energy stocks were this year's version of "Internet stocks". I avoided internet plays even during the boom year of 1999 when I started really paying attention to the market, because they never quite seemed legitimate. Somehow, oil stocks and their attendant hype did not ring the same BS sensors, and I've lost a fair chunk of money trying to engage in oil investments this year, after the hype had reached monster levels and it's clear that most of the investors are speculators now. It pains me all the more considering I was invested in oil in 2000 -- Chesapeake Energy to be exact, at 7 dollars a share. Once again, I was in too soon, and sold before the huge spike in oil prices that precipitated this frenzy.

Now, there's a claim that the oil discovery in the Gulf of Mexico is huge and some even talk about it reconfiguring scenarios about the future and the decline of our oil stocks now that a giant surplus has been discovered. There's still debate about how big that surplus really is, but what the market's reaction has shown me is that even if oil is a legitimately scarce resource, it's incredibly volatile (duh) and even beginning to view it as a stably-priced commodity is pure and simple naivete. The talk of oil prices remaining at a certain, $60-plus level smacks of "the new economy" philosophy that was used to justify extravagant price jumps in Internet stocks -- another similarity. All hype markets start to look the same.

So, more fool me for engaging in a hype market. Although I'm typically very skeptical about markets like that, the overall stagnancy of the market and non-directionality made it very difficult to find stocks that were clear winners and so I suppose I succumbed to the hype, the "quick and easy pickings" of gold and oil, none of which netted me a thing. In fact, the one holding that served me very well this year was Falconbridge (ex. Noranda), that was eventually purchased by Xstrata. A nickel and copper mining play that I got into before those markets heated up, before it was on anyone's radar. And that's what successful stock investing is all about to me -- finding markets that are off people's radar, or that are hated, and getting in early. It's difficult now to find a pure information edge on anyone else, but this is kind of a secondary edge, one that involves making use of people's behavioural tendencies to negate the supposedly free information. Information is much more readily available, but that has not improved people's interpretations of it, and that's why I'm still more willing to side with Warren Buffett than Efficient Markets proponents when philosophizing about the equity markets.