When the New York Stock Exchange first set up shop, stocks traded in minimum increments of 1/8 = $0.125 dollars. This system was probably a holdover from the Spanish trading system, whose largest gold coin was valued at eight escudos. If academics in finance would break apart a universe of stocks into eight different groups and rank their performance based on some rigorous filtering criterion, it would tie in nicely with our New York Stock Exchange tradition of shares changing hands in 1/8 increments. Unfortunately, these competitive publish-or-perish types seem to prefer decile categories over pieces of eight. Any last remnants of Wall Street’s Spanish roots were given the heave-ho when the SEC mandated decimilization for stock trading on all U.S. exchanges starting in 2001. So ends the pieces-of-eight legacy.
My investment advisory firm is located within a five-minute drive of the Mississippi River here in the St. Louis metropolitan area. Not long ago, I heard a tall fishing tale from an underwater welding specialist who repairs bridges along the Mississippi River. The oversized dimensions he described of a river catfish that brushed alongside him while he was doing some repair work on an arch bridge sounded almost unbelievable. There are similarities in the way a bottom feeder catfish hunts for food and in the way an enterprising investor finds undervalued securities using a selection approach that Benjamin Graham wrote about in his book The Intelligent Investor.
The latest U.S. Census Bureau statistics show more people currently on some form of means-tested public assistance than working full-time. Fortunately, that dismal employment statistic is not evenly distributed across all industries in our economy. One industry in particular that has been relatively isolated from the jobless recovery is the oil and natural gas sector.
I’ve been running my investment advisory firm here in the St. Louis area for the last twenty years. My physical proximity to other businesses struggling to keep their doors open in Ferguson might give me a slightly different perspective than the overcrowded hashtag I’ve been following on my phone. This outer suburb of St. Louis has transitioned to a battlefield where law enforcement has moved from a theme of “protect and serve” to “engage the enemy”. On the one side, police officers dressed in camouflage are brandishing assault rifles in the faces of protestors, and on the other side, unlikely activists feel compelled to join the angry mob. This includes a ninety-year old Jewish holocaust survivor who was hauled off after protesting the deployment of National Guard troops patrolling the streets of Ferguson.
Ayn Rand’s novel, Atlas Shrugged, describes a world that was on a slow but steady path toward ever more central planning by meddling bureaucrats interfering with the entrepreneurial class who relied on one another for their production of output. A character in the novel, John Galt, tucks himself away in a secret hideaway and convinces fellow entrepreneurs to join him in dropping out of society.
Ayn Rand wrote an influential book, Atlas Shrugged, in the ’50s that seems to resurface in popularity with each new wave of government intrusion on the lives of our overregulated, overtaxed citizens. The book describes a world that was on a slow but steady path toward ever more central planning by meddling bureaucrats interfering with the entrepreneurial class who relied on one another for their production of output. As the pages of the book are turned, this “road to serfdom” (a phrase I borrow from Friedrich Hayek), reaches a peak with the last of a small subset of productive entrepreneurs dropping out of their respective professions and sealing themselves off in a secret location created by John Galt. Their isolation from government interference in Galt’s secret hideaway was designed to allow this subset of creative, hard-working individuals to pursue their dreams and live in a rational way, trading value for value with one another. The vision of Galt in his hidden refuge is consistent with the Ayn Rand objectivist philosophy that she advocated her entire life as an immigrant to America from the Soviet Union.
When the topic of investing comes up in conversation, I’m often asked to recommend an investment book. Since I’m biased toward the value investing philosophy, one of Benjamin Graham’s books always comes to mind. But what if I were to tweak the question a bit and not recommend an investment book, but only a particular page of an investment book? What single page above all other pages from a book on investing would I recommend?
The performance of gold stood in sharp contrast to the return on stocks over the previous decade. Most people are not aware that stocks had a negative average annual return from 2000 to 2009. This time period produced even worse results than the Great Depression of the 1930s.[I] That terrible performance even assumes an investor reinvested the dividend income on their stock holdings. Given that backdrop of lousy equity performance, gold was viewed by the retail public as the asset class of choice over the previous decade. The chart below shows how gold almost quadrupled in value while the S&P 500 stock index remained slightly below where it started. As gold continued climbing over the previous decade, more investors joined the social contagion bandwagon and diversified into the yellow metal.
We’ve experienced a number of years over the recent past where the broad stock market average produced a negative rate of return. The year 2000, 2001, 2002 & 2008 all produced negative returns for someone invested in a stock index fund. Experiencing the occasional bear market year in stocks is inevitable for those investors following a buy-and-hold approach to stock investing. Given the difficulty in market timing stocks over the long term, buy-and-hold investors will on occasion be forced to endure bear market years in their portfolio.
The retail public enjoys the storytelling of growth stocks and the financial press is more than happy to fill that void. It is easy for an investor to fall into what finance professor, Jeremy Siegel, refers to as a “growth trap”, focusing on stocks with rapid sales and earnings growth in new industries that are highly disruptive. Humans have a predisposition to see patterns where none exist. Connecting the dots and extrapolating above average growth trends far into the future is an example of this pattern seeking behavior. Let’s take a look at the evidence and see if past growth in earnings really does continue into the future for stocks we want to invest in.