26 replies to this topic

[thefirstimmortal]

After major upsets such as the Last 3 years, some investors have taken refuge in bonds. This issue of stocks versus bonds is worth resolving it up front, and in a calm and dignified manner, or else it will come up again at the most frantic moments, when the stock market is dropping and people rush to the banks to sign up for CDs. Lately, just such a rush has occurred.

[thefirstimmortal]

Investing in bonds, money-markets, or CDs are all different forms of investing in debt-for which one is paid interest. There’s nothing wrong with getting paid interest, especially if it is compounded. Consider the Indians of Manhattan, who in 1626 sold all their real estate to a group of immigrants for $24 in trinkets and beads. For 362 years the Indians have been the subjects of cruel jokes because of it-but it turns out they may have made a better deal than the buyers who got the island.

At 8 percent interest on $24 (note: let’s suspend our disbelief and assume they converted the trinkets to cash) compounded over all those years, the Indians would have built up a net worth just short of $30 trillion, while the latest tax records from the Borough of Manhattan show the real estate to be worth only $28.1 billion. Give Manhattan the benefit of the doubt: that $28.1 billion is the assessed value, and for all anybody knows it may be worth twice that on the open market. So Manhattan’s worth $56.2 billion. Either way, the Indians could be ahead by $29 trillion and change.

Granted it’s unlikely that the Indians could have gotten 8 percent interest, even at the kneecracker rates of the day, if in fact there were kneecracker rates in 1626. The pioneer borrowers were used to paying much less, but assuming the Indians could have wangled a 6 percent deal, they would have made $34.7 billion by now, and without having to maintain any property or mow Central Park. What a difference a couple of percentage points can make, compounded over three centuries.

[thefirstimmortal]

However you figure it, there’s something to be said for the supposed dupes in this transaction. Investing in debt isn’t bad.
Bonds have been especially attractive in the last twenty years. Not in the fifty years before that, but definitely in the last twenty. Historically, interest rates never strayed far from 4 percent, but in the last decade we’ve seen long-term rates rise to 16 percent then fall to 8 percent, creating remarkable opportunities. People who bought U.S. Treasury bonds with 20-year maturities in 1980 have seen the face value of their bonds nearly double, and meanwhile they’ve still been collecting the 16 percent interest on their original investment. If you were smart enough to have bought 20-year T-bonds then, you’ve beaten the stock market by a sizable margin, even in this latest bull phase. Moreover, you’ve done it without having to read a single research report or having to pay a single tribute to a stockbroker.

[thefirstimmortal]

(Long-term T-bonds are the best way to play interest rates because they aren’t “callable”, or at least not until five years prior to maturity. As many disgruntled bond investors have discovered, many corporate and municipal bonds are callable much sooner, which means the debtors buy them back the minute it’s advantageous to do so. Bondholders have no more choice in the matter than property owners who face a condemnation. As soon as interest rates begin to fall, causing bond investors to realize they’ve struck a shrewd bargain, the deal is canceled and they get their money back in the mail. On the other hand, if interest rates go in a direction that works against the bondholders, the bondholders are stuck with the bonds.

[thefirstimmortal]

Traditionally bonds were sold in large denominations-too large for the small investor, who could only invest in debt via the savings account, or the boring U.S. savings bonds. Then the bond funds were invented, and regular people could invest in debt right along with tycoons. After that, the money-market fund liberated millions of former passbook savers from the captivity of banks, once and for all. There ought to be a monument to Bruce Bent and Harry Browne, who dreamed up the money-market account and dared to lead the great exodus out of the Scroogian thrifts. They started it with the Reserve Fund in 1971.

[thefirstimmortal]

It’s one thing to prefer stocks to a stodgy savings account that yields 5 percent forever (less today), and quite another to prefer them to a money-market that offers the best short-term rates, and where the yields rise right away if the prevailing interest rates go higher.

If your money has stayed in a money-market fund since 1978, you certainly have no reason to feel embarrassed about it.

You’ve missed a couple of major stock market declines. The worst you’ve ever collected until recently is 6 percent interest, and you’ve never lost a penny of your principal. The year that short-term interest rates rose to 17 percent (1981) and the stock market dropped 5 percent, you made a 22 percent relative gain by staying in cash.

[thefirstimmortal]

During the stock market’s incredible surge from Dow 1775 on September 29, 1986, to Dow 2722 on August 25, 1987, let’s say you never bought a single stock, and you felt dumber and dumber for having missed this once-in-a-lifetime opportunity. After a while you wouldn’t even tell your friends you had all your money in a money-market- admitting to shoplifting would have been less mortifying.

But the morning after the crash, with the Dow beaten back to 1738, you felt vindicated. You avoided the whole trauma of October 19. With stock prices so drastically reduced, the money-market actually had outperformed the stock market over the entire year-6. 12 percent for the money-market to 5.25 percent for the S&P 500.

[thefirstimmortal]

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Two months later the stock market had rebounded, and once again stocks were outperforming both money-market funds and long-term bonds. Over the long haul they always do. Historically, investing in stocks is undeniably more profitable than investing in debt. In fact, since 1927, common stocks have recorded gains of 9.8 percent a year on average, as compared to 5 percent for corporate bonds, 4.4 percent for government bonds, and 3.4 percent for Treasury bills.

The long-term inflation rate, as measured by the Consumer Price Index, is 3 percent a year, which gives common stocks a real return of 6.8 percent a year. The real return on Treasury bills, known as the most conservative and sensible of all places to put money, has been nil. That’s right. Zippo.

[thefirstimmortal]

The advantage of a 9.8 percent return from stocks over a 5 percent return from bonds may sound piddling to some, but consider this financial fable. If at the end of 1927 a modern Rip Van Winkle had gone to sleep for 60 years on $20,000 worth of corporate bonds, paying 5 percent compounded, he would have awakened with $373 ,584.-enough for him to afford a nice condo, a Volvo, and a haircut; whereas if he’d invested in stocks, which returned 9.8 percent a year, he’d have $5,459,720. (Since Rip was asleep, neither the Crash of ‘29 nor the ripple of ‘87 would have scared him out of the market.)

In 1927, if you had put $1,000 in each of the four investments, and the money had compounded tax-free, then 60 years later you’d have had these amounts: $ 7,400 Treasury bills, 13,200 Government bonds,17,600 Corporate bonds, 272,000 Common stocks

[thefirstimmortal]

In spite of crashes, depressions, wars, recessions, ten different presi­dential administrations, and numerous changes in skirt lengths, stocks in general have paid off fifteen times as well as corporate bonds, and well over thirty times better than Treasury bills!

There’s a logical explanation for this. In stocks you’ve got the company’s growth on your side. You’re a partner in a prosperous and expanding business. In bonds, you’re nothing more than the nearest source of spare change. When you lend money to somebody, the best you can hope for is to get it back, plus interest.

[thefirstimmortal]

Think of the people who’ve owned McDonald’s bonds over the years. The relationship between them and McDonald’s begins and ends with the payoff of the debt, and that’s not the exciting part of McDonald’s. Sure, the original bondholders have gotten their money back, the same as they would have with a bank CD, but the original stockholders have gotten rich. They own the company. You’ll never get a tenbagger in a bond-unless you’re a debt sleuth who specializes in bonds in default.

[thefirstimmortal]

Especially after the latest drop in stock prices a good question is, “but what about the risks? Aren’t stocks riskier than bonds?” Of course stocks are risky. Nowhere is it written that a stock owes us anything, as it’s been proven to me on many of sorry occasions.

Even blue-chip stocks held long term, supposedly the safest of all propositions, can be risky. RCA was a famous prudent investment, and suitable for widows and orphans, yet it was bought out by GE in 1986 for $66.50 a share, about the same price that it traded in 1967, and only 74 percent above its 1929 high of $38.25 (adjusted for splits). Less than one percent worth of annual appreciation is all you got in 57 years of sticking with a solid, world-famous, and successful company.

Bethlehem Steel continues to sell far below its high of $60 a share reached in 1958.

[thefirstimmortal]

Buy the right stocks at the wrong price at the wrong time and you’ll suffer great losses. Look what happened in the 1972-74 market break, when conservative issues such as Bristol-Myers fell from $9 to $4, Teledyne from $11 to $3, and McDonald’s from $15 to $4. These aren’t exactly fly-by-night companies. Buy the wrong stocks at the right time and you’ll suffer more of the same. During certain periods it seems to take forever for the theoretical 9.8 percent annual gain from stocks to show up in practice. The Dow Jones industrials reached an all-time high of 995 in 1966 and bounced along below that point until 1972. In turn, the high of 1972-73 wasn’t exceeded until 1982.

[thefirstimmortal]

With the possible exception of the very short-term bonds and bond funds, bonds can be risky, too. Here, rising interest rates will force you to accept one of two unpleasant choices: suffer with the low yield until the bonds mature, or sell the bonds at a substantial discount to face value. If you are truly risk-averse, then the money-market fund or the bank is the place for you. Otherwise, there are risks wherever you turn.

[thefirstimmortal]

Municipal bonds are thought to be as secure as cash in a strongbox, but on the rare occasion of a default, don’t tell the losers that bonds are safe. (The best-known default is that of the Washington Public Power Supply System, and their infamous “Whoops” bonds.) Yes, I know bonds pay off in 99.9 percent of the cases, but there are other ways to lose money on bonds besides a default. Try holding on to a 30-year bond with a 6 percent coupon during a period of raging inflation, and see what happens to the value of the bond.

[thefirstimmortal]

Frankly, there is no way to separate investing from gambling into those neat categories that are meant to reassure us. There’s simply no Chinese wall, bundling board, or any other absolute division between safe and rash places to store money. It was in the late 1920s that common stocks finally reached the status of “prudent investments,” whereas previously they were dismissed as barroom wagers-and this was precisely the moment at which the overvalued market made buying stocks more wager than investment.

[thefirstimmortal]

For two decades after the Crash, stocks were regarded as gambling by a majority of the population, and this impression wasn’t fully revised until the late 1960s when stocks once again were embraced as invest­ments, but in an overvalued market that made most stocks very risky. Historically, stocks are embraced as investments or dismissed as gambles in routine and circular fashion, and usually at the wrong times. Stocks are most likely to be accepted as prudent at the moment they’re not.

[thefirstimmortal]

For years, stocks in large companies were considered “investments” and stocks in small companies “speculations,” but in the last bill run small stocks have become investments and the speculating is done in futures and options. We’re forever redrawing this line.

[thefirstimmortal]

The greatest advantage to. investing in stocks, to one who accepts the uncertainties, is the extraordinary reward for being right. This is borne out in the mutual fund returns calculated by the Johnson Chart Service of Buffalo, New York. There’s a very interesting correlation here: the “riskier” the fund, the better the payoff. If you’d put $10.000 into the average bond fund in 1963, fifteen years later you’d come out with $31,338. The same $10,000 in a balanced fund (stocks and bonds) would have produced $44,343; in a growth and income fund (all stocks), $53,157; and in an aggressive growth fund (also all stocks), $76,556.

Clearly the stock market has been a gamble worth taking-as long as you know how to play the game.

[thefirstimmortal]

Thou­sands of experts study overbought indicators, oversold indicators, head-and-shoulder patterns, put-call ratios, the Fed’s policy on money supply, foreign investment, the movement of the constellations through the heavens, and the moss on oak trees, and they can’t predict markets with any useful consistency, any more than the gizzard squeezers could tell the Roman emperors when the Huns would attack.

Nobody sent up any warning flares before the 2000-02 stock market debacle, either. Back in school I learned the market goes up 9 percent a year, and since then it’s never gone up 9 percent in a year, and I’ve yet to find a reliable source to inform me how much it will go up, or simply whether it will go up or down. All the major advances and declines have been surprises to me.

[thefirstimmortal]

If I could avoid a single stock, it would be the hottest stock in the hottest industry, the one that gets the most favorable publicity, the one that every investor hears about in the car pool or on the commuter train, and succumbing to the social pressure, often buys.

Hot stocks can go up fast, usually out of sight of any of the known land­marks of value, but since there’s nothing but hope and thin air to support them, they fall just as quickly. If you aren’t clever at selling hot stocks (and the fact that you’ve bought them is a clue that you won’t be), you’ll soon see your profits turn into losses, because when the price falls, it’s not going to fall slowly, nor is it likely to stop at the level where you jumped on.

[thefirstimmortal]

Look at the old chart for Home Shopping Network, a hot stock in the hot teleshop industry, which in 16 months went from $3 to $47 back to $31/2 (adjusted for splits). That was terrific for the people who said good-bye at $47, but what about the people who said hello at $47, when the stock was at its hottest? Where were the earnings, the profits, the future prospects? This investment had all the underlying security of a roulette spin.

The balance sheet was deteriorating rapidly (the company was taking on debt to buy television stations), there were problems with the telephones, and competitors had begun to appear. How many zirconium necklaces can people wear?

There are various hot industries where sizzle led to fizzle. Mobile homes, digital watches, and health maintenance organiza­tions were all hot industries where fervent expectations put a fog on the arithmetic. Just when the analysts predict double-digit growth rates forever, the industry goes into a decline.

[thefirstimmortal]

There couldn’t have been a hotter industry than carpets. As I was growing up, every housewife in America wanted wall-to-wall carpeting. Somebody invented a new tufting process that drastically reduced the amount of fiber that went into a rug, and somebody else automated the looms, and the prices dropped from $28 a yard to $4 a yard. The newly affordable rugs were laid down in schools, offices, airports, and in millions of tract houses in all the nation’s suburbs.

Wood floors were once cheaper than carpets, but now carpets were cheaper, so the upper classes switched from carpets to wood floors and the masses switched from wood floors to carpets. Carpet sales rose dramatically, and the five or six major producers were earning more money than they knew how to spend, and growing at an astonishing pace. That’s when the analysts started telling the stockbrokers that the carpet boom would last forever, and the brokers told their clients, and the clients bought the carpet stocks. At the same time, the five or six major producers were joined by two hundred new competitors, and they all fought for customers by dropping their prices, and nobody made another dime in the carpet business.
High growth and hot industries attract a very smart crowd that wants to dry copies, as opposed to the original wet ones. Xerox got frightened and bought some unrelated businesses it didn’t know how to run, and the stock lost 84 percent of its value.

Several competitors didn’t fare much better.

Copying has been a respectable industry for two decades and there’s never been a slowdown in demand, yet the copy machine companies can’t make a decent living.

[thefirstimmortal]

Another stock I’d avoid is a stock in a company that’s been touted as the next IBM, the next McDonald’s, the next Intel, or the next Disney, etc. In my experience the next of something almost never is-on Broadway, the best-seller list, the National Basketball Association, or Wall Street. How many times have you heard that some player is supposed to be the next Willie Mays, or that some novel is supposed to be the next Moby Dick, only to find that the first is cut from the team, and the second is quietly remaindered? In stocks there’s a similar curse.

In fact, when people tout a stock as the next of something, it often marks the end of prosperity not only for the imitator but also for the original to which it is being compared. When other Computer companies were called the “next IBM,” you could have guessed that IBM would go through some terrible times, and it did. Today most computer companies are trying not to become the next IBM, which may mean better times ahead for that beleaguered firm.

[thefirstimmortal]

Whisper stocks have a hypnotic effect, and usually the stories have emotional appeal. This is where the sizzle is so delectable that you forget to notice there’s no steak. If you or I regularly invested in these stocks, we both would need part-time jobs to offset the losses. They may go up before they come down, but as a long-term proposition you lose money on every single one Some examples: Worlds of Wonder; Pizza Time Theater (Chuck E. Cheese bought the farm); One Potato, Two (symbol SPUD); National Health Care ($14 to 50 cents); Sun World Airways ($8 to 50 cents); Alhambra Mines (too bad they never found a decent mine); MGF oil (a penny stock today); American Surgery Centers (do they need patients!); Asbetec Industries, American Solar King (find it on the pink sheets of forgotten stocks); Televideo (fell off the bus); Priam Vector Graphics Microcomputers GD Ritzys (fast food, but no McDonald’s); integrated Circuits; Comdial Corp; and Bowmar.

What all these longshots had in common besides the fact that you lost money on them was that the great story had no substance. That’s the essence of a whisper stock.

The stockpicker is relieved of the burden of checking earnings and so forth because usually there are no earnings. Understanding the p/e ratio is no problem because there is no pie ratio. But there’s no shortage of microscopes, Ph.D.’s, high hopes, and cash from the stock sale.

What I try to remind myself (and obviously I’m not always successful) is that if the prospects are so phenomenal, then this will be a fine investment next year and the year after that. Why not put off buying the stock until later, when the company has established a record? Wait for the earnings. You can get tenbaggers in companies that have already proven themselves. When in doubt, tune in later.

[thefirstimmortal]

Often with the exciting longshots the pressure builds to buy at the initial public offering (IPO) or else you’re too late. This is rarely true, although there are some cases where the early buying surge brings fantastic profits in a single day. On October 4, 1980, Genentech came public at $35 and on the same afternoon traded as high as $89 before backing off to $71.

[thefirstimmortal]

As often as a dull name in a good company keeps early buyers away, a flashy name in a mediocre company attracts investors and gives them a false sense of security. As long as it has “advanced,” “leading,” “micro,” or something with an x in it, or it’s a mystifying acronym, people will fall in love with it.