Fear Factor

Some people thrive off of fear – buzzing from the rush they get from skydiving or bungee jumping. Others become paralyzed by fear and are unable to make even the smallest decision. These are not the people who do well in life – or in the stock market.

I don’t know if I should tell you this.

I should be afraid that you might use what I’m about to tell you. You’ll use it against me in the market.

What I’m about to tell you is the only real edge I possess as an analyst and as an investor.

But I’ve pledged to serve you, dear reader, and serve you I must, to the utmost of my ability. So it is that I must reveal the greatest single secret of investing as I have learned it.

Before I tell you what the greatest single secret of investing is, though, I want to tell you why I’m going to give it to you. I’m going to tell you this secret because it’s hiding in plain sight. I bet going public with it won’t hurt me any, because knowing it doesn’t change the fact that you still have to do lots of work to take advantage of it.

So here it is, the #1 secret of investing.

The secret is that fear is the dominant emotion in the market at all times.

I’ve never heard anyone say this, but I know of several famous investors whose actions reflect a clear understanding of it.

Extreme Value Investing: Fear, Not Greed

When Warren Buffett bought shares of Wells Fargo back in the early 1990s, everyone thought he’d lost his touch. He got a call from a colleague in New York – strictly on the QT – saying that Wells Fargo wasn’t going to make it.

Buffett never let the fear get to him. Today, Wells Fargo is the only AAA-rated bank in the country. Buffett has made in the neighborhood of 20% a year on it.

But even Buffett has misquoted the secret. He said once something like, "to make money, you have to be greedy when everyone else is fearful and fearful when everyone else is greedy."

I think Warren Buffett is wrong about that one, and I bet if I called him up and told him, he’d agree with me.

If people were really greedy, they’d wait until stocks were in their darkest hour – and therefore at their lowest prices – to buy them. But most people don’t do that.

They wait to buy. Nobody wanted stocks in 1982, the perfect moment to be greedy. There was no reason to be afraid, no reason to wait. You don’t wait to buy something that’s priced right unless you’re afraid. Period. That’s why I say that fear is the dominant emotion in the market at all times.

Instead of doing their own work and relying on the conclusions of their own thinking, most investors – including most of Wall Street – let the price action of the entire market, or even of a single stock, pinch hit for their own intellects.

Maybe it’s not great insight to say that everyone is afraid at market bottoms. But what about tops? Everyone is greedy at tops, right?


Extreme Value Investing: Safety In Numbers

The reason so many people become involved in stocks at market tops is because…everyone else is buying. That’s what everyone is waiting for. When you’re filled with fear, you wait for some sign that it’s safe to buy again. The sign investors choose most often is the actions of others.

Otherwise sensible people, crazy as it sounds, though blessed with a perfectly good brain, often choose to substitute the product of someone else’s brain for the product of their own brain. Somehow, if someone else is doing something, it makes it more legitimate than if they thought of it on their own.

Henry Blodget is a good example of fear personified, and a total lack of confidence in his own mind. Blodget worked for Merrill Lynch, and got famous in the late 1990s as an Internet analyst. He said Amazon.com would go to $400, and it did (that’s a pre-split price).

Recently, I read an article written by Blodget. Now he says you’re best bet is – are you ready for this? – index funds. There’s hardly been a worse time to buy the big indexes. But it feels safe to do that, the way it felt to buy Amazon at $400, though I can’t speak from experience. Blodget, it seems, is not capable of thinking for himself. He’s so scared of thinking he just can’t bring himself to take a position.

Henry Blodget’s heart is filled with the fear.

Here we are, the paragon of animals, and most of us don’t get past the behavior of lemmings when it comes to investing.

But investing doesn’t work like that, does it? In order to make money, you have to stand on your own. You have to do your own thinking. You have to do your own research. You have to make your own decisions, and handle the consequences every step of the way.


Dan Ferris
for The Daily Reckoning

January 26, 2005 — London, England

P.S. That’s what Extreme Value is about at its core. We don’t buy cheap stocks because we think they are exciting. Extreme Value investing is many things, but exciting is not one of them. To most folks, I’m guessing that’s how it is. But it’s like Fourth of July and Christmas every day to me.

Recently, one of Dan’s favorite mutual funds re-opened to new investors. This fund had to close its doors to new investors over three and a half years ago because too much money was pouring in – the fund’s managers couldn’t invest it all properly. Investors were scrambling to put their money into this fund because it’s one of the best performing mutual funds in the world, returning an average of 20.21% a year since inception. That means you double your money every three and half years. (If you had put $10,000 in the fund back in 1996, you’d be sitting on $33,000 right now.)

There is a catch, however. Actually two catches. You can’t buy this fund through your broker. And, there’s no guarantee how long it will stay open. Dan has written a detailed report on this investment – just click on the link below to access it.

This method of investing is what made Warren Buffett the second richest man in the world. And a 27-year independent study at the University of Chicago proved that these value stocks outperformed all others by an average of 167% per year.

Yesterday was a countertrend day.

Stocks went up. The dollar went up. Gold went down.

While this countertrend could go much further, we doubt that it will do believers much good. Unless you are a nimble and lucky trader, buying stocks or the dollar are not likely to pay off. Stocks are already expensive. And the dollar is still over-priced. Not that we know what the proper price of the dollar is. All we know is its value: zero. Sooner or later, price and value have a way of coming together.

Gold, meanwhile, we have no particular opinion about…except that it is better money to put in your safe than paper dollars. Thirty years ago we could buy a decent suit for an ounce of gold. Today, we can still buy a decent suit for an ounce of gold. And thirty years in the future, we expect we’ll still be able to do so. What the dollar will be worth then, we have no idea…except that it will be less than it is today.

It is vanity that has pushed the dollar up…and it is vanity that will push it down. Economists and central bankers delude and flatter themselves, thinking that they can create a paper money that is both stable and expandable at the same time. Now, along comes the Bush Administration to prove the point. Yesterday’s news reports that Bush has asked for $80 billion more to continue its forced conversion (to democracy) of the ancient Mesopotamian tribes. This brings the total to $283 billion. At the beginning of the war, we reported an estimate that seemed outrageous – even to us. The cost would rise above $1 trillion, we said. Well, we’re more than a quarter of the way there…and the most senior operations officer in Iraq was quoted as saying current levels of troops would be there for another two years.

Even at the present level, the Bush team has spent about $10,000 for every citizen of Iraq and Afghanistan – or more than the combined GDP of Israel and Argentina. At that price, you’d think that direct bribery would have worked better than bullying.

But the people in charge of Bush foreign policy are vain world improvers. And the world improvers don’t feel that they’ve done a good day’s work unless they’ve killed someone. All the greatest world improvers have been mass murderers. Alexander, Caesar, Tamerlane, Genghis Khan, Hitler, Stalin, Mao…Even the peaceable improvers, such as Mahatma Gandhi and perhaps Wilson, so upset the order of things…that millions died in the mess they left behind.

But the Bush people think that voting is worth the price, in blood as in treasure. Why they think so is a mystery.

Democracy is widely thought to promote peace and prosperity. Yet, we have a superb counter-example in a new book by James Bartholomew: The Welfare State We’re In. In the 50 years of the last century, Hong Kong citizens barely cast a vote for anything. Instead, during most of the period they were ruled by a distant, and almost uninterested bureaucracy, represented in the colony by a Mr. John Cowperthwaite. Mr. Cowperthwaite arrived in 1961. He was a flinty Scott and a modest civil servant who had been appointed Financial Secretary in charge of all that concerned Hong Kong’s economy and never wore a cowboy hat in his entire life.

Cowperthwaite found himself in charge of an economy of millions of poor people – the output per capita was only 1/5th that in Great Britain – with millions of refugees streaming in from China. The colony had little arable land. It had no natural resources. It lacked even enough water. But it had one huge advantage: it had no democracy.

Back in England, explains James Bartholomew, the government was busy responding to the voters. More and more social programs were added. Taxes were raised. Wars were financed. By the 1970s, Britain was nearly bankrupt…and had to beg money from the IMF.

In Hong Kong, meanwhile, Cowperthwaite resisted all entreaties to follow Britain’s example. Taxes were left at 15%…and only on salaries. The rich paid no higher rate than the middle classes. Other forms of taxation were almost non-existent. Regulations were few. There were few social welfare programs. If the middle classes wanted housing, they could pay for it themselves, said the Financial Secretary. If businessmen thought a cross-harbor tunnel is such a good idea, let them build it with their own money, he added. As a result, Hong Kong boomed. Its annual growth rates during the entire period were typically two or three times those of Britain. By 1992, Hong Kong’s output per person passed Britain itself – the old colony was richer! No vote had ever been taken. No election had ever held. No voice of the people had ever been heard. Instead, Hong Kong became one of the most peaceful and most prosperous places on the entire planet.

More news, from our team at The Rude Awakening:


Tom Dyson, reporting from blustery Baltimore…

"Whatever the case, the Hunts were forced to liquidate parts of their position, and silver crashed…from over $50 at its intra-day peak, to below $10 less than two months later. The Hunts went bankrupt and Paul Volcker organized a $1.1 billion dollar loan to ‘prevent the very fabric of American finance from tearing apart.’"

For the rest of this story, and for more market insights, see today’s issue of The Rude Awakening:


Bill Bonner, back in London:

*** Why did the Hunt Brothers try to corner the silver market?

It wasn’t greed, or even recklessness. No, apparently they were just trying to hedge their fortune against inflation. Tom Dyson, our roving bull market emissary, explains:

"Everyday the Hunt family were trading innumerable gallons of a scarce natural resource – petroleum – for paper dollars. At the same time, inflation was running rampant, and it was by no means certain that Fed Chairman Paul Volcker could contain it. It’s exactly the logic you read about in the Daily Reckoning every day…"

"Looking back, Hunt should have tried to corner the market in government bonds or technology stocks…stuff no one wanted in 1980. Imagine that. He’d probably be remembered like Templeton or Soros…rather than the bankrupt buffoon the press still make him out to be."

For the full story, see today’s edition of the Rude Awakening – Bunkered: The Great Crash of 1980…

*** The other great success story of the post-war period was Japan. Japan managed growth rates twice as high as most of the developed world between 1950 and 1973. By the end of the ’80s, Japan was one of the richest and most widely admired countries in the world. In Japan, people did vote. Democracy had been imposed by the United States at the end of the war. But the Japanese never voted with much enthusiasm, and almost always for the same people.

*** A reader writes:

"I have to tell you I love your site. I love your style of writing, your humor and your eclectic interests. I always find you interesting and informative.

"Unfortunately, I have no money to invest and that is not an exaggeration. I am retired and on a limited income. However, I learn a great deal about what is going on economically around the world. More importantly, I am
often able to better assess what Canadian politicians are telling the public about our economy.

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*** We have readers of all sorts, smart and not so smart. Here, one of the latter comments:

"This are my comments and response to the January 22nd D.R. written by Bill Bonner from Paris, France. I think your comments about the President of the United States regarding his inaugural address are absolutely wrong and unfair. You have expressed an opinion that is biased and left wing political trash. You should stay in Europe and not return to the USA. Also, you should keep you comments about President George W. Bush to yourself and I certainly will never read you D.R. material ever again. You mist have a high opinion of yourself and believe that others are interested in your D.R. published material. You are very wrong in all your negative trash that you send by email from Paris. Stay far away."

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