Markets are Rigged...So What?
Great gobs of money continue to drain away from stock mutual funds. And even some big-name investors have put up the white flag. Louis Bacon famously gave back $2 billion to his investors a couple of weeks ago because, he says, he can’t figure the market out.
This has led some to say that the era of stocks is over. “The cult of equities is dying,” writes the oft-quoted Bill Gross, who manages money at Pimco. “Like a once bright-green aspen turning to subtle shades of yellow then red in the Colorado fall, investors’ impressions of ‘stocks for the long run’ or any run have mellowed as well.”
I’m with David Goldman, who writes in the Asia Times under the penname Spengler that Gross is only “half-right.” The market, as always, has its enthusiasms. He writes:
Visible and reliable cash flows trade at an unprecedented premium as bond yields collapse. Valuations of utility, tobacco, energy trust and other big dividend payers are stupidly rich and are likely to remain so. A sea change in equity valuations has put a premium on secure cash flows while amplifying the effect of uncertainty. It is possible to measure these changes by a number of statistical means, some direct, some indirect.
Goldman points to mining stocks, which are very uncertain and have returned a negative 24% in the last two years. Utilities, by contrast, are very stable. Utilities have returned 30% in the last two years. That’s very frustrating for those holding mining stocks.
He offers more evidence, but you get the idea. Stable, predictable cash flows and yields are popular. Unstable, uncertain cash flows with no yield are not. (Eventually, this will break. Timing is, as always, uncertain.)
Second, I wonder if the points Gross raises are even relevant. I mean, investors have been yanking their money out of stock mutual funds since the crisis of 2008. The market has more than doubled since. And it is now within spitting distance of all-time highs.
Volume, liquidity, public participation in equities… All of these are overrated concepts. Market values can move dramatically with hardly any volume at all and be just as real as a change accompanied by lots of volume.
Beyond these objections, though, I think there is some truth to what Gross is saying.
I hear more and more people say the market is rigged against them. They say it is a game for insiders to fleece gullible outsiders. Wall Street has not helped this image at all. There seems to be no end to lurid scandals or crises of confidence in the system.
I have to say I, too, have felt this way more often of late. However, I believe there are ways to invest safely and feel good about it. You can ignore the scandals. You can ignore Wall Street.
One way does involve direct investments in stocks, but by paying careful attention to the tenets of what I call the CODE System:
- Cheap — as measured by stocks trading below replacement costs or below private market value
- Owner-operators — as measured by high insider ownership of the people in charge and/or a good track record of delivering results for shareholders
- Disclosures — which means a business we can understand and that reports results with good disclosures. Transparency is another word for the virtue we seek here
- Excellent financial condition — as measured by a relative absence of liabilities, lots of cash and/or cash flow and the ability to “do deals” (i.e., borrow at super-attractive rates, take advantage of opportunities, convert assets to other uses, etc.).
I like to call this philosophy “investing like a dealmaker.” It is one I’ve distilled from a decade of experience as a corporate banker doing deals, along with my own ongoing two-decade study of investing. Of course, I’ve also managed money on my own account all along the way.
Another way to beat rigged markets is to invest in funds or private partnerships that also pass the CODE test.
For example, you can easily buy shares in Gabelli’s Focus Five Fund (GWSVX). This is a fund with a well-defined mission and cut from a process that has produced stunning results. Own some shares and sit on them. Let portfolio manager Dan Miller do the hard work for you.
So my ultimate answer to Gross is this: Who cares? For those of us willing to dig, there are always plenty of opportunities — some of them in the stock market and some not. The question is not about any cult of anything. It’s about what makes sense and what doesn’t. Whatever other people do or think is irrelevant.
I’ve been particularly influenced by the ideas of Martin Whitman, who for years managed the Third Avenue Value Fund. He’s also written a pair of excellent, though technical, books that express similar ideas: Value Investing: A Balanced Approach and The Aggressive Conservative Investor. (Far less technical, though written in the same spirit, is my own first book, Invest Like a Dealmaker: Secrets From a Former Banking Insider.)
In my Capital & Crisis newsletter, I’ve been more draconian in applying the CODE of late, which in part has accounted for an itchy trigger finger in selling positions. The time to get tough is when the market is merrily rolling along. Before things roll over — not after. Otherwise, I’m happy to sit with my cash for a while until an extraordinary new opportunity opens up.
More time and care yield a much more-satisfying result. This is the way it is in life. Investing is no different. The results will be better and more satisfying than if we try to take shortcuts to find and trade more ideas. In my mind, it’s a lot like finding and eating good food.
Last night, we ate dinner on the back patio amid the hum of cicadas. We had basil from our garden, tomatoes from my in-laws’ garden and cheese from a local farm. Of course, it would be easier to just buy tomatoes and cheese from the grocery store. But it would not be the same.
I grilled chicken thighs over hardwood charcoal. (We raise chickens, but for eggs.) It’s a rare thing to do it this way nowadays. It takes more time. You have to light the fire and let the coals ash over and spread them around. The heat is uneven and you have to watch more closely what you are grilling.
I remember one little guest asking once, “What’s that?”
“Charcoal,” I said.
“Oh,” he said. “My dad just turns it on,” he said.
Yes, it would be faster to have an electric grill that you just turn on. But I can’t help but think of the words of that great eater (and cook and writer) Nicolas Freeling. “Nothing, of course, could be more stupid than an electric barbecue,” he writes in his classic The Kitchen Book. “The principle of a grill is that the food should meet smoke as well as heat.”
Of course, it would be much easier to just buy ticker symbols based on what you hear other people tell you on TV or what you hear in the news, rather than do all this research. But the result, like a store-bought tomato, is very different from the juicy blood-red tomato from a home garden. It is the difference between the work of an electric grill and that done by flames and smoke.
Everyone is always in a hurry, it seems to me. I say relax and slow down with your life and money. Enjoy, savor and seek out quality over quantity.
I just finished reading Bill and Will Bonner’s book, Family Fortunes: How to Build Family Wealth and How to Hold on to It for 100 Years. The key to old money — those long-lasting fortunes — boils down to one thing. “The secret is simply this,” the authors write: “The rich take the long view.”
They go on:
“If you look carefully, almost all ‘Old Money’ secrets can be traced to a single source: a longer-term outlook. The truly wealthy are careful to spend their money on things that hold their value over time…
“Serious Old Money investors barely follow the news and never react to it. They know that the really important trends take years to develop and then many years to play themselves out. You can take your time… months… years… before making a decision. There is no need to feel rushed…
“Investment success happens by taking big positions in big trends and leaving them alone for a long time.”
Not easy to do, but I think this is right. It is something to shoot for.