The Fallacy of Predicting Market Tops

Dear Investors,

First of all, I want to start by saying that all of our thoughts and prayers are for any of you that have or will be impacted by this terrible hurricane season.  Seeing the images of massive amounts of families being displaced and in jeopardy is never easy, but hopefully some good comes with the bad as divided communities come together to rebuild as we have so many times.  Between these natural disasters and the global trepidation involving the developments in North Korea, there has been no lack of negativity for people to dwell on.  At T&T Capital Management, our goal is really to invest your hard-earned assets in a way in which your funds are protected and where we can maximize risk-adjusted returns.  While we cannot do anything to protect people from certain disasters, we are 100% committed to helping to avoid the financial disasters that have plagued market participants for hundreds, if not thousands of years if you really think about it.

The difference between investing and speculating is that investing is based on the expectation of profitable returns based on a comprehensive fundamental analysis of the facts.  Speculation is usually based on things like intuition or a gut feeling.  Over my investment career, I’d honestly say that just about every quarter, I’ve had somebody tell me that they expect the market to collapse.  These gut feelings are usually more prominent when the market has already shown signs of weakness and the percentage of success of these intuitive bets are very likely in the low single-digits in my estimation.  A great example was prior to last year’s election, where many allowed their emotions to keep them out of a market that was offering some very compelling investment opportunities, particularly in financial stocks, where we made a tremendous amount of money by focusing on the financials.

This is not to say that it is wise to ignore the overall market completely.  The overall stock market as defined by the S&P 500, the Nasdaq, and the Dow are all overvalued in my opinion.  The only way that this would not be the case would be if interest rates stayed this low for the next decade or so, which I view as being a very unlikely event.  If one is investing only in these markets by being long index funds or mutual funds that closely follow the indices, it is going to be very difficult to make money over the next decade.  If I were to tell you what month or quarter, the fundamental tide of these markets will shift, my predictive ability would likely be at the same low single-digit level as other market-timers.  That is why we, as always, focus on fundamental analysis and individual investment selection.  Even during bear markets, there are stocks and securities that can perform exceptionally well!

This 8 1/2 year-long bull market has seen numerous sectors experience bear markets.  Often these reactions are over-reactions, and allow us the opportunity to invest in securities that offer both a margin of safety and large return potential.  Even now, we have some very attractive investment opportunities in areas that are highly out of favor for various reasons.  When pessimism is so great that it feels almost painful to hold on to securities, based on the constant negative news cycle, that it can often be the most fertile ground for promising investments.

Think of areas such as generic drug manufacturers, mall-REITs, and retail.  Many of these stocks are universally hated to the point where the valuations have almost no relation to fundamentals, as defined by cash flows, intrinsic value, etc.  Let’s say the overall stock market performs poorly over the next 3-5 years, but the future of these companies proves to be slightly less horrid than current expectations are.  Because these stocks have already sold off so aggressively, a slight regression to the mean could easily produce double-digit annual returns even when the overall market might be negative.

We might find opportunities in the common stock, preferred stock, or debt, but the universal idea of taking advantage of fundamentally mispriced securities remains the same.  When you invest in a manner where you are not even attempting to correlate to any indexes, you should expect short-term and long-term divergence from time to time in performance.  This is our only hope of being able to produce above-average long-term returns, and if we are correct that the overall market does not look very promising over the next 3-5 years, it is by far our best hope of attaining strong absolute returns.

It is very easy for a stock to drop from $50 to $32, and then rally to $68 within a year or two.  Was the investment a mistake at $50, or $40, or $35?  Of course, the answer is no as long as the investment was based on proper fundamental analysis.  Our current strategies that we are implementing, which I’m not going to detail too comprehensively for competitive reasons, are more different than basic index investing, than they have ever been.  It is not being done on a 6 month basis, but instead we are planting the seeds for strong 3-5-10 year returns, which is how you really create wealth.

As always, if you need anything or if we can assist in any way, please don’t hesitate to contact me at 805-886-8140!  Below is an article about market tops from the WSJ this week, which outlines some similar points.  Thank you very much!

The Myth of Stock-Market Tops