This is a guest post from Troy at The Financial Economist. If you’d like to guest post, please contact me.
Yes, you did read the title correctly. In order to make profitable investments, you do not need to predict the future. I understand that at this point, what I’m saying doesn’t make much sense. Let me elaborate.
Most investors are accustomed to predicting the future of the stock market – where will it be in the next 3 months, 6 months, 1 year, etc. They do “research” online, and come up with all these predictions backed up with fancy data. However, I prefer to invest differently.
I’m not a very smart guy – I literally spent a year preparing for my SAT’s, just to get a meager 1490 (considering the effort v. reward ratio, my score was disappointing). Hence, my brainpower (or lack of) doesn’t let me predict the future like all those Harvard MBA analysts on Wall Street can. My investment style is simple and straightforward: instead of predicting what the economy will be like in the next 3 months or 6 months, I just recognize the fundamentals when they appear. Now you’re probably asking “How does simply recognizing reality give you an edge? You’re not ahead of the curve at all!”
Truth is, you don’t have to be ahead of the curve to make money, because often times the market is behind the curve. Often times, the market will ignore reality and continue on its disillusionment, as in the case with bubbles and market panics. Here’s how to make profitable investments without predicting the future.
- Recognize a divergence between the real fundamental situation and what the market only wants to see.
- Don’t invest just yet – other investors can carry on their disbelief of reality for a long time, and as long as no one cares, the market will not converge with the fundamentals.
- Continue investing on the side of the market hysteria until it ends, even when you clearly see that the fundamentals and the market have diverged. It’s painful to be a benchwarmer and watch the game from the outside.
- Wait until people are forced to notice the fundamentals – when the fundamentals are so obvious that like a 300 pound gorilla, you can’t do anything except care. This sudden change in investors’ perception of the fundamentals is evident because volatility spikes. Wait until people start to care. Then start thinking contrarian investing.
- The key isn’t in knowing that an investment hypothesis is correct, but in knowing the investment is correct right now.
As a corollary, I’d like to add two side notes:
- This investment style is only applicable for major market turning points, when the fundamentals & price diverge. When the fundamentals and price trend are aligned, the market is not moving against reality.
- A big component of this style is that the market doesn’t care whether the economy is good or bad. The market only cares whether the economy is better or worse. Thus, less negativity in the economy means bullishness, contrary to what logic would have us believe.
Here’s an example. From 2010 – 2013, the Euro problem has never been solved. At random times, the Euro will tank and European interest rates will skyrocket because people are FORCED to care when reality has strayed too far from belief.
Welcome to the Future..
We’ve already established that you only need to recognize the future – you don’t need to predict it. The important question is, how does one recognize the current fundamentals as soon as possible?
Most economic indicators tend to be useless – I’m not questioning the accuracy of their measurements, although sometimes the numbers do seem to be oddly skewed (hey, at least our data is better than Chinese economic “data”!). The problem with most economic indicators is that they come out a month or two after the events have already happened! February’s economic data might be released in April, a whole 2 months after February’s over. What good is data that’s 2 months old? It’s almost useless for investment purposes. There is a solution to this problem though – gauge the economy via real time sources:
- I follow serious business leaders who are in-tune with the business community and are known to speak the truth, such as Jack Welch.
- I watch closely what the likes of Jeff Gundlach (the bond king), Ray Dalio (the investment god) and other serious thinkers have to say.
- I pay special attention to people who speak out against the trend, especially if speaking out does NOT ENTAIL any personal gain. For example, banks were pretty much Ground Zero for the 2008/2009 financial crisis. In February 2009, a lot of CEO’s in the major banks came out to say that things weren’t actually as bad as expected. By saying so, they literally put their lives on the line – lying would be like committing suicide.
- For perennial bulls like Warren Buffett, I probably don’t give a toot about his “Don’t Bet Against America” speeches. But on the rear occasion that he’s bearish – something that you don’t see every day – then red flags should start going off in your head.
Like this post? Read more about finance and investing on Troy’s blog, The Financial Economist. Cheers!