How are you going to play this hand? Alternate Title: Where's the Growth?
Investor psychology is a funny thing. Winning just feels so darn good. When Mr. Market gets on a roll, the overwhelming desire to hop on the wagon becomes almost unbearable. Just look at all the money that people are making on the street today. It's raining cash out there. I don't want to miss out on the next huge bull market! I have to get in on this ASAP right? You can, but as hard as it is to do I'm going to have to pass...and believe me it's not easy.
While many would like you to believe that investing isn't the same thing as gambling, in many ways it is. I liken investing more to a poker game than to a house game like blackjack or even worse one of those funky ones like "Caribbean Stud Poker" or "Let It Ride." In poker, the odds aren't inherently stacked against you like they are in most of the house games where it is nearly impossible for investors to consistently win over the long run. With poker, you only have to be better than the other people who you are playing against at your table. Of course, you have to outperform them by enough to make up for the frictional costs of gambling at a casino like the rake that the house takes and the tips that you throw the dealer and waitresses. These frictional costs are similar to the commissions that one has to pay when investing.
So how are you going to play this hand? Aggressively or Conservatively?
Here's a parable (based upon a true story) that fits situation like a glove. I have a good friend who works on Wall Street who is what many would consider to be a compulsive gambler. A few weeks ago he went down the Atlantic City and bought in for several thousand dollars at a high roller blackjack table. He caught a hotter wave of cards than I have ever seen. He was pulling unbelievable cards and just crushing the dealer hand, after hand, after hand.
Of course, he was betting aggressively as well. By the time the evening was over he was up over six figures! He literally had a duffel bag of cash sent up to his free suite. It completely blew my much smaller-rolling mind. I try to avoid house games and stick to poker myself, but the desire to throw my cash down on the table and ride his hot hand was unbelievable.
In the end I was able to master my emotions and prevent myself from making large bets on a game where I know the odds are stacked against me. I am doing the same thing today with my investing. A lot of positive news has come out over the past week and a half. The Federal Reserve is pulling out all the stops to get interest rates to drop from their already unbelievably low level, Geithner finally official plan to get toxic assets off of banks' books, the retail sales numbers have been better than expected, sales of existing homes were better than expected, etc...
Still to me the U.S. economy is still appears to be very fundamentally flawed. It's way too dependent upon consumer spending and at a time when the consumers that still have jobs are cutting back and increasing their savings rate and the largest generation in our nation's history has passed its peak spending years.
Does this mean that I think we're all doomed? Absolutely not. I just don't see what is going to drive growth over the next several years. There's no awesome invention like the Internet out there that will enable worker productivity to skyrocket. Demographics certainly aren't working in our favor. Interest rates are already about as low as they can go, so we won't get help from falling rates...not that it would matter because consumers are leveraged up to their eyeballs and probably wouldn't be interested in borrowing much anyhow.
I just keep asking myself, with a nod to the classic Wendy's "Where's the Beef" commercial, "Where's the growth?"
I don't see where economic growth is going to come from over the next several years. Do you? If so, please let me know because I'm baffled. When there's no economic growth, earnings growth for companies is very tough to come by. When earnings don't rise, neither do stock prices. That's why I have been investing for yield rather than capital gains for a while now.
Investing for yield doesn't completely preclude me from participating in a rally like today's. I'm not short anything in real life and I am short very few things in CAPS. While I am sitting on a pile of cash and I haven't bought anything but bonds in a while, I still have a bunch of common and preferred stock in dividend-paying companies that are up today, including a bunch of preferred stock in Chesapeake Energy and a couple of small positions in BofA and WFC preferred that are doing very well.
Still the conservative nature of many of my investments virtually guarantees that I will underperform on major rallies like today's. Despite the fact that I am short only 28 companies out of 200 total picks in CAPS, the conservative nature of many of my long positions has caused me to lose a whopping 350 CAPS points today. Ouch.
That's not fun and it sure makes it tempting for me to try to trade the market and pick up a ton of ultra-long ETFs to ride this wave. Heck, I might even toy with a few in CAPS. The Triple Emerging Markets Bull ETF (EDC) that I green-thumbed while screwing around in CAPS the other day is up nearly 20% today.
Trading's just not my style though. To me, all of the evidence out there so overwhelmingly points to a period of slow to no growth that I plan to keep bulk of my real and CAPS portfolios in relatively conservative, low beta, dividend-paying stocks and bonds for the foreseeable future. Regardless of what happens in the short run, like a few weeks in the market or a few hours at the blackjack table, in the end when the odds are stacked against you - you lose. I'm sure that my friend will eventually give back all of the money that he won during that one epic night at the tables and if I am reading the economy right I'm not missing out on anything by not hopping on the bull train right now.
Traders who hopped on this green wave have made quite a bit of money and they may continue to do so for the next couple of weeks, but I'm no trader. I'm more like that grinder character named Knish who John Turturro played in the classic movie Rounders. I won't become an instant billionaire and win a seat at the World Series of poker table by being a conservative investor, but I won't lose all of my money and get my face beaten in by some thug named Gramma in a bathroom either. As a family man with a bunch of people who depend upon him, that's fine with me.