The InvestMentor

February 1, 1999

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The typical frontline analyst on Wall Street is a left-brained, quant nerd--a guy or gal who has an addiction to data. I know because I used to be one; in fact, I’m a reformed quant nerd who became a better investor when I learned to pull my head out of my 10Ks and get "perspective." The new on-line investor is led to believe that information is the key to their quest for profitable investments. That’s only partly true. In addition to acute analytical skills, you should seek to hone your own peculiarity. By becoming a pariah you avoid becoming part of the herd that buys at the top and sells at the bottom. Shared information leads to consensus thinking, and that’s not how money is made.

Most stock investors fall into one of two camps. There are those that believe that the Market is a place where stock prices efficiently reflect all the known information about the future prospects of a company, as manifested in the rational trading behavior of informed participants. Then there are those who beat the Market by buying from, and selling to, members of the other camp.

Don’t get me wrong. There is a relationship between the amount of information you have about a company and your success as an investor in that company. What people don’t realize is how quickly the "law of diminishing returns" applies to the effort of collecting information. Do you think that the individual who spends 40 hours-a-week reading about IBM does twice as well as the individual who spends 20 hours-a-week reading about IBM? I doubt it. In fact, the first individual probably suffers from information overkill. Too much information impairs your judgment. Once you’ve developed an opinion about a company, you start to see what you want to see.

The Internet has made information available to everyone in real time—something totally unique to this Bull market. However, since we’re all sharing the same information (much of it quantitative in nature) we will naturally be led to the same conclusions. This herd-like behavior has no losers in a rapidly rising market where all stocks rise and the difference between good choices and bad choices is measured by whether you made a little profit versus a lot of profit.

For most of the ‘90s, you could’ve done well picking stocks by throwing darts at a list of companies. You didn’t even have to hit the dartboard. That’s not going to cut it in the years to come as the developed markets (particularly the U.S.) revert to their normal rates of return. Good returns in the future will not be evenly distributed to all investors. The unfortunate thing is what a shock this will be to the millions of investors whose entire experience with investing began after 1990. To make good money in 1999, you’ll need to think and act like a pariah.

We saw a little of this uneven performance in the U.S. last year. For example, the S&P 500 index of stocks (which is heavily weighted to reflect the largest 50 companies) was up 28.7% but the Dow Jones Industrial average was only up 18.1%. Further, the Russell 2000 (a small cap index) was down 3% and the average New York Stock Exchange-traded stock was down 4%. That’s a huge spread folks and likely to be more, not less, indicative of the kind of discriminate investment returns of the coming years. 

So if we all have the same information, and more information does not necessarily translate to better returns, how does someone get the "edge up" on the herd? By developing a unique perspective, by investing where others fear to tread, and by thinking like a pariah. How do you do that? There are several ways to build these skills:

• Discount information provided by the "general media" (non-financial, national and local news). "General media" distributed information is the fertilizer for growing consensus. By the time information about Wall Street makes it to Main Street, it’s watered down, over-generalized, and too stale to be of use. By then, it’s not "news"…they should call it "olds." Concentrate your newsgathering on a few financially oriented sources (such as the "Journal," The Financial Times, The Economist, CNBC, Reuters, Quicken.com). Last year, the "general media" told you the best returns were going to be in the U.S. 1998 and that Asia was a lost cause. While the U.S. did well in 1998 (the average U.S. stock fund was up 14.5%), the best place to be was actually Europe (average fund up 22%) for the third year in a row (but you don’t hear much about that, do you?). The media chose to make Korea the poster child for the Asian Crisis. How did Korea do last year? It was the best performing market in the world, up 80%.

• Question your assumptions, be a bit contrarian. Pure contrarianism (betting against the crowd solely to be in the minority position) is a losing strategy. This once-popular investment methodology has waned in recent years, as it would have suggested everything from avoiding U.S. stocks since 1993 to eschewing any of the big technology stocks. However, there is something to be said of the endeavor to question the assumptions with which the crowd develops its opinions and strategies. When you read anything, ask yourself three questions:

• Who wrote this? What is their perspective? How should they know?

• What is the motivation behind this piece? Is the author objective? Do they have anything to gain by winning over my opinion?

• How much of their point is based on statistics? One of the great books is "How to lie with Statistics." Statistics can be manipulated and are often abused in print.

Consensus is often wrong—and therein lies the opportunity. Go back to the Korea example. The consensus was that Korea was going to see recession in 1998 and therefore was a bad place to invest. They did see recession. But the underlying assumption was that the Korean market didn’t have that properly priced-in already. That was wrong. Korea had been on a multi-year slide going back several years. By mid-1998, fears were so ridiculously over-accounted for in stock prices that anything short of a communist takeover was likely to boost prices—and it did.

Ignore what the brokerage houses tell you. As far as the brokerages are concerned, if you stick your fingers in your ears every time a brokerage spokesperson tells you what to do, you’ll be better off. This industry, under assault from all sides, has a vested interest in creating transactions—and they have no shame in suggesting a weekly shift in your investment choices.

Be weird and trust your instinct. I’m weird. That’s part of why I invest well. I watch what the herd does; then I try to find a pattern; then I try to make fun of it by writing to you about it; then I make money for clients by being on the other side of the herd’s bet. Your instinct about a product is the best insight you have about the future growth of a company. Ten years ago shoemaker LA Gear had two interesting qualities: a great stock and crappy shoes. It was a big shock to some when the stock imploded after the company’s sales evaporated. At the risk of repeating myself once too often, let me do so: the answer is not in the numbers. The market is a dynamic, organic, emotional, visceral place where the calculator is less valuable than common sense, a unique perspective, and the courage to execute based on instinct.

In the next issue, I’ll share with you my thoughts on how a pariah can profit in 1999.