The Mastery Of Investing — And — Is This The Last Leg Of The Bull Market?

Is mastery possible when it comes to investing?

Well, I suppose it depends on whom you ask, and on their definition of mastery.

Looking at the four one-liners offered up by Merriam Webster, I’ll go with the fourth:

“Skill or knowledge that makes one master of a subject.”

So let’s say one embarks upon a mission to master investing. Where to begin? Maybe study those who the world believes to have themselves mastered the art. Warren Buffett, Stan Druckenmiller, Jim Simons, Ray Dalio, Paul Tudor Jones immediately come to mind. I know firsthand that there exists sufficient literature on the methods of each to obtain serious knowledge on how these investors became billionaires. And, you know, there aren’t two of these gents whose systems remotely resemble one another: I.e., none achieved their “mastery” through mimicry; each developed his own unique system. 

So back to MW’s definition — “knowledge that makes one master of a subject” — there’s no test, no advanced degree, no objective method for crowning one a master of investing. Other than, let’s say, the net worth they obtained, and sustained, as they maneuvered through the ups and downs of the markets they traded.

Buffett studies companies, their balance sheets, their income statements, their business plans, their management’s style, he determines what he believes to be their intrinsic value and buys the ones whose market value hasn’t yet reflected it. Druckenmiller studies macro, top down stuff, and buys and sells the currencies, commodities and any other securities where he can express his theses. Dalio studies centuries worth of history, defines long-term trends in the world’s economies, and expresses his theses through wide diversification among multiple uncorrelated markets. Simons leverages the genius of mathematicians and physicists who program algorithms that exploit various patterns in various markets. Jones studies charts and follows trends.

Again, each does it differently, and each, often enough, takes big positions that pay off in big ways. If there’s one consistency for certain it’s that each executes his system masterfully; which means they unflinchingly take their losses (yes they make losing trades, more often than you might imagine) when they realize they’re wrong — happens often in every instance. For example, Simons, the best of the bunch (by a bunch) in % terms, loses money on half of his firm’s trades. And they (well, Dalio for sure) exercise extreme patience — some (again, Dalio for sure) in the face of steep losses — when they believe a thesis remains sound, even amid a disagreeing market.

Now we can get all bound up in — and certainly learn from — the theory, methodology, and machinations of each of these geniuses, this I also know firsthand, but first, last and foremost, we need to understand what successful investing actually is in its most basic form: Which is the ability to understand what motivates the decisions of the majority of traders and investors at any given moment, and what that says about the decisions this majority will be making in the weeks, months and years to come.

To know what the majority knows, or thinks it knows, about present conditions and what that says about the value of a share of stock, one must have sufficient knowledge of present conditions (and, not to mention, of crowd mentality) and what it is about them that would have the majority doing what they’re doing in the present.

At this point in time, the majority is pushing the stock market to all time highs in historically-aggressive fashion. So what’s their motivation?

Present conditions, trends and circumstances suggest the following:

1. Investors perceive a high correlation between Fed money printing and rising stock prices.
2. They believe that the Fed will step in, or step it up, anytime the market shows signs of stress.
3. They believe that “phase one” of the China trade deal will be good for business, and animal spirits.
4. They believe that Trump will survive impeachment and win reelection.
5. They fear missing out on the obvious gains in stocks the above 4 excuses are bound to generate.
6. Opportunistic traders perceive that the crowd embodies the above perceptions.

What might inspire a double-digit correction in stock prices? I.e., what would frighten this crowd of bulls?

1. The labor market shows signs of weakness.
2. Corporate earnings, en masse, begin to miss expectations.
3. The Fed attempts to slow down the rate of growth in its balance sheet (in money printing).
4. It becomes clear that the conditions that would allow a legitimate “phase two” with China can’t be met. 
5. A far-left candidate gains real traction in the polls.
6. Trump is removed from office, or resigns amid new evidence.
7. Geopolitical disruption (Iran, etc.).
8. Opportunistic traders perceive that the crowd of bulls is about to thin.

What will (note that I didn’t say “would” or “can”) bring on (or exacerbate the next correction to the point of bringing on) the next crushing bear market?

Frankly, that one’s easy: It’ll be stress in the corporate debt market — which now embodies all of the characteristics of a classic bubble — brought on by a slowing economy with its attendant credit downgrades, a marked rise in interest rates, or some other development that tightens financial conditions.

Speaking of crowd behavior, and of Jim Simons, here’s from Gregory Zuckerman’s revealing 2019 book The Man Who Solved the Market: How Jim Simons Launched the Quant Revolution:

“What you’re really modeling is human behavior,” explains Penavic, the researcher. “Humans are most predictable in times of high stress — they act instinctively and panic. Our entire premise was that human actors will react in the way humans did in the past … we learned to take advantage.”

Yes, folks, the present setup in my view is classic, and if the cracks widen beyond the point where central banks can fill them, indeed, “human actors will react in the way humans did in the past.”

However, as I suggested in an email yesterday to a client who’s a bit perplexed by the market’s strength amid questionable data, we can’t know for sure if this is indeed the last leg of the bull market, but, despite recent gains, the overall setup’s legs are sufficiently wobbly to take heed. 

Here’s me in that email correspondence:

“In terms of the negative stats, that’s how it happens at the end of all bull markets; the stats go negative, then the Fed starts printing money and the politicians start promising to spend like mad (tax cuts, stimulus plans, etc.). Traders either believe the stimulus will halt the decline in the data, or they believe that naive investors will believe that it will — and they’ll thus ride the train awhile longer (make it go faster in fact), hoping to jump off before it derails.

Now, we don’t know if this is that last leg of the train ride, but I can tell you that this is how the data begin to look when it is. Sometimes the train wobbles but stays on the track, like in 2011, and 2016… Question now is, can it happen three times during one long ride? Certainly possible; I will say that the data are worse now than they were during either of those times, but, again, it’s indeed possible.

My job is to make sure that we’re not investing as if everything is fine, like we did from the bottom in ’09 till the summer of last year, when the data — as they are now — are telling me that things are deteriorating and that the train is now at greater risk of wobbling off the track than its been this entire bull market. If things stabilize, we’ll go back to investing consistent with a more stable train ride. Until then, we remain careful.”

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