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From the Publisher“…a well-researched work…goes against thegrain…” (Gulf Business, January 2006)
[Author interview in Offshore Engineer] “…fewbooks have caused as much consternation…”
[Author interview in Offshore Engineer] “…fewbooks have caused as much consternation…”
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Andy Kessler is a modern-day Investment Renaissance Man. He does it all. He was a research analyst and investment banker for some of the biggest firms on Wall Street. He wrote about his experiences in his first book, Wall Street Meat. He then went on to co-found Velocity Capital Management, a hedge fund that raised $80 million. Kessler turned it into a cool $1 billion in a matter of five years, and then got out at the top! He chronicled those days in the book Running Money. He now writes Wall Street Journal op-eds, as well as articles for Forbes and Wired, and appears frequently on CNBC, CNN, Fox News, and Dateline NBC. And he stays in top physical shape by keeping up with his four sons!
His latest book, How We Got Here, talks about industrial development, from the steam engine through the Internet. Andy lives in Northern California with his wife and four sons and is working on a mysterious new project, which he promises to share with me once he has it figured out. You can find out more about Andy at andykessler.com, where you can also get a free download of his latest book. -John Mauldin
Signposts in the Fog
by Andy Kessler
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Years ago, I decided to climb Mount Washington, dragging a reluctant friend, Paul, along with me. It was a beautiful August morning in New Hampshire, not a cloud in the sky, birds chirping-couldn't be better. Paul ran marathons and had already run eight miles that morning but agreed to my "little hike." He still had his running clothes on; I was sporting a fresh Blue Oyster Cult T-shirt.
We parked the car and found the trailhead. Next to the usual warnings about poison ivy and rabid squirrels hung a huge sign that read, "STOP. The area ahead has the worst weather in America. Many have died there from exposure, even in the summer. Turn back now if the weather is bad."
I looked up at the cloudless sky and said sarcastically, "Looks pretty bad to me; let's roll."
The climb was strenuous, for me anyway, but not a killer. At some point the trees gave way to rocks, the temperature dropped, and a fog bank came out of nowhere to sit not 10 feet above our heads. We kept climbing until we were engulfed in the fog.
"Any idea where the trail is, Einstein?" Paul asked.
"I can't see a damn thing."
"I heard there were trail markers-signposts or something," I said.
"Like that?" Paul asked, pointing to a barely visible yellow rock sitting on top of a vertical stack of four larger rocks.
We headed through the fog to the yellow rock. When we got there, we were almost able to make out another yellow rock on another stack 10 or 15 feet away. And so we proceeded, making out signposts in the fog, slowly, surely-steady progress, freezing our asses off. At one point we couldn't make out anything. You could barely see your feet. I wasn't sure if I was making out yellow rocks or just hallucinating; but we kept heading upward and, sure enough, found another yellow rock, closer to our goal.
It stopped being fun, but it was sure exhilarating. Around two in the afternoon, hungry, cold, and barely speaking, we made it to the top of Mount Washington. Rather than planting a flag, we headed into the restaurant and fought the crowds who took the Cog Railway, drove, or were bussed to the top. Paul and I both bought rather overpriced Mount Washington sweatshirts, wolfed down greasy cheeseburgers, and hung out for about five minutes until Paul said, "Ready to head down the hill?" This time we knew what we were doing.
And that, my friends, is how I learned how to invest.
INVESTING IN THE FOG
Investing is hard-as hard as Chinese arithmetic, as another friend of mine used to say. It's onerous, treacherous, humiliating, and subject to extreme weather conditions.
My old partner Fred Kittler said it best: "The stock market trades to inflict the maximum amount of pain." I don't know about you, but I have a very low threshold of pain. Yet I spent a career on Wall Street, first as an analyst following volatile technology companies, as an investment banker, a venture capitalist, and finally running what ended up as a billion-dollar hedge fund.
I did it by investing in the fog.
YOU CAN'T MAKE MONEY STANDING IN THE SUNSHINE
As any junior-year "Stocks for Jocks" course will tell you, a stock price is nothing more than the net present value of a company's future earnings. How easy is that? All you need to know is how much a company is earning today, how fast it is growing, and what discount rate to apply to future earnings to get that net present value. This reminds me of the Saturday Night Live routine with Chevy Chase playing President Gerald Ford in the election debates. Asked about the effect of inflation on budget deficits, Ford/Chase answers, "Uh, I was told there wouldn't be any math."
On any given day, the math is quite easy. Widgets 'R' Us earned a dollar per share last year. Its growth rate was 12 percent. The inflation deflator is 2.83 percent; hence, the stock is worth exactly $18.42. You can get the formula out of any good economics textbook. Good luck with that.
Maybe the stock really is $18.42. Maybe it's $20 and you should short it, or maybe it's $15 and you should buy it. I wouldn't touch it either way. Why?
Because everybody already knows about the $1, 12 percent, 2.83 percent deflator. The sun is shining bright. Say what you want about the efficient market theory, if everybody knows something, you ain't gonna make money on it. "But the widget business is growing nicely," you tell me. Yeah, so what? We don't live in a static world. As my baby's bib reads, "Spit happens."
The widget business is not going to stay that way. It's either going to get better or it's going to get worse; but unless they are cooking the books, it's not going to grow exactly 12 percent for the foreseeable future. Yet the stock, today at least, is valued for 12 percent growth.
Inputs to the model change every day. That's why the stock market is open Monday through Friday. That's why it is never closed more than one day a week during holidays. Values of companies change. There are a lot of inputs to those silly formulas, almost none of them written in concrete. Sales need to be closed. Profits need to be earned. Spending plans at the beginning of a quarter only guess at how much revenue might support them. Growth is based on global economics. A butterfly batting its wings in Indonesia won't necessarily change stock values, but a coup in Thailand just might (such events happen every couple of years).
Formulas rarely have an input for risk. Even if they did, it's an unquantifiable number. A risk-adjusted growth rate is about as specific as economists can come up with.
The problem with Widgets 'R' Us, the stock anyway, is that it's out in the open, right out there in the sunshine. Everybody can see it. Everybody agrees on its prospects. Whoop-dee-doo. The weather's gonna change.
I'd rather be out in the fog where nobody knows nothin'. Then, if I'm good, I can peer out into the fog and spot some yellow rocks to show the way to a higher level. Once I get to the signpost, it's quite clear, and my stocks based on getting to that signpost will be properly valued; so I slog on looking for the next signpost.
THE IMPORTANCE OF SPOTTING THE SIGNPOSTS IN THE FOG
If I haven't scared you away from investing yet, you are either persistent or a fool. That's good; one of these is a good attribute for successful investing.
This whole idea of investing in the fog is not about being a contrarian. It's about seeing things before others. If you think everybody is going to sit in Starbucks sipping lattes using laptops connected to the Internet via Wi-Fi (like I am now), that's a pretty investable idea. There might be half a dozen interesting investment ideas that would benefit from that trend. But might I suggest that you look around Starbucks, and if everyone is already sitting around sipping and surfing, you are too late. The stock market already knows about it and has discounted the potential growth for chip software and service companies. Sip enough lattes, and you too can hallucinate the future.
Investing in the fog is about seeing things others can't. Most people get in the fog and panic; but the trick is to get in the fog and feel comfortable, let your imagination run wild, imagine what things might look like up ahead, make out vague outlines in the distance, and invest as if those outlines were real things.
I remember a comedian on Ed Sullivan (I'm dating myself, I know, but it was funny) saying his mother-in-law drank so much, she saw color television years before anyone else. Get her a fund to run!
Over time, if those outlines become real, or even close to being real, you will have invested at such a discount to the eventual value that you will make a killing. Just don't forget that you are no longer in the fog when you can see what was once an outline and is now living breathing reality. Get ye back into the fog. The stock market always looks ahead. A great investor has a continued paranoia concerning who knows what, what they know, and when they knew it.
Step onto any trading desk or into any money management firm and you enter a bizarre world. Lots of screens, all filled with blinking information. Stock prices, headlines, press releases, news stories, CNBC on monitors scattered around the room, often muted. Money managers read the Wall Street Journal cover to cover, the New York Times business section, Barron's on weekends, scan Forbes and Fortune, have their assistants read BusinessWeek, subscribe to thestreet.com, get MarketWatch e-mail alerts, and scan message boards on Yahoo! and Motley Fool. And that's before the market opens. They also get e-mails from every major brokerage firm, with comments from their Morning Calls, what analysts have to say about everything. Bigger firms get calls from salesmen and saleswomen from Wall Street with a synopsis, and then the analysts call as the day goes on to provide color. Every firm I know has expanded its voicemail systems, which would often stop accepting messages by 10 a.m., so full of hyperbabble they were.
Do they get stock ideas from all this stuff? I highly doubt it. The fire hose of information is for one reason and one reason only-to take the pulse of the market and figure out what everyone else already knows. Information is sunshine. I want to know everything, because then and only then can I know if my investment ideas are already out there-or are they still just figments of my twisted mind, outlines in the fog, flutters in my gut.
The trick is to figure out what the fire hose of information overload is going to say in three months, six months, 18 months, even three to five years if you are really patient. When all that information is blaring loud and clear what you squinted to see way back when, then that's it, it's over, you win. The market has caught up with you and is sitting right on top of the yellow rock you could barely make out before. You get the return for seeing it first when no one else believed it. The stocks you own based on that trend are now worth not 20 percent or 30 percent more, but two times, three times, ten times more. Now that's investing.
PICKING THE RIGHT SIGNPOSTS
Okay, okay, enough about fog and sunshine, I think you get the point. So what are these signposts or trail markers I'm talking about? Quite simply, they are big trends that you believe in, have confidence in, know in your gut to be true, have 99.99 percent probability of coming to fruition. These aren't picked randomly or without lots of work, tons of sweat, and consternation. As my hero Bullwinkle once said, holding up a drawing of two people, "This is Froth with Portent."
Pick the wrong trend and you are following signposts off a cliff. Sometimes worse-pick too obvious a trend and you'll never find your way into the fog to discover the hidden paths to riches. In the twenty years I spent on Wall Street, I have only been able to find two real signposts for investing in the fog. Two. How lame, really. I was a professional, recommending stocks and then running a billion of other people's money, and it was all based on two stinking trends.
Yup. But what wonderful trends they were-probably still are.
I thought about writing ten or fifteen more paragraphs about how cool these trends are and then suggest you send a thousand dollars in small bills to a post office box in Palo Alto and then I might tell you one of them. But what the heck, I've written a couple of books that more or less spilled the beans, so here they are (drum roll please):
Elasticity: lower cost creates its own huge markets.
Intelligence moves out to the edge of the network.
If you're disappointed and saying, "Huh? That's it? You made me read this stupid chapter and that's all I get?" take it easy and let me explain.
Elasticity in the Marketplace
Back in 1985 and 1986, I was a 26-year-old know-nothing-about-stocks electrical engineer hired to be the semiconductor analyst at PaineWebber in New York. The industry had just seen a jolt of orders in 1985 and then a big whopping recession by April of 1986. Intel, TI, Motorola, and AMD all saw their stocks plummet. Orders dried up and prices for memory and microprocessors were plummeting.
I somehow figured out it was distributors buying chips in 1985, not IBM, so I actually had one of the rare sell recommendations on these stocks. My star was rising on Wall Street. With these stocks headed to hat sizes 6-7/8, 7 ... I was looking for an excuse to turn around and recommend them. I read an article in Electronics magazine about EPROMs-Eraseable Programmable Read-Only Memories. It suggested that every time prices dropped for EPROMs, some new device would use them, or use more EPROM-16,000 bits instead of 1,000 bits (remember, this was 1986!).
Videogames, PCs, modems, each of them would somehow design in more EPROMs, or denser EPROMs, whenever prices collapsed; and at some point, when the cycle turned, even though prices were still low, sales would increase because more EPROMs would be sold. I looked it up, and the word that describes this phenomenon is elasticity.
As an engineer, I was forced to take Econ 101 (and blew away econ majors because they couldn't handle the math), but not much else on the econ or financial front. Good thing. Elasticity is one of those things that doesn't model well. Economists don't understand it, so they don't talk about it much (except for things that are inelastic, like cigarettes and booze, which economists may have a bit too much of).
So anyway, I went to work on this wacky concept of elasticity of chips and semiconductors, looked back in time at other cycles, and sure enough, it was real. Intel founder Gordon Moore made the observation that chip density doubles every eighteen months (in Electronics magazine, it turns out), and Moore's Law was relentless. Elasticity is just the financial explanation of how the industry grows whenever prices of bits or gates or functions drop. The industry magically grows (and stocks eventually go up), and a smart semiconductor analyst would get ahead of this curve.
So I went out with that call. Done selling? Great, now buy back Intel and Motorola, because elasticity will kick in and this will be a great growth market for microprocessors with faster and faster clock speeds.
I got a lot of "what the hell are you talking about" looks from my portfolio manager clients. Oddly, I was used to this look from friends and family.
So I calmly explained that every time prices dropped, some new application would open up to take advantage of the cheaper functionality. Told them I wouldn't be surprised if we saw laser printers put all that cheap memory into them to print pages faster and cheaper. Lucky for me, desktop publishing was soon born, and my elasticity argument proved out.
I've been milking this old elasticity thing ever since.
Excerpted from Just One Thing by John Mauldin Excerpted by permission.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.
1. Signposts in the Fog (Andy Kessler).
2. The “Not-So-Simple” (But Really Utterly So) Rules of Trading (Dennis Gartman).
3. The Triumph of Hope over Long-Run Experience: Using Past Returns to Predict Future Performance of a Money Manager (Mark T. Finn and Jonathan Finn, CFA).
4. The Long Bond (A. Gary Shilling, Ph.D.).
5. Risk Is Not a Knob (Ed Easterling).
6. Psychology Matters: An Investors’ Guide to Thinking about Thinking (James Montier).
7. The Means Are the Ends (Bill Bonner).
8. The 2 Percent Solution (Rob Arnott).
9. The Outsider Trading Scandal (George Gilder).
10. The Winner’s Rule (Michael Masterson).
11. Rich Man, Poor Man (Richard Russell).
12. The Millennium Wave (John Mauldin).
Posted November 11, 2005
I read John's book, Bull's Eye Investing, and Just One Thing contains has the same high level of investment knowledge, unique market insights and discussion of key financial issues as his first book. This time around, however, he has brought together financial gurus to write one chapter, such as: Rob Arnott, Bill Bonner, Ed Easterling, Mark Finn (along with Jonathan Finn), Dennis Gartman, George Gilder, Andy Kessler, Michael Masterson, James Montier, Richard Russell, A. Gary Shilling AND Mr. Maudlin himself. This is a MUST READ if you are investing in the stock market.Was this review helpful? Yes NoThank you for your feedback. Report this reviewThank you, this review has been flagged.