Best of Investment Truisms, Are They True?
A few of my earlier posts concerned investment truisms, which I’ve learned dozens of over my decades in the business. I like to quote them to my team whenever I get tired of thinking and need to reduce complex situations to bite-size chunks of wisdom. These adages have been passed down from Wall Street generation to generation — but are they true?
Below are seven truisms that I evaluated in the prior Substacks.
Don’t Fight the Fed — This seems truer than it is in practice. For example, the Fed was raising rates from 2003 through 2006, yet global stock markets were rallying the whole time. The Fed was reacting to above-trend U.S. growth driven by macro factors including China’s insatiable demand for commodities and a real estate bubble — which same factors were powerful enough to keep the market party going for years after the rate hikes had started.
If you didn’t “fight the Fed” in 2003-06 you missed out on a 50% gain in developed stocks and 200% in the MSCI Emerging Markets. Of course, the Fed’s withdrawal of liquidity was slow-acting poison for most financial assets, which finally collapsed in 2007-08. (Junior mining stocks, the most hyped, cracked first, in mid-’06; appropriately, they were the canaries in the coal mine.) By contrast, the Fed was cutting rates throughout 2001-02 and the S&P still lost 32%, given deteriorating economic and geopolitical conditions.
So I’d revise the truism to say “Don’t Forget the Fed,” since what they’re doing will impact financial assets, sometimes sooner and sometimes not for a while.
Sell When You Can, Not When You Have To — When I was a law associate, my boss had a friend named Bobby Spiegel, an ex-Salomon Brothers investment banker and part owner of a singles restaurant/bar on the East Side. We’d go to lunch and he’d discourse on finance in a language that was new to me, as a 26-year-old former English major, e.g., “EBIT,” “pretax income,” “accelerated depreciation.”
Having been around long enough to see peers blown up in stock market and real estate crashes, Spiegel’s mantra was, “Sell when you can, not when you have to.” I rate it true, if it means that you should stay ahead of potential cash needs. I’ve heeded Sensei Spiegel, always living below my means (and debt-free since January 1998), but in one of our funds I did have the experience of a liquidity squeeze. I didn’t enjoy it.
In early 2008, with a crisis brewing, we failed to prepare enough for the fund’s likely outflows, given that it had monthly liquidity and was for many of its investors among their readiest (or only) sources of cash. The fund survived, but the problem with selling assets in distressed conditions is that buyers only bid for the best stuff, and at discounts to intrinsic value. A portfolio put through that wringer will have its long-term value impaired.
On the other hand, if Spiegel’s truism is interpreted to mean that you should always be taking profits, I disagree. As I’ve written, including in a recent post here, one of the biggest investment mistakes is to keep “trimming” your champion stocks, as long as they remain champions.
The Market Can Stay Irrational Longer Than You Can Stay Solvent — This adage, attributed to John Maynard Keynes, is a companion to the previous one. Investors who are leveraged may have to sell in distress or go bust. Long-Term Capital Management, the hedge fund whose Board included two Nobel Prize winners, is proof of Keynes’ wisdom. LTCM believed its trading models were so robust that they could safely be leveraged 30-40x. As the 1998 emerging markets crisis unfolded, with spreads blowing out to “thousand-year flood” levels, instead of reducing risk, LTCM let the leverage grow to 50x, then to 130x. They just knew that if they held on, sanity would return.
The problem is that counterparties’ patience is not unlimited, and when the whole Street knows you have a problem that you can’t or won’t fix, it will take the form of a giant predator and rise up from the ooze to finish you off. LTCM finally needed a bailout organized by the N.Y. Fed, lest the size of their exposure collapse the whole market. Incidentally, my Russia fund was caught in August 1998 with just some leverage and we received a surprise margin call. I must’ve sounded rattled on the phone with the broker, and word went around, because I soon got a call from Ron Insana at CNBC, asking if we were “blowing up.” Survival mode kicked in and by the end of the day we’d done whatever we had to do to remove any leverage.
So the #1 way to stay solvent is to avoid significant leverage. There’s a second way: don’t drink your own or anyone else’s Kool-Aid. I’ve always had faith in my own funds, but am aware of their risks and never had my entire net worth exposed to them. As a result, during numerous crises I never faced the prospect of personal ruin and could remain calm. As mentioned above, I’ve lived well within my means — an especially good idea for anyone who depends on the markets for their living.
The biggest Kool-Aid risk I see today is crypto. Say you’ve been converted to believing that crypto is wonderful, you tell everyone so, you put most of your assets into it, then it starts going down. “Why?” you ask. “It’s irrational that it’s falling when we know how good it is.” Maybe you buy more, but it keeps falling, now it feels too late to sell, and your spouse starts yelling that you’re going to lose everything. It’s inconvenient for you that this is happening — but the market doesn’t care about your convenience.
To avoid this and similar nightmares, don’t drink Kool-Aid and stay diversified.
Don’t Catch a Falling Knife — This truism, which provided the name for my Substack, I rate 80% true. A crashing stock attracts the attention of buyers who envision themselves cool-headed hunters snaring a bargain while others panic. The problem is that when a stock is broken, it can fall farther than anyone imagines, and the once smug contrarian can find himself down 50% and crying. I like to quote Bob Dylan: “When you think you’ve lost everything/You find out you can always lose a little more.” It’s better to wait and see the sellers capitulate, and the stock bounce along the bottom for a while, before you buy. One caveat is when the stock is illiquid and a meaningful stake can only be bought on the way down, as blocks are puked.
Buy When There’s Blood in the Streets — Attributed to the 18th century British Baron Rothschild, this saying is often applied to emerging markets. In this context, it is both true and bad advice. There is always blood in the streets somewhere, but your outcome from buying, say, Russian vs. Lebanese stocks today will be very different. Some of my best investments were in places where the blood was, if not flowing, recently dried, e.g., Russia in 1994 and Georgia in 2004.
On the other hand, I have also seen people get excited about Next Big Thing markets that never were, like Iran and Cuba. Plenty of investors have tried to buy Ukrainian stocks during previous turmoil and experienced only losses (though several men I know returned home without riches but with wives who were way out of their league). It has to be certain blood and certain streets to work, and no one has a roadmap.
Bulls Make Money, Bears Make Money, Pigs Get Slaughtered — This suggests taking profits and not overstaying your welcome. While it may be good advice for short-term trades, for most investors, as noted above, I urge holding on to your best stocks. As for bears, in my experience it is the unusual one who makes money in a big way — as someone once said, you don’t meet a lot of billionaire pessimists. And on the third clause, I recall a partner at my old law firm dismissing it, saying, “My best clients are professional pigs.”
The Trend is Your Friend — No it isn’t. If you want a friend, buy a dog.