The Tycoon Report

Why Mr. Market Calls Me Paranoid

Wednesday, August 15, 2007 | Dylan Jovine

DR. PHIL WOULD PROBABLY REFER TO IT AS HAVING A NEGATIVE PREDISPOSITION.

But since I can't stomach that freak of nature, I think I'll go with what others have said:  my investing paranoia is the result of several hard-fought (and ultimately scarring) investment experiences from my early professional life.

Regardless of the psycho-babble analysis, one thing is certain: at this point of my life, my habit of first looking at everything that can go wrong with an investment is ingrained in my DNA.

As I’ve said in these pages more often than I care to admit, I’m not a stock analyst or a security analyst; I’m an “insecurity” analyst.

And believe me when I tell you that my investment “insecurity” runs very deep.

"How deep does it run, Dylan?"  Well, growing up on Wall Street for me was at times as painful as growing up a fat, unloved red-headed step-child with last year's toys, freckles and a perpetually runny nose.

But at least it’s the usual culprits that haunt my nightly investing dreams: we’re faced with some big, unanswered questions as we move into the 4th quarter, the answers to which may have serious ramifications for us as we begin to wind down the year.

What's the FED going to do with respect to interest rates?  What effect will the recent spike in commodity prices have on global economic growth?  How come none of the quantitative models Wall Street used to predict market action assumed that the fluctuations of the past week would only happen once in a thousand years?  Has Tom Cruise absorbed Katie Holmes yet?  Will their child Suri be allowed to live her life outside of Scientology?

These and many other questions should give us pause as we enter Q4.  And while I'll never bet against the amazing resiliency of the U.S. economy, there’s a real chance that U.S. equities will have a rough go of it during the next three months.

Indeed, if you exclude the two painful years that followed the collapse of the Roaring 90’s, it’s fair to say that for the vast majority of the past 20 years, investors have had it very easy.

That’s because during this time, total annual returns (including reinvested income) of U.S. stocks have averaged 13%.  That compares to the 9.7% stocks have earned each year for the past century!

Just think about that for a moment:  for the past 20 years, average returns on U.S. equities have been 34% higher than the 100-year American average.

What does that mean in real dollars and cents?

    * If you invested $10,000 at the abnormally high return of 13% annually (which is what we’ve witnessed for the past 20 years), your money would have grown to $115,230.

    * In contrast, the same $10,000 invested at the historical annual rate of return of 9.7% over 20 years would have grown to a little over half of that, $63,698.  

Does that mean that over the past 20 years investors have made $51,532 more than they “should” have?

Well, yes and no.

Financial history has proven that periods of abnormally high rates of return are always followed by a reversion back to the mean.

Following this thinking to its logical conclusion, one of two things has to happen for stocks to get back to their long-term rate of return of 9.7%:

   1. Stocks have to drop by 34% quickly; or

   2. Stocks have to trade in a tight sideways range for a decade or two until time catches up and the average return of 9.7% is reached.

What does that mean for you?

If centuries of international financial statistics are true, it means that, at the very least, stocks will likely trade sideways for some time.

But now, it is a different era than it was back then.  Things are very different due to all the new investors in the marketplace and with stocks being so widely held.  Even technology has made the old rules antiquated.

You are certainly forgiven for thinking this way.  In fact, if you read market histories going back hundreds of years (in different countries), you’ll see that investors have always believed that “this time” is different.

But it never is.  Why?  Because stocks, like all things financial, are governed by the laws of economics.

And that means:

    * In the long-term with stocks, P/E’s will always trade in relation to what a businessman could pay for earnings in a private market transaction; and

    * Over the long term, stocks return on average 75 – 80% of their historic returns-on-invested capital.  Everything else being equal, investors’ return on stocks should approximate the companies' own return-on-capital (ROIC).


What to Expect in the 4th Quarter

For one thing, history suggests that it’s a waste of time to join in the silly debate of whether we’ll see a new bull market or a new bear market.  Over the next several months, stocks may trade higher or may trade lower, but just understand where we are in the context of history.

But as always, "caution" is the watchword for U.S. stocks.  Regardless of historical context, finding cheap stocks to buy always presents different challenges.

Ultimately, though, you and I will make our money together the way that we've made it through good markets and bad: finding great companies selling for discounted prices.

This does not mean that investing in Q4 will be easy - far from it.  But with a careful eye on the markets, and a solid understanding of historical precedent, readers of The Tycoon Report can rest assured that we will work our hardest to help you avoid the pitfalls – and identify the opportunities – on the investing road ahead!


****** WOULD YOU LET A PEZ DISPENSER MANAGE YOUR MONEY? ******

Last week's article of that name drew our greatest number of comments ever on a single day at 119.  As much as I'd like to pat myself on the back, my suspicion is that it had more to do with the subject matter than it did with anything brilliant I had to say.

Regardless of whether it was my usual genius or the subject matter, one thing is certain: You, our Tycoon Report readers, are the most incredibly smart, thoughtful and engaged readers of any daily financial newsletter anywhere.

And that means the world to me.  Whether you agree with what we're saying on any particular day or not, I can't tell you how pleasantly surprised I was by the passionate responses you submitted last week.  The more you respond, the more passionate we're going to be in our writing, because we're not used to having such a big audience of readers.

Indeed, when we first started The Tycoon Report, we started with 50 readers.  That's back when we would publish two times a week (Tuesday and Thursday) with two articles in each issue, both of which I would personally write (talk about some hard work).

Soon afterward, word had spread to the point where we had 1,000 readers.  And I remember thinking to myself, "Wow! 1,000 readers are reading this stuff each week.  What a trip to actually share my thoughts on investing with that many strangers!"

I had never experienced anything like that before on Wall Street, where secrecy of one's thinking is what separates the men from the boys.

Today, there are a couple of major differences from when we first started.  The first is that we're closing in on 200,000 readers, 50% of whom I'm proud to say came to us through word of mouth.  The second major difference, of course, is that we publish Monday - Friday (who on earth wants to read about finance on the weekend?) and I'm not the only one writing anymore.

But the biggest difference by far is that I don't consider you strangers at this point.  Based on the emails, comments and articles many of you send to us each week, I feel like we're an extended family.  And the benefit I get each week from knowing that one thing we said might have helped you to avoid a financial disaster is worth more to me than any amount of money I could ever earn, no joke.

(Before you begin inviting yourselves over for Thanksgiving and all, keep in mind that in our Tycoon family, we put the "DIS" in "dysfunctional".)

Anyway, I just wanted to thank you all for being who you are.  Keep letting us know when we're doing a good job, and we'll try harder to do more of it.  Let us know when we're doing a bad job or something else stupid, and we'll try to correct it quickly.


John McCain's "Popeye" Moments

For those of you who posted comments asking what a "Popeye" moment was:  It's a moment when McCain raises his right forearm and swings it from left to right at his midsection with a closed fist to emphasize a point (especially when discussing Iraq).  Every time I see him do that, I just can't help but wonder if he's doing that Popeye chuckle ("Yup, yup, yup, yup, yup, yup, yup" or "I yam what I yam").  Watch him at the next debate and tell me if you don't see the "Popeye connection."

Anyway, you're all winners on this subject.  That's right - everyone who submitted a guess gets a FREE 1-year membership to Fallen Angel Stocks (just write in to customerservice@tycoonresearch.com with the subject line "Popeye", and we'll set you up).

How is it possible for all of you to win, you ask?  Simple:  I misplaced the piece of paper with McCain's Popeye moments on it and erased the TIVO recording I had to look back and re-count them.  Of course, I could have searched YouTube or something, but you're all too great of a crowd, so I thought you should all win for being good sports and taking the time to guess (translation: I just couldn't bring myself to watch the whole video again).

Here are the winners and their respective guesses:

Al Schopp - 7                           John - 3
Joseph Conlin - 2                    Duane - 6
Bill Margret - 12                      John - 6
George - 20                            Flintstone - 9
Jimmy - 4                                Richard - 9
JP Fuhr - 7                              John - 9
Henry Fulmer Jr - 1                 Donald Phair - 8
Gerry - 11                               Ron A - 6
Justin - 15                              Steve Greenwald - 11
Handysams - 6                       Charles Cassmeyer - 3

Good luck, folks - I hope I don't let you down with your FAS membership!


Notable Comments

I went through and read each and every one of the comments you posted last week, and I'm STUNNED to report that EACH AND EVERY ONE of them was good enough to feature in here.  But with space limitations being what they are, I was limited to pick the feedback below:

(I would strongly suggest going back to the original article to read some of other postings, especially some of the longer, more in-depth ones that I wish I had the space to feature here.  You can view all the comments and the original article here.) 

Ethan Roberts
The trouble with our elected officials is that they never take the time to really think issues through.  It is so much easier to just beat one's chest and make it look like you have the easy solution to the problem du jour for the little people.  Perfect example was Hillary Clinton yelling about predatory lending, and throwing a billion dollars into the pot to help people who haven't made a mortgage payment in 12 months to save their houses.  We used to have a work ethic in this country, but now, no matter how irresponsible you are, or what country you are here illegally from, it's all OK, we will just take you in and enable you.

The current P.C. obsession with "green" is another example of not thinking things through. The thinking goes like this: Oil bad, ethanol good because it comes from corn.  Never mind that it takes more energy to produce that corn, or that it will become inflationary.  The short sightedness with which out politicians do things will eventually render us a third world country.  And although I picked on Hillary, the Republicans have no shortage of fools, either.

Steve Hernon
If corn or other food products are used to attempt to obtain so-called 'energy independence", there will be signficant inflation and an increased likelihood that the Democratic Party will be elected in 2008.  This in order to increase the entitlement programs and further weaken the will-power of the individual and thus undermine the purpose of the country which is to lead the rest of the world into use of human intelligence rather than emotional animal response in solving problems. This cannot be done by weak-willed people.

Lifetime Tycoon family paid subscriber, Dean
Gee Dylan,

No candyarse are for opening up the dirty P word!  Anyhoo, I just love Ron Paul because he wants to abolish the IRS and Federal Reserve (Because they're illegal.)  Anyone who reads the Constitution can clearly see that the government cannot impose an income tax!

It's time for a Libertarian (with a Republican label) to do away with the waste and silliness that rules our current system of punishing success with our graduated tax system.  The free market would simply explode if the guy could even accomplish a portion of what he wants to do.  Just check out ronpaul2008.com and check him out. If that's not the correct URL, just Google it!

Catherine Powell
What about hemp?  I understand it can be grown on marginal land, takes no fertilizer or water input and actually improves the soil.  Political problems, however.  Second choice would be sugar cane which works for Brazil.  If the price of sugar went up - great - we would all stop being unhealthy and obese. Ethanol from corn is not long term viable as the net energy gain is teeny, and as you have observed, takes food from the mouths of cows not to mention third world children. Boo on corn ethanol.

Robert
The idea of making energy from corn is flawed from the start.  It is only in existence because some people in Washington want to get reelected.  These people are from farm states.  It makes no sense and is energy negative (takes more to make less.)  We need only look to Brazil to see how to do it right. The country is 100% ethanol fuel for autos. They do it with sugar cane, and it works, and we do not raise the price of tortillas for poor people in Mexico.

Bill Morgret
My guess for McCain's "popeye moments" is 12.

Dennis Schechinger
It is better that the farmer gets a good price for his crop than the Arabic countries getting our cash and using it to kill our troops.

Gene Horn
Your statements on the impact of oil independance on food costs is blatantly false.

It is a well-known fact that for most, if not all, food products, the cost of the raw product is less than 10% of the total price. If farm prices were to triple, the direct impact on the selling price would be 30% or less.  Recently, corn prices have gone from around $2.00 per bushel to $3.80 compared to an historic range of $2.00 to $3.00. This is before the inpact of increased planting, higher yields, good weather, etc. occur.

By the same token, you have totally ignored the economic benefit to the US of a domestic source of energy or the benefit against terrorism and rogue states of forcing the Arabs to drink their oil instead of funding terrorism.

barbararbrookie
Please don't worry about a shortage of corn.  It is a renewable resource.  There are farmers getting paid to not farm.  If they could make more money farming putting the fields into crops, that's what they would do.  Also, we cap oil wells that are marginal.

Jimmy
It would be more feasible to ease the restrictions on Oil Companies so they could equitably re-open old, and build new refineries. We have plenty of oil under us right here in the USA, but only 1/2 the refineries we had 30 years ago.  We also need to ease the restrictions on erecting new oil drilling rigs so they are not so price inhibitive. This would keep the labor market strong (thereby reducing inflation), and we would not be adding to inflation through higher food costs. Those costs are not included by the Fed in figuring the "rate of inflation" anyway.

McCain's Popeye moments = 4 (He's "toast" anyway...)

Larry Douglas
Being energy independent and tripling food prices do not have to be synonomous. Ethanol was thrust upon us and most of the publi, being the sheep that they are fell right in with the party line without a second thought. Of course there are many other alternative to ethanol, but our politicians decided to throw much of our money at this method alone. People be damned if I can get a vote here. Of course no thought of the consequence, feasibility or sanity of their actions.As usualawe will pay that piper for years to come.

JP FUHR
Dylan:

Thanks for you insights week after week....much appreciated.

I'll take a stab at the McCain gaffes before talking corn: I'll go with 7.

I detest the short sightedness of the whole ethanol fiasco, in addition to the negative unintended consequences you already pointed out there's the fact that corn is one of the hardest crops on the soil...it strips it of nutrients....hence millions of tons of fertilizer to grow it, which end up in our drinking water, rivers, lakes, etc. The whole competition for food think is repulsive also....

that's why I love the idea of Algae as a feedstock for fuel...check out a penny stock I've been following: gspi.pk, the benefits of algae are astounding from it's rate of growth to its CO2 eating to its energy density...described better in one of Greenstar's recent press releases...

I've got to get back to work. thanks again for your wit and candor.

Marcia Dalsky
So that is where these high prices are coming from! Here in the dairy state of Wisconsin, cheese runs from $4.50 /lb - 6.98/lb, butter is $3.00 and pork runs around $4 to $5/lb, beef up to $11/lb.

With all of the recent info coming out on shale oil and natural gas here, I have high hopes these endeavors will be fruitful.

Thomas Zabel
I've certainly noticed the price of milk rise - about $0.75 per gallon here in Dallas. Cereal is up too - and not just corn based cereal.

While we are talking energy independence - which is probably a good thing on balance - let's consider the alternatives to oil that WON'T (directly in any case, probably not at all) result in an increase in food prices: coal, nuclear, solar, geothermal, hydro, wind, and tidal sources. Also, let's recognize that there are still sources of oil and natural gas in the US that need to be developed (sitting in Dallas, I'm right near the Barnett shale natural gas field).

Of course, all of what I mentioned will work fine for stationary purposes - like electric generation. Most won't work well - if at all - for transportation (at least not in the short term). So we do need to work on things like electric cars, better hybrids, and other alternatives to the good old gasoline engine. We also need to work on conservation. In short, there are both costs and opportunities here. There are opportunities for investors - and there are more than a few opportunities for entrepreneurs.

And, while the next election cycle is important in determining what happens next, this whole thing - opportunities, costs, challenges, debates, will continue far longer than that.

John
For starters, I am not sure what a McCain "Popeye" moment is, but my guess is 3.

As for alternative energy...I am a great believer in laissez-faire economics policy and Adam Smith's Invisible Hand. The market will find the best solutions. When prices get out of wack, someone will step in to exploit the opportunity. Much of what constitutes an energy policy that politians are talking about amounts to buying off some group of voters (in your example: farmers) at the expense of the majority of the citizenry.




Dylan Jovine
Contributing Editor
The Tycoon Report