Mr. Irving Kahn is 108, to be exact. Born in 1906, he began investing before the Crash of '29. He spotted the anomaly...and decided to take advantage of it. He sold stocks short.
"During the Great Depression, I could find stocks trading at tremendous discounts. I learnt from Ben Graham that one could study financial statements to find stocks that were a 'dollar selling for 50 cents'. He called this the 'margin of safety' and it's still the most important concept related to risk."
"Indeed, he uses the same approach today. "During the recent crash and in other sell-offs, Tom and I looked for good companies selling at a discount, which do surface if you're patient. If the market is overpriced, an investor must be willing to wait."
Mr. Kahn does not believe in market timing. Instead, he just looks for underpriced stocks. As the market rises, he finds fewer and fewer. At the extremes, he is forced out of the market entirely by a lack of good value. That's what happened to Buffett in 1968, when prices had gotten so high that he couldn't find any way to use the money he had under management. What could he do? He sent the money back to its owners.
STS is for people who are not going to do the difficult work of studying company filings to figure out where the value is. We're just going to get in and out according to a very rough measure of value - P/E ratios - with no consideration of discounted income streams, debt levels, taxes or anything else. As we saw yesterday, that this approach would have it would have greatly outperformed 'buy and hold' over the last 114 years.
But we still have an open question: how is it possible that this sort of opportunity exists - even for someone who doesn't do the hard research? How come there are still dollars lying on the ground, when there are so many smart people who should have picked them up? Couldn't Goldman Sachs simply hire a few mathematicians, program a few computers, and arbitrage away these gains?
We put the question to Porter Stansberry:
# 1. They are conflicted.
Take my prediction that GM would go bankrupt. Here was a car company that hadn't made a real profit in 20 years, was sitting on $400 billion in debt, and had more retirees on the payroll than workers. Seemed like a pretty simple bet to me. However, Wall Street was making a lot of money selling GM bonds. There were huge incentives not to rock the boat. Likewise with my prediction about Fannie and Freddie going bust. Everyone on Wall Street was selling those clowns paper that was worth $0.20 for a full $1.00. Going along with the lie was more profitable than shorting the stocks could have ever been.
#2. Far too much opportunity cost.
Trying to arbitrage every minor discrepancy in value would take far too much capital. Firms that have tried to do this (Long Term Capital Management) end up using far more capital than they can afford to borrow. There are just too many financial instruments to handicap. Likewise, there's too much knowledge to manage to do so accurately and in a timely fashion.
#3. Far too much risk.
Even when investors possess superior knowledge, getting the timing right and managing all of the other variables is impossible. Take my short sell of Netscape, for example. Back in 1999 I was shorting Netscape, which produced the first web browser. Microsoft began "bundling" web browsers inside its operating system, so nobody needed Netscape -- which had given its software away and had no revenue model. The stock was a zero. I was shorting it (personally, with real money) as it sank from $25 per share all the way down to $15. Then, I come into work one day with the news that AOL bought it, using stock, for $90 per share. I got wiped out. And it wasn't until about a year later that AOL's stock collapsed, in large measure because it had been fudging all of its accounting. (They were budgeting marketing expenses on the capital account.)
I'm sure we'll find that the market is least efficient (and we have the best opportunity to make outsized returns) when:
But it doesn't settle the question, either. If there is a dollar lying in the street, there may be a reason - a reason you don't see - why no one has picked it up. Maybe no one is looking. Maybe 'The Street' wants you to believe it isn't there...Maybe it's too hard to see...or too hard to pick up.
But maybe it isn't really there!
More to come, tomorrow, as we wrap up our series on 'How to Invest in an Ignorant World."
Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.