Buy low, Sell high is the basic rule

Sep 15, 2014

Gualfin, Argentina

The Dow closed below 17,000 on Friday. October is coming. Excess liquidity is disappearing. US stocks are in "sell territory," with P/Es over 20. Watch out.

We finished our series on investment theory last week. Now we turn to practical application.

There are three parts to the investment world. One part is Aristotelian, Cartesian, Pythagorean - it is a world of logic and calculations. He who calculates best, wins.

Another part is Socratic and Emersonian. The investment world, like the rest of the world, follows rules. That is, when you do something 'wrong' you will pay the consequences. You forget to pay a parking fine...and you will probably regret it. Leave a rake lying in the yard, turned up the wrong way, and you will almost surely step on it. Buy an expensive 'story stock,' recommended to you by a broker you've never met, calling from Boca Raton, and you will most likely lose money.

That is true on in a larger sense, too. An economy that goes too deeply in debt will have to bear the consequences. No amount of Quantitative Easing or Zero Interest Rate Policy will make the consequences disappear. They can only distort and displace them.

This is not to say that moral rules will play out the way you expect in every instance. It is wrong to kill. But had you snuffed a certain housepainter in Vienna in the '20s, the world might not necessarily be a worse place. Likewise, not every foolish bet goes bad. Still, you're probably better off believing it will.

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Finally, the other part of the investment world is just completely unpredictable and unfathomable. Mr. Market gets up to mischief from time to time; he drives moralists mad and logicians to drink.

The numbers we presented Friday show that the typical investor does not beat the indexes...not even close. This leads the Efficient Market Hypothesis crowd to say: 'Just buy an index fund. You can't beat the market.'

But our Simplified Timing System (STS) tells us that there's a good time to buy and a bad time. 'Buy low; sell high,' is the basic rule. US stocks are now expensive. Shiller puts the P/E ratio on US stocks at 26 - way above our limit (20). What to do?

The trouble with our system is that it is too long-term for most people. It pushed us out of the US stock market in the late '90s. We've never gotten the signal to come back in. In March '09, the P/E dropped to 13. We waited. It has to hit 10 before we buy. It never has.

So, we've been out of the US stock market for nearly 20 years...missing two big bull markets. Who would want to do that? Not many people.

What do you do when you are out of the US stock market for two decades? Well, you need to find markets that aren't so pricey.

Such as the Russian stock market! There, the P/E is under 6.

You're thinking: 'Hmmm... Russian stocks are treacherous. Everybody says so. And what with sanctions, they could go much lower.' One of our own clever readers warns:

    The downside on Russian stocks is still 100% from here. Mathematically that is the maximum loss one can have buying Russian stocks. Once in the last hundred years that happened; when the Bolsheviks closed the stock market in 1917. ... If Russian stocks fall another 10% you require a 20% rally to break even, if they fall 20%...Since US stock markets have never lost 100%, while Russian ones have, by a historical perspective US stocks, even at 20 times earnings, are likely a better investment than Russian stocks (nevermind whether they use an accounting system you can trust). Just wait until Russia closes the market to foreign investors, issues capital controls and the ADRs and ETFs go to zero.

He may be right. But we don't presume to know, neither what is really going on now...nor what it will mean for the future. Neither in Russia nor in the US.

All we know is that our calculations (as primitive as they are) tell us you get more value per dollar in Russia.

Our 'moral' rule tells us that you don't make money speculating on the future. You make money by buying wisely in the present.

And our guess is that Mr. Market aims to make fools of as many investors as possible... Right now, there are far more investors who are short (out of) Russia than long (in).

Still ahead: how to pick stocks to beat the market... to get rich...and why it might be better to stay poor.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

Disclaimer: The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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