FSO Editorials: Some Thoughts on Investing by Robert B. Gordon 02.28.2003

Viewed from a suitable space platform, the United States and other developed nations would appear to be part of a well-organized civilization. Planes would be taking off and landing at the airports, trains would be running on their tracks and cars would be moving in the cities under the control of traffic lights. But if our space visitors had the tools to look inside the buildings in Wall Street and Washington DC, they would see the occupants moving and acting in an apparent random and discordant fashion.

Looking further into our nation, they would discern various segments of our society - the younger group in schools of education, a large mid-aged working group and the older retired worker group. Assuming they possessed a unique capability to examine the investing habits and skills of these three age groups, what would they find? Let me take a guess.

In the kindergarten thru high school level, there would be no attempt to teach the rudiments of thrift or any training of the basic principles of investing. At the college undergraduate and graduate levels there would be courses in economics, from the basic to advanced levels, to prepare students for jobs in education, business and government. Based on the proven inability of economists at all levels to correctly predict our recessions and depressions, they now appear to be living and working totally apart from the real world. Our graduate schools teach subjects like corporate finance to prepare students for jobs in business, but I am not aware of any courses aimed at developing better investing skills. I have occasionally seen notices of junior college evening courses in investing along with their vocational courses.

It is a universally recognized fact that, in the end, we all die and cannot take anything with us. But, the great majority of people on this globe fail to make good use of their talents early enough in their lives to amass wealth for a worry-free retirement at the end of their working days. In this essay, we will examine this problem and suggest ways to combat it but knowing, quite well, that it will influence only a small number of readers.

Great fortunes have usually been built by industrial tycoons, sometimes known as robber barons. Pioneers in steel, oil, railroads, banking etc. have created foundations that bear their names. In recent history, two names come to mind, Bill Gates and Sam Walton, who revolutionized computer software and retail marketing. I can think of only one man who created huge wealth through his patient following of basic investing principles, namely, Warren Buffett. Unlike Gates and Walton who happened to be in the right spot at the right time, Buffett studied the great writings of value investors like Benjamin Graham and used them to build a huge fortune. He has summarized his methods as "Being fearful when others are greedy and being greedy when others are fearful!" In other words, his message for any investor is buy low and sell high. He applied this principle to buying entire companies when they were bargain-priced and is today the one great example of successful investing over a full lifetime.

History is full of stories about heirs who squandered their inherited wealth. Individuals who are both wealthy and wise try to take steps to prevent their assets from being dissipated. Thus we have huge amounts of money entrusted to foundations who are now losing the amassed funds of their founders. The saddest fact is that, in this major bear market, there will be no place for large foundations to take safe refuge. This is due to the massive ignorance at all levels in our society of the history of previous market manias and panics.

So the tiny minority of investors who followed Robert Prechter’s warnings in the late 1990s now have to watch; while many trillions of paper wealth in stocks and bonds simply vanishes.

This nation and the rest of the developed world are now in the process of losing a great amount of their wealth. Various estimates are that we have lost, in this country alone, in the order of eight to twelve trillion dollars. Small and large investors, corporations, government pension funds, insurance company reserves and institutions of all kinds continue to lose in their traditional stock and bond investments - all gone to money heaven, never to return.

Even more serious than the loss so far, is the fact that the losses are almost universally considered to be temporary, not permanent. That is why, in the fourth year of this "once-in-a-century" bear market, the majority of Wall street analysts are bullish and recommending a customary 70% stock allocation. So, along with the bullish recommendations of our major mutual funds, most working Americans are still contributing monthly to their 401(k) retirement plans. These losses will keep rising as the bear market continues its relentless path to a distant future bottom.

When average American investors finally recognize their "paper" losses are in fact permanent, then and only then, will they start rearranging their investing habits and life style in a belated attempt to save whatever remains of their life savings. Based on the investing records after 1929-32 and 1973-74, it will be a long, long time before many return to the stock market, if ever. And of course, this bear is very much greater than the two earlier ones.

It is painful to repeat my words in many earlier essays about this subject. It grieves me greatly. Macroeconomics is the branch of Economics that deals with our entire economy and is supposed to understand the large boom and bust swings in our society. Its abysmal record in predicting large and small events is only half as good as flipping a coin. It failed our nation in the1920’s bull market and 1929 Crash and again in the even greater Mania of the 1990’s. This unbelievably bad record is hard to report but very true. The recent statements of leading economists sound exactly like their predecessors before and after 1929. There has been no advancement in knowledge in the past 70 years except for Ralph Elliott’s brilliant discovery of the Wave Principle, published in 1938, and virtually unknown except for a small group of devoted followers.

I urge my readers to read my November 2, 2002 essay in FSO titled "Wall Street’s Greatest Crime", which presents excerpts from several of the major classic books on our past Manias. It also critiques the books of Robert Shiller and Jeremy Siegel who are frequently featured on CNBC. Despite being associated with major universities, neither of them has a good grasp of what is now going on. Dr. Siegel has recently claimed the end of the bear market and neither of them show any awareness of Ralph Elliott’s brilliant book disclosing the great "Elliott Wave Principle."

I am aware of only two articles by Ph.D. university professors on Elliott’s great contribution to the field of macroeconomics. Dr. Hernan Cortes Douglas has done me the honor of having my "Greatest Crime" essay translated into Spanish and used as required reading in his Economics classes in a Chilean university. Dr. John Casti, an eminent mathematician, wrote a very readable and popular account of Elliott’s work in the August 30, 2002 issue of the New Scientist magazine. Although totally ignored by the Economics profession in this country, Elliott’s discovery of the Wave Principle as the ruling factor in stock cycles stands as a great advance in the field of Macroeconomics. As detailed in Robert Prechter’s 1995 book "At the Crest of the Tidal Wave," the current stock market wave that topped in 2000 has been traced back to the London stock market of early 1700 - a great achievement in scholarship.

We will not repeat here our extensive writing on the Elliott Wave Theory. New readers are urged to read them all. Elliott’s great work is so important and so fundamental to the art of investing, despite the sad fact that his message has not yet been recognized by our Ph.D.’s in academia or our Wall Street experts. Having this amazing knowledge, while the rest of the world slumbers in ignorance, gives individual investors a huge advantage. Its like having a key to the money vault.

We will mention and stress only one great truth from Elliott’s pioneering work. It is the crucial point that nearly all investors fail to understand because of their built-in prejudices. The Elliott Waves, at all time intervals from seconds to centuries, are created by a completely natural phenomenon - the unknowing herding instinct of masses of investors. They are not caused by external factors like news events but, in fact, they cause many events and trends in our society. So nearly all other observers are wrong in attributing stock market movements to external events. Even the death of a President or a major catastrophe has only a temporary effect on the stock market here and abroad. But a completed major Elliott Wave can mark the beginning or end of a decades-long bull or bear market in stocks as it did in 1982-2000.

I encourage my readers to read everything they can get on Elliott Waves, because being one of a small minority of investor-believers in Elliott puts them in a special class apart from the masses. And in our opinion, the masses who allow themselves to be led by ignorant self serving sales types will always be wrong in the long run.

It is not necessary for any individual today to go through the long and grueling process that I reported in my essay titled "Education of an Investor." It should be possible in the current information and computer age to equal and improve on my education in about five years. I did not learn about the Elliott Wave Principle until 1995 when I read Robert Prechter’s great "At the Crest of the Tidal Wave." It took me several years to accept the truth and enormity of this great advance due to the amount of unlearning I had to do.

It is probably a blessing that our entire educational system does not offer a start in the process of investor education since much of it would be plain wrong or misleading for the student. The harm would be especially great in our post-graduate schools, which appear not to know that the Elliott Wave Principle even exists. One of the most exciting experiences in my 62 years of investment learning was the realization that virtually no one in Academia, Wall Street or our Washington government understands what causes booms and busts, manias and depressions. I now know that I am a privileged member of a small group of investors that follow the natural laws discovered and published by Ralph Elliott in August 1938. Earlier, in March 1935, he had sent a telegram to Charles Collins, an investment counselor, announcing that the Dow and other averages had just made their low for the year -- the first great market prediction of this new tool.

For all serious investors facing many difficult years ahead., while Grand Supercycle Wave IV works its way to completion later in this century, I recommend reading, in order, the following three great books:

RECOMMENDED READING

At the Crest of the Tidal Wave - a Forecast for the Great Bear Market by Robert Prechter - a huge volume of information, originally published in 1995.
Elliott Wave Principle: Key to Market Behavior - published in1978, it forecasted the great new bull market. By Frost and Prechter and now in its 20th anniversary edition.
View From the Top of the Grand SuperCycle - Robert Prechter’s brand new, just published charts and text describing the topping of the market, including amazing side-by-side comparison charts of the 1929 and 2000 bull markets - a complete education in itself.

I conclude this section by suggesting that these 3 great books, normal intelligence and the ability to reject all conventional "wisdom" will give investors of all ages a great start to a successful investing career.

We now know that Elliott Wave cycles in stocks have existed through all four centuries where stock exchanges existed. We also know, and you will too if your read the books, that these cycles follow rules that are seen elsewhere in nature in trees, snowflakes, shells etc. They all follow a unique series of numbers known as the Fibonacci sequence or Golden number series used by the Egyptians and Greeks and rediscovered in the 12th century.

In my considered judgment, it is impossible to be a successful investor over a lifetime without knowing the bull/bear position in the existing long Elliott Wave cycle. Without that knowledge, success will only occur with blind luck resulting from buying at a market low and selling at a market high. It is true that an investor buying at the 1932 low of Dow 42 and selling in 1982 at Dow 1000 would have a profit, but not that great in real dollars. In my lifetime the dollar has dropped to a few cents. From my experience in the Great Depression, I still have a habit of picking up pennies since in my childhood I could take one and buy a candy bar.

I do not have any statistics, but it is my feeling that very few investors do well over the long run. We do know that, in the recent 18-year bull market, investors did much worse than the market as the result of buying and selling mutual funds at the wrong time. We also have strong opinions against buying and holding for the long-term as advised by Wall Street and the mutual funds. We hold this opinion because we place conservation of principal very high in our priorities. We prefer to take profits when the market gives them to us, rather than risk big losses at a later date.

Today, a veteran manager from a well-known mutual fund was on CNBC arguing for buying stocks now because (1) they were fairly valued and (2) he expected a stock rally in the 2004 election year. Anyone who falls for this "rot" deserves his or her fate. This great bear market has a very long way to go in both time and price. When the bottom finally comes, no one will be recommending and buying stocks.

Although it is impossible to predict the future, my guess is that the next 50 years will be extremely difficult, even for the small group of knowledgeable, experienced investors. Here is what I think it will take to do well:

BE PREPARED

Understanding the history of all past market manias. The great books are fun to read.
Access to periodic reports on the intermediate Elliott waves in the stock, bond and gold markets.
A long range plan to own only the very best asset classes for the expected market climate.
A portfolio consisting of conservative and aggressive classes, whose ratio is selected to meet individual needs for risk and conservation of capital.
A periodic rebalancing plan to readjust the asset classes to their original percentages.
As dictated by Elliott Wave data, revise the asset classes held, but continue to follow steps 4 and 5 above to assure growth and safety over the long-term.
Expect surprises and prepare for them in so far as possible.

The present Elliott Wave status shows that equities are in a long-term bear market. Gold and silver are in the last wave of very long bear markets and should be watched carefully for a major buying opportunity. Bonds of all maturities are at the top of a very long bull market and are about to repeat what stocks did in 2000. Remember that when interest rates start to rise, bonds will enter a serious bear market as their prices fall. The U.S. dollar is falling now against major foreign currencies and is in a major bear market. Use carefully selected Foreign Government bond funds to hedge against losses in the dollar.

Just as short funds can be used to protect equity positions, it is now possible to profit from a bond bear market through purchase of an available short bond fund. There are also a number of new bond ETFs (Exchange Traded Funds) available that, like stocks, can be sold short for profits from a bond decline.

DO’S AND DON’TS

Watch CNBC (if still alive) for amusement, not ideas.
Read the Sport pages, not the Business pages, of your local paper.
Use mutual funds as a convenient place to invest assets, not a valid source of investment information.
Use on-line discount brokers, not your local brokerage firm, to buy stocks and funds.
Do not take investment tips and advice from friends, strangers or self-claimed experts.
Do read for general background the web pages of recognized investment experts.
Check the financial safety of your bank, broker or insurer at www.weissratings.com on line. Weiss furnishes excellent quarterly reports for only $7.95 - a huge bargain.

Many would-be investors think it is possible to delegate the responsibility to manage their invests. They are wrong, very wrong. If one picks another manager, the investor must still manage the manager through a process of selection, managing and firing if needed.

Immature investors are quick to take and use free advice from any and all available sources, often with tragic results. Serious advice should never be accepted from any commission-hungry broker or salesperson. Taking investment advice from anyone without full knowledge of their background and ability to handle a vicious bear market could cause very bad losses.

We know from current press reports that most analysts on Wall Street are still bullish. We know that most equity mutual fund managers are bullish from their actions. Recently I have had a few e-mails from sales representatives in regional brokerage offices who say they are the only one in their large offices who understand this secular bear market. I have also had a few letters from CFPs and CFAs who recognize the current very serious market situation. I do not usually have any details about Investment Advisors except by reading the words of those advisors that publish on various web pages. The one advisor I know the most about has read and agrees with many ideas published in my essays.

I have few facts on the more than 130 readers who have requested the addresses of the 3 advisors as mentioned in my recent essay. Several of them mentioned having assets in 6 or 7 figures which would qualify them to split their assets between a number of advisers. Even with careful selection, there is always more safety with two than one as it provides an easy way to compare results. I’d like to mention the response I recently gave to a young reader asking advice on what to do with substantial assets. I suggested very broadly, as I always do, that most of it should be in short-term U.S. treasuries at present. Then, I suggested that another part be placed with two advisors knowledgeable of this bear market. Finally, I suggested that the remainder be used to start two bear market learning portfolios as described in my recent essay. So most of the assets would be safe from market fluctuations. The rest would be in two advisor managed accounts and two personally managed learning accounts. This allocation of assets provides safety and tremendous diversification and should make for a great learning experience over the next few years.

CHARACTERISTICS OF A SUCCESSFUL INVESTOR

Feels lonely at a bull market peak AND at a bear market bottom.
Realizes that the effects of news events on the market are temporary.
Keeps abreast of the Elliott Wave status of major asset classes.
Is aware of the effects of market action on major asset classes.
Abhors losing money in the market.
Makes decisions based on careful thought, not on impulse.
Designs a portfolio to succeed in the prevailing market climate.
Plans to make changes as dictated by market action.
Considers risk and chooses suitable ratios of asset classes.
Teaches his children and grandchildren what has been learned.
Refuses phone calls from cold-call salespeople.
Throws all "Get Rich Quick Mail" in the trash.
Does not offer advice to friends or strangers.
Sleeps soundly each night.

Anyone of normal intelligence, man or woman, can become a successful and happy investor in good markets and bad. Often, from my experience, people of higher intelligence, especially those in the professions, will have to work much harder to learn than others.
There is much more bad information to unlearn, which for some people is even harder than new leaning. Learn from bona-fide experts, not from the man next door.
Put these quotes from Warren Buffett in large print on your wall:
Rule 1. Do not lose. Rule 2. Don’t forget Rule 1
Be Fearful when others are Greedy. Be Greedy when others are Fearful.
Acquire a firm knowledge of Elliott Waves and past Manias as early in life as possible.
Believe very little you read or hear from most sources and experts. Test everything against your own knowledge.
Read the fine print before you leap into any investment. Do not put all your eggs in one basket.
Do not buy and hold anything for the long-term, including cash, gold and real estate.
Buy and hold things that are going up. Do not let your losses run. Cut them short.
Sell on dips to turn a paper gain into a real gain.
Every portfolio needs your attention at least once a month depending on its volatility.
Read our many essays on selecting asset classes and portfolio rebalancing- a little known tool that can shorten the "Road to Riches."