Home » Headline, Investing

Investing In A World Where The Impossible Is Possible

13 August 2010 One Comment

By Monty Pelerin

Investing is never easy, although sometimes it seems that way.

During a bull market, most everyone is successful and believes he has superior abilities. Many investors were geniuses, at least in their own minds, during the decades of the 1980s and 90s.

In the 21st Century, markets and the economy changed. Many of the geniuses flunked market tests provided by brutal financial and real estate markets. They didn’t suddenly become stupid. They were never as smart as they believed.
Many are now trying to rebuild savings for a decent retirement. Some are beyond retirement age. The next senior greeter you meet at Walmart or behind the counter at McDonalds might have been brilliant and wealthy just ten years ago.

History suggests that I lived in a “sweet” spot. I was lucky to be born in the right place, America, and at a propitious time. I was born during WWII, the ending of which arguably marked the beginning of America’s golden era. Other than worries regarding Vietnam, times were good. You could attend college without borrowing money. A decent summer job often was enough to pay for a year of college.

Your world is a lot harder. It is unlikely you will see a stock market bubble like the period 1982 to 2000 when the Dow went from about 750 to well over 11,000. In 1995 the Dow was 4,000. Six years later it was over 11,000. It was hard not to believe you were a genius during those heady times.

The good news, I hope, is that you will never face an economic collapse like we are now in. The bubble is deflating. The bad news is that this bubble has a much longer way to deflate and it will be painful. The country’s standard of living will not grow as fast and may even shrink for a while.

No Shortage of Opportunities

There will be great opportunities to make money as there always are. Fortunes will be made although investing success will be harder than last century. If you could throw a dart, last century you made money during most periods. Making money in the next ten years will be an accomplishment rather than something anyone can do.

You will see things in markets and the economy that have never happened before, at least in this country. These will present great opportunity but also great risk. Traditional investment advice is probably not going to be very helpful for the next decade.

Top-Down Analysis

You must have a top-down view. Understanding the economy will be extremely valuable. Understanding the political economy will be even more so. History, especially of countries that have experienced similar declines or tough times, should be helpful. Understanding the Great Depression, not on the superficial level you were taught in school, might be of value.

We are in a period, for better or for worse, where Washington has unprecedented control of the economy. Decisions made there will be more important in determining economic outcomes than ever before. Having an 800 pound gorilla bounding around in markets complicates investors’ tasks. Government will likely do things you cannot imagine. You will see events that “experts” said could never happen. If you understand nothing else, understand this: The impossible has a 20% probability.

Buy and hold is apt to be a fool’s strategy, at least for the foreseeable future. Nimbleness and quickness are likely to be rewarded. Staying out of markets is sometimes the best investment decision you can make.
Stock picking will be less important. The megatrends of politics and macroeconomics will produce market moves that overwhelm individual stocks. A good stock pick is almost always a bad investment in a bad market, at least in absolute terms.

The Key to Investing

Successful investing is little more than seeing the future better than others and then adjusting your portfolio in anticipation. Becoming super-wealthy is being able to anticipate what “impossibilities” are going to occur. These are the truly wealth-altering events.

An example of seeing the future better than others can be illustrated with prices. Deflation seems to be the problem de jure. Are you prepared for it to continue? What if we get inflation instead? Data series are historical, often biased and too dated to enable you to outperform fellow investors. However, grocery prices move real time. They are a better read on what is happening now. Watching a basket of items is likely to provide an advantage over your investing competitors.

Another illustration with regard to spotting economic turns may be useful. Alert barbers know earlier than most when a change is occurring in the economy. People take more time between haircuts when they are afraid or cutting spending. Similarly, dry cleaning is another barber-type leading indicator. You can develop your own methods, but these two will probably be six months ahead of government data.

“Impossible” Events

What about the “impossible” events? In a world with an 800 pound, irresponsible gorilla, the “impossible” will happen. While these events are more difficult to anticipate, they are most important. They are the real wealth builders or destroyers.

Only a thorough understanding of economics and politics will enable you to anticipate such events. Even that, is not a guarantee. You need not become an expert in either. Find yourself some people that understand both and have a reasonable track-record regarding the implications. The internet is full of “experts” in these areas. Your task is to separate the wheat from the chaff and then follow the wheat. Be careful, there is a lot of chaff out there.

What do I mean by “impossible?” Frankly, I am not sure anything is impossible. Suppose I suggested that you go to bed tonight in a deflationary environment and when you wake up tomorrow prices will have tripled. That’s right, 200% inflation overnight! Virtually everyone would say that is impossible. I say it is possible.

A post entitled Desperate Economic Action Ahead? deals with just such a scenario. You may judge for yourself how unlikely it might be. The point is that it is not impossible and might be considered quite plausible.

Should such an outcome occur, it would be a major wealth-altering event. If your investment strategy were on the wrong side of this event, you might be destroyed.

The inflation overnight scenario is just one example of the “impossible” happening. These types of events are difficult to foresee, but they will be more commonplace over the next decade than ever before. It is important that you scour all possibilities, even the ones that appear to be impossible. These are the major wealth-changing events that you must protect against.

Your challenge, more so than any other time, is to anticipate such “impossibilities.” In a government-controlled economy, discontinuities will occur. They can be in the form of unexpected legislation, economic interventions or public unrest. International events might also qualify.

It is unlikely that you would place bets, certainly not big ones, on “impossible” outcomes. Yet, it is critical that you be aware of them. A portfolio that doesn’t at least recognize there is a probability for the “impossible,” is an imbalanced portfolio. If the event happens, your portfolio will not hold up well.

“Think outside the box” is a cliché I am not fond of, but it does apply to your investing success. Good luck and hard work tend to correlate. I wish you both.

One Comment »