{"id":33119,"date":"2012-10-24T23:45:35","date_gmt":"2012-10-25T03:45:35","guid":{"rendered":"http:\/\/countingpips.com\/forex-news\/2012\/10\/the-little-book-of-bulls-eye-investing\/"},"modified":"2012-10-24T23:45:35","modified_gmt":"2012-10-25T03:45:35","slug":"the-little-book-of-bulls-eye-investing","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex-news\/2012\/10\/24\/the-little-book-of-bulls-eye-investing\/","title":{"rendered":"The Little Book of Bulls Eye Investing"},"content":{"rendered":"

By The Sizemore Letter<\/a><\/p>\n

John Mauldin is far too much of a gentleman to say \u201cI told you so,\u201d but he would certainly be within his rights to do so.<\/p>\n

When Mauldin published the original Bull\u2019s Eye Investing <\/em><\/a><\/strong>in 2003, he made his case that U.S. stocks were in the early stages of a secular bear market.\u00a0 Today, nearly a decade later, he has been proven largely correct.\u00a0 The S&P 500 is still below its 2007 all-time high and, far more significantly, still below the previous high set after the secular bull market of 1982 – 2000.\u00a0 Adjusted for inflation, investors that held throughout this period would be sitting on some stinging losses.<\/p>\n

\"\"<\/a>\"\"
\nThe Little Book of Bull\u2019s Eye Investing<\/em><\/a><\/strong>, published in 2012, <\/em>is a shorter, more digestible update to Mauldin\u2019s original magnum opus.\u00a0 And Mauldin is adamant that, despite his belief that the secular bear still has a few years left in it, the book is not about \u201cdoom and gloom,\u201d and \u201cthe world as we know it is not coming to an end.\u201d\u00a0 There is money to be made; it just so happens that you might have to look in unfamiliar places to find it.<\/p>\n

Let\u2019s start with a few definitions.\u00a0 A secular bear market is a long-term period in which stock prices are flat or falling.\u00a0 In practice, this has been anywhere from 8 to 20 years, with approximately 17 years being the average of the past century.<\/p>\n

Investing in a secular bear is very different than investing in a secular bull.\u00a0 As Mauldin writes,<\/p>\n

In secular bull markets, an investor should search for assets that offer relative returns<\/strong>\u2014stocks and funds that will perform better than the market averages.\u00a0 If you beat the market, you\u2019re doing well\u2026<\/em><\/p>\n

In a secular bear market, however, that strategy is a prescription for disaster.\u00a0 If the market goes down 20 percent and you go down just 15 percent, you\u2019d be doing relatively well, and Wall Street would call you a winner\u2026 But you are still down 15 percent.<\/em><\/p>\n

In markets like these we face today, the essence of Bull\u2019s Eye Investing is to focus on absolute returns<\/strong>.\u00a0 Your benchmark is a money market fund.\u00a0 Success is measured by how much you make above Treasury bills.\u00a0 <\/em><\/p>\n

Mauldin sees another five to six years of secular bear market conditions, \u201cin terms of valuations, if not in price.\u201d<\/p>\n

This requires a little explaining.\u00a0 In a secular bear market the price<\/em> of most stocks falls or stagnates, but price is less significant that valuation<\/em>.\u00a0\u00a0 A stock that cost $500 can be \u201ccheap,\u201d just as a penny stock can be \u201cexpensive.\u201d<\/p>\n

Value has to be measured relative to something\u2014such as earnings, revenues, cash in the bank, or accounting book value.\u00a0 In a secular bull market, investors become more and more optimistic about the future earnings potential of stocks and assign them higher and higher valuations, often to the point of absurdity.\u00a0 By the time the S&P 500 reached its top in early 2000, the average price\/earnings multiple was over 30, and it was not uncommon to see multiples of well over 100 on popular technology stocks.<\/p>\n

But in a secular bear market, this works in reverse.\u00a0 Investors get progressively more skeptical of future growth and assign lower and lower valuation multiples.\u00a0 Today, more than twelve years after the last secular bull ended, the average price\/earnings multiple is 15. That is less than half of the 2000 high.<\/p>\n

Interestingly, throughout the cyclical bull market of 2003-2007 (in which the S&P 500 hit a new all-time high), valuations continued to shrink.\u00a0 To keep things in perspective, had valuations remained at 2000 bubble levels, we would have seen the S&P 500 priced at 4,000-5,000\u2014and the Dow Industrials priced at 40,000 or more.<\/p>\n

Mauldin recognizes that markets go through long cycles of expanding and contracting valuations. But this is distinctly not<\/em> the advice you are going to get from Wall Street or from most financial advisors.\u00a0 Instead, they use modern portfolio theory (or, in Mauldin\u2019s words, a \u201crigged\u201d or \u201ctwisted\u201d version of it) to justify a buy-and-hold investment plan under any and all scenarios.\u00a0 After all, stocks \u201calways\u201d generate 7-10 percent returns over the long term<\/em>.<\/p>\n

Unfortunately, the \u201clong term\u201d can be very long indeed, particularly if you are in or near retirement.<\/p>\n

Mauldin on Market Psychology<\/p>\n

\u201cThe new era economists argue that we are now smarter than our fathers, something I understood implicitly when I was in my 20s,\u201d Mauldin writes. \u201c Since then, as the father of seven kids, six of whom are older than 18, I have developed doubts.\u201d<\/p>\n

Speaking facetiously, Mauldin writes that \u201cour emotional forebears invested without the wisdom that we now possess.\u00a0 They didn\u2019t understand that markets will go up eventually and that all you need to do is buy and hold and not worry about corrections and other transient phenomena.\u201d<\/p>\n

And naturally, we now have a smarter and more experienced Federal Reserve to step in and save us when need be.<\/p>\n

All of this sounds good, of course. \u00a0We do know more about economics and about the workings of capital markets than our counterparts in prior generations. \u00a0But ultimately, it doesn\u2019t matter as much as we would hope.\u00a0 As Mauldin makes clear, emotion drives the stock market.<\/em><\/p>\n

The biggest factor driving stock returns, in Mauldin\u2019s view, is not earnings growth or underlying economic conditions.\u00a0 It is investor perception <\/em>of these, and as investors lose faith in the ability of equities to generate high returns, their selling creates a self-fulfilling prophecy that takes years to fully play out.\u00a0 Thus, we have secular bear markets.<\/p>\n

How To Invest in a Secular Bear<\/p>\n

\u201cThe essence of Bull\u2019s Eye Investing is quite simple,\u201d Mauldin explains.\u00a0 \u201cTarget your investments to where the market is going, not to where it has been.\u201d<\/p>\n

Fair enough.\u00a0 But what about specifics?<\/p>\n

Mauldin has a couple recommendations:<\/p>\n

    \n
  1. Go for a deep value approach.\u00a0 Invest like a Benjamin Graham by systematically buying companies that are priced so cheaply they can be cut up and sold for spare parts at a profit.\u00a0 This requires time, research, and patience that many investors may find too onerous, but you simply are not going to be able to generate decent returns in a value strategy by buying and holding a mutual fund.<\/li>\n
  2. Whatever your trading strategy, \u201ccut your losers and let your winners ride.\u201d\u00a0 Set stop losses on your positions, and stick with them.\u00a0\u00a0 You should also have an exit strategy.\u00a0 Set targets for profit taking before<\/em> you actually invest.\u00a0\u00a0 And naturally, \u201cdo not fall in love.\u201d\u00a0 The stock will not love you back.<\/li>\n
  3. Consider dividend-paying stocks as income\u00a0 vehicles\u2026but only if you are reasonably confident that a broad market crash isn\u2019t around the corner.\u00a0 During bear markets, dividend stocks fall less than the broader market.\u00a0 But they still most certainly fall.<\/li>\n
  4. Actively trade.\u00a0 On this count, Mauldin is a little harsh, saying that only about 1 percent of his readers are really traders at heart.\u00a0 \u201cAny of the other 99 percent who venture in will be their cannon fodder.\u201d<\/li>\n
  5. Investigate alternative investments, and particularly absolute returns funds.\u00a0 On this count, select your managers very carefully and be sure to do your due diligence.<\/li>\n<\/ol>\n

    Finally, Mauldin\u2019s best advice, as a confessed \u201cserial entrepreneur,\u201d is to consider starting your own business if you have a good idea and have the endurance to see it through to the end.\u00a0 Even in a low-growth \u201cmuddle through\u201d economy, there are new opportunities.\u00a0 It\u00a0 is simply a matter of finding them and exploiting them.<\/p>\n

    The Little Book of Bull\u2019s Eye Investing<\/em> is a nice, succinct primer on John Mauldin and his approach to the investing process.\u00a0 It offers no quick fixes or get-rich-quick advice, but it is a good book to keep readers grounded in reality.\u00a0 I keep a copy on my bookshelf, and I recommend it to readers today.<\/p>\n

    SUBSCRIBE <\/a><\/strong>to Sizemore Insights<\/em>\u00a0via e-mail today.<\/p>\n

    The post The Little Book of Bulls Eye Investing<\/a> appeared first on Sizemore Insights<\/a>.<\/p>\n

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