FWIW # 3 Investment Management March 2020

One thousand Dow points up; two thousand Dow points down. Locked limit down. Over and over again. All the media can do is blame it on COVID-19. The virus was the last card placed on the investment markets’ house of cards. The real culprits are

1. the incredibly egotistical idea on Wall Street that anyone can predict the future.

2. the development of algorithms that are purportedly smarter and more disciplined than the human participants in the marketplace.

3. the increased leverage used by market speculators due to a decade of Federal Reserve financial repression.

4. the flawed concept Wall Street casino operators have sold to the general public, that nonprofessional market participants are better off owning passive multi-security packages than individual stocks and bonds.

When this fourth structural flaw moves to the forefront of people’s minds, and it’s likely to happen, the run on security prices will be greater than any past or current challenge.

The hysteria of the moment over the virus will pass. Unfortunately, the Wall Street casino operators and their media associates are here to stay. Think about what information is communicated by the casino operators through the media:

1. The stock market in February making all-time highs was not overvalued. If investments or markets are making all time new highs, and the price declines by 10% from those all-time highs, how does this mean a correction? If the assets were grossly overvalued (which the market was) and are now just highly overvalued, how does that make investments attractive? What if it is 20% below the gross overvaluation, but is still above historical average valuation? Is it a good buy just because of the pullback, like they say on Wall Street? Announcing a bear market for a 20% drop from gross overvaluation is designed to do what? Scare people out of their securities, even if the market is still overvalued by sensible metrics?

2. Value is dependent on the level of interest rates at any given moment. If interest rates are lower due to deliberate suppression by the government, the value of all assets goes up, even if the interest rate is substantially below historical and appropriate levels. If interest rates do go back up, the value of all assets falls. How does this make sense for determining long-term investments’ value? It doesn’t. What it does do is feed the Wall Street casino operators new money to skim from those who believe their propaganda.

What You Need to Know

Let’s sort out the issues and concepts necessary to use the markets today for potentially making large sums of money over time:

A. It’s fallacious and dangerous for the media to call everyone investors. This is important. Look at the definition of investor, and it’s a positive description. Look at the definition of speculator, and it’s a shadier description of someone guessing the future. That distinction is important to understand. So is the fact that speculators are not investors, yet investors have a certain amount of speculative bent in them. This is important because most civilians (non-Wall Street market participants) want to be investors. They are saving for their children’s education, a home purchase, or retirement. They want their money to grow, but really don’t know how to make it happen. When they hear the media calling rank speculators, like hedge funds, day traders, option players, and everyone else “investors,” civilians think the tactics these people use are what they should be doing as well.

Nothing could be further from the truth. This is a gross disservice to civilian market investors bordering on malfeasance. Understand what you are – an investor.

B. To fully understand just how important speculation on future volatility is to the Wall Street casino operators, all a person must do is make a list of all the different ways Wall Street has designed to interface with security volatility. The list is long and complicated, ranging from mutual funds to exchange traded funds, futures contracts, option contracts, annuities, ABSs, CMOs, and other structured investments in the equities and fixed-income markets. Only three items on the list are important for investors: individual common stocks, specific real estate, and individual fixed-income securities consisting of individual bonds and/or preferred stocks. These three asset categories are the basis of every manufactured or designed security on the list. The others are just fancy packages designed to make money for the Wall Street casino operators at the expense of the civilian speculators who are fooled into believing they are investing. Investors should own individual companies and fixed-income securities.

C. Over the years, with the help of their friends in the media and Washington, the Wall Street casino operators have steadily put in place the market structure to force civilian market participants to use the packaged securities created by Wall Street. These created securities extract huge sums of money from the captured investors in the form of fees and use of the securities in the packages to make money for the packager. Mutual funds, exchange-traded funds (ETFs), and other structured and packaged investments have added expenses the holders are forced to pay. These packaged securities with their embedded fees are now required investments in most retirement accounts other than individual IRAs. Offsetting these forced investments with individual securities in IRAs and portfolios outside of retirement accounts is helpful.

D. Much of Wall Street’s media emphasis is on the concept that capital gains and trading are the ways to get rich, but this is false. Some lip service is devoted to the “long-term” appreciation of the markets and the need to hold investments through volatile times. Having stated that perspective to satisfy the regulators, the combine of Wall Street and media spends its time highlighting daily and weekly moves in markets and individual securities to entice the greed factor. A prime example is the switch in reporting stock price changes. A company with a share price of $30, for example, that gains 37 cents is reported to gain 1.25% that day! The implication is that the viewer should pay attention and either buy because the share price is moving up or, conversely, sell because there is a new profit to be taken.

On the professional side, Wall Street casino operators and independent professional market traders have spent enormous sums developing algorithms designed to analyze past historical data and current price changes in the markets for reading data and anticipating what the future market action will be. There are now algorithms that are designed to anticipate what other algorithms will do. Two points should be understood:

These algorithms work best over a short period (a few minutes or a fraction of a second), extracting small numbers of market inefficiencies at a time.

The focus on Wall Street to urge the unsuspecting civilian investor into owning inexpensive passive investments in market index funds works best for the Wall Street casino operators. Their algorithms are not as efficient when applied to individual stocks. Individual stock values are what is important for an investor, not the level of the market.

E. Anyone with financial knowledge and experience on Wall Street and in the media understands that compounding of returns is the way to wealth, but both Wall Street casino operators and the media focus on highlighting the “growth” strategy. This concept of fastest sales growth is predicated on the belief that at some point the company will be profitable or corner a marketplace. The concept works part of the time – in a rising bull market. Its flaws are twofold:

To realize the benefit of the increased value, the shares must be sold. But wait! Someone will say the shares can be borrowed against, thus reaping both liquidity and future growth. Numerous small speculators, large speculators,

and senior leaders at companies have lost all their fortunes borrowing against high flying “darlings” of the market that crashed.

Some “growth” stories unravel because management constantly tries to keep the rapid growth happening and eventually either makes bad decisions or sees the limits of their economic sectors bring growth down. Investors build portfolios designed to compound returns without liquidation.

F. Wall Street casino operators do not want individual investors to understand the concepts of total return and compounding. That’s why many Wall Street firms offer what is called Monte Carlo Simulations. These are computer programs that guess future returns and withdrawals; the numbers are put in the computers, and a person finds out they have enough money to last until they are a certain age. That comes with a big if: IF the stock market doesn’t drop dramatically anytime during the period of retirement. It’s not possible to predict the future, so why do the Wall Street casinos bet client futures on unknown factors?

G. Predatory investors take advantage of fear when markets are volatile. After the first two days of the market decline, the virus and its economic impact were marginal compared to the struggle between Wall Street operators who have trading strategies and algorithms, some with high amounts of leverage, stressed by the market activity. Any time a market moves in multiple percentages, some very large speculators are being forced out of the market. Because the media and Wall Street don’t acknowledge that fact, civilian market participants, worried about their assets, are driven by fear to needlessly liquidate their positions. Investors use these volatile periods to buy individual stocks to improve their portfolios.

H. Speculation isn’t all bad. Even though the speculative strategy of Wall Street casino operators and their media friends is seriously flawed, true investors are extremely fortunate the markets have developed this speculative path. Why? Because it’s inevitable that periods like the one we’re experiencing now are going to happen. The hysteria of the speculators will give real investors the opportunity to own quality companies at very attractive prices. So, the investor should cheer the foolish on while placing orders at terrific prices to buy quality companies.

I. To be a smart investor, it’s helpful to write 1,000 times: No one knows the future.

J. Common sense dictates that you take measures to ensure your own financial safety. Investors should have investments with

a) above-market current cash flow from dividends and interest.

b) companies that show sound management and a stable balance sheet.

c) ample and reliable reserves for times when the foolish panic – like now.

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