Three Questions That Count
Note: This is taken from an article by Kenneth L. Fisher appearing in the October 17, 2005 edition of Forbes magazine.
You want to maximize your chances of getting good results from stock picking? Here is a system, and it boils down to focusing on just three big questions. They aren't what you might expect - like questions about the market's price/earnings ratio or interest rate forecasts. Rather, they have to do with your own psyche. Overcome your psychological failings and you can be a better investor.
First question: What do you believe is true that's actually wrong? If you are captivated by some market myth, other investors probably are, too. Figure out what that popular but wrongheaded belief is and you can disassociate yourself from it. You can bet against it.
Example: Most investors believe that years when the market is trading at a high multiple of its collective earnings are bad years in which to invest and low-P/E market years are good times. This popular belief is contradicted by the evidence. Yes, there are some high-P/E years that turned out to be disasters (2000 and 2001, for example). But there are just as many occasions when buying into a high-P/E market was the right thing to do, for example 1932, 1998 and 2003.
So when you see folks freaked out by high-P/E markets, you can bet against them. You know something they don't know. You can invest knowing the market P/E is irrelevant. (And it should be.)
Question two: Can you fathom the unfathomable? If you have the right instinct for turning market statistics into buy-and-sell signals, you seek correlations first, then causal relationships that would explain them.
For example, the main force driving cycles when growth stocks do well versus value is time-lagged shifts in the yield curve. The yield curve plots the yield on Treasury notes and bonds against their maturity dates. The historical pattern has been this: About 9 to 12 months after the yield curve gets flat, growth stocks start beating value stocks, and they continue to beat value until the curve gets very steep again. The causal relationship is very simple. A flat yield curve reflects a reluctance of banks to lend to commercial borrowers. And value stocks are very borrowing-dependent, while growth stocks aren't.
At the moment (October 17, 2005) the yield curve has gone close to flat - the yield on ten-year Treasurys, 4.1%, is not much more than the yield on two-year Treasurys, 3.9%. So mid-2006 is the time to prefer growth to value.
Question three: What is your blind spot? Investors suffer from self-blinding psychological traits like confirmation bias and reframing; fear of heights, myopia, and Stone Age hardwired thinking. It takes time and effort, but you can learn. For example, if you are myopic and suffer confirmation bias, you are a trend-follower and will miss upcoming changes like the capital expenditure and agricultural booms starting in 2006.
* * * * *
You want to maximize your chances of getting good results from stock picking? Here is a system, and it boils down to focusing on just three big questions. They aren't what you might expect - like questions about the market's price/earnings ratio or interest rate forecasts. Rather, they have to do with your own psyche. Overcome your psychological failings and you can be a better investor.
First question: What do you believe is true that's actually wrong? If you are captivated by some market myth, other investors probably are, too. Figure out what that popular but wrongheaded belief is and you can disassociate yourself from it. You can bet against it.
Example: Most investors believe that years when the market is trading at a high multiple of its collective earnings are bad years in which to invest and low-P/E market years are good times. This popular belief is contradicted by the evidence. Yes, there are some high-P/E years that turned out to be disasters (2000 and 2001, for example). But there are just as many occasions when buying into a high-P/E market was the right thing to do, for example 1932, 1998 and 2003.
So when you see folks freaked out by high-P/E markets, you can bet against them. You know something they don't know. You can invest knowing the market P/E is irrelevant. (And it should be.)
Question two: Can you fathom the unfathomable? If you have the right instinct for turning market statistics into buy-and-sell signals, you seek correlations first, then causal relationships that would explain them.
For example, the main force driving cycles when growth stocks do well versus value is time-lagged shifts in the yield curve. The yield curve plots the yield on Treasury notes and bonds against their maturity dates. The historical pattern has been this: About 9 to 12 months after the yield curve gets flat, growth stocks start beating value stocks, and they continue to beat value until the curve gets very steep again. The causal relationship is very simple. A flat yield curve reflects a reluctance of banks to lend to commercial borrowers. And value stocks are very borrowing-dependent, while growth stocks aren't.
At the moment (October 17, 2005) the yield curve has gone close to flat - the yield on ten-year Treasurys, 4.1%, is not much more than the yield on two-year Treasurys, 3.9%. So mid-2006 is the time to prefer growth to value.
Question three: What is your blind spot? Investors suffer from self-blinding psychological traits like confirmation bias and reframing; fear of heights, myopia, and Stone Age hardwired thinking. It takes time and effort, but you can learn. For example, if you are myopic and suffer confirmation bias, you are a trend-follower and will miss upcoming changes like the capital expenditure and agricultural booms starting in 2006.
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posted by Bob Moser at
5:12 PM
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