The Prospecting Professor

Warren Buffett and Emotions

"Pessimism is the most common cause of low prices. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It's optimism that is the enemy of the rational buyer."...Warren Buffett

Investing decisions that are driven by normal human behavior can have a deleterious effect upon long-term wealth accumulation. Many investors, even the most savvy, allow their emotions to get in the way of rational investment decision-making. Our emotions have the nasty habit of encouraging investors to buy and sell at the wrong time...causing us to buy high and sell low...which is the reverse of what should be done.

Three Common Behavioral Issues. 1. Herd Mentality reflects the natural tendency to do what is currently popular, e.g. buy securities AFTER the market has risen, or sell securities AFTER significant declines. Herding is defined as a group of investors following each other into (or out of) the same securities over a period of time. 2. Regret Aversion is the avoidance of the pain of regret associated with bad decisions. This trait causes investors to hold onto losing positions too long...or to avoid the markets during periods of depressed prices, at exactly the right time to invest more. 3. Mental Accounting is used by investors to build portfolios as separate accounts, and to disregard the correlations among assets. Investors do not evaluate investments based on the contribution to the overall portfolio return and total risk, but only upon the recent performance of the asset layer.

For long-term wealth-accumulation, investors are encouraged to think counter-intuitively. Contrarian investing and portfolio rebalancing are the most effective manifestations of counter-intuitive investment thought.

Speaking of rebalancing, in the May issue of "Financial Planning," there is an interesting article that discusses a new software program that performs sophisticated rebalancing techniques...that enhance portfolio returns even beyond what 'normal' rebalancing accomplishes.

Invest Like a Senator

In the 10/31/05 issue of the New Yorker, author James Surowiecki discusses the investment habits of U.S. Senators. After discussing the current travails of Senate Majority Leader Bill Frist, who is now under probe by the SEC, Surowiecki refers to an interesting study published last year, that investigates the investment results of U.S. Senators. "see article"

The study was undertaken by Alan Ziobrowski, a professor at Georgia State University. He found that during the boom years of 1993-1998, a majority of the U.S. Senators were trading stocks, and beating the S&P 500 by 1200 basis points.

Since this was the first-ever systematic study of politicians as investors, it begs the question..."Are politicians really that smart?" Or are some of the Senators trading on "non-public material information?"

However, before drawing too many conclusions from the study, one should look closer at the particulars of the study itself. During the years in question, 62 Senators disclosed some 6,000 stock trades. Nearly 50% of the trades were reported by just four lawmakers: Claiborne Pell of Rhode Island, John Warner of Virginia, John Danforth of Missouri, and Barbara Boxer of California. Said another way, these four Senators accounted for 3000 of the trades in the study...which would mean that they made, on average, 150 trades per year in the five years in question. John Warner and Barbara Boxer are still in the Senate. John Danforth and Claiborne Pell have since left.

I wonder if these Senators were trading stocks with a "substantial informational advantage?"  I also wonder if their trading patterns have slowed down somewhat...given the realities of the markets today?

James J. Cramer

James J. Cramer is the co-founder of TheStreet.com and a commentator on CNBC. To say that he is outspoken is an understatement.

In a recent issue of New York magazine, Cramer gets right to the point. The title of the article says it all, "How to Withstand the Coming Bush Economic Crisis" Some excerpts from the article:

• "He's gone on both the biggest spending binge and the lowest taxation course in U.S. history, which, alas, will produce gigantic liabilities down the road."
• "It's dawning on Wall Street that George W. Bush may be the first president since Lyndon Baines Johnson who believes that we can have a guns-and-butter federal spending policy without creating a serious inflation spiral."
• "But considering Bush has never vetoed a spending bill and would rather die than raise taxes,  you have to believe we'd be plain stupid to make a huge 401(k) bet on strictly domestic stocks."

After building his case that Bush is "fiscally clueless", Cramer goes on to recommend five "imminent-Bush-disaster-stocks." Here they are:

1. Goldcorp (gold)
2. Rio Tinto (Brazilian minerals company)
3. Total (French oil company)
4. Sasol (South African energy company)
5. Fording Canadian Coal Trust ((Canadian coal)

Look...I don't want to get in the business of making stock recommendations.  And James Cramer has had his own stock-picking issues in the past. Yet, he makes some interesting points. The article is worth reading in order to get a more complete picture of his perspective.

Tomorrow, I will discuss how you could use the viewpoints in this article to attract notice...from a prospecting perspective. Please stay tuned.

Bond Fears

Do you have clients or prospects who desire to have bonds in their portfolio...who should have bonds in their portfolio...yet who are paralyzed by the fear of a rising interest rate environment? Listen up. An investor who has a defined investment horizon, and who desires to hold bonds in their portfolio should NEVER wait...they should buy bonds now, regardless of the current level of interest rates.

In the August issue of the Journal of Financial Planning, two finance professors argue the case for buying bonds now, in an article entitled "Now is Always the Best Time to Buy Bonds".

Here's their argument:

• Bond prices are less volatile than stock prices, and the returns are less than perfectly correlated with stocks. Bonds offer risk-averse investors to generate a steady income stream and provide stability to the portfolio by diversifying asset classes.
• There is NO penalty for investing in bonds, even in a rising rate environment.
• The pure expectations theory states that the current yield curve is an unbiased predictor of future interest rates. In this case, the authors show that the total return from buying bonds now exactly equals the return expected from buying bonds later.
• The liquidity premium theory states that the current yield curve includes not just expectations of future interest but also an additional return called the liquidity premium. In this case, it is shown that postponing investment in bonds reduces total return because the investor fails to receive the available liquidity premium.
• In the portfolio context, now is always the right time to own bonds, because bonds will always be part of a market portfolio.

If you have investors on the "bond fence", and you can't get them off...this is a must article for you. Make a copy. Study it. Find a way to translate and explain the central points such that you can explain it to your intransigent bond investors. You, and they, will be glad you did.

Changing the subject completely...Happy Birthday to Otis Redding, one of the best performers and singers of soul ballads ever!

Stocks vs. Real Estate

In a good article in the NY Times last Friday, the authors illuminate that although housing prices have done will recently, over longer term time periods, the equity markets have been significantly better. "In the Long Run, Sleep at Home and Invest in the Stock Market".

Since 1980, the average annual return for the S&P 500 is +10.2%...compared to a +7.7% rise in housing prices in New York, or a +6.7% increase in Los Angeles.

However, many investors are completely fixated on the returns of the past five years. While the S&P 500 is down 2.7%...housing prices are up 12% and 15.5%, in New York and Los Angeles, respectively.

Yet, when comparing the returns of equities to housing prices, it is often an apples and oranges comparison.Stocks are more volatile, and their price changes can be viewed daily. Moreover, real estate is typically a leveraged investment...which means that the effect of real estate's recent upturn, has been exacerbated.

The other obvious difference is that, if housing prices soften, you'll still have a roof overhead. One can't live in their portfolio.

Tulipmania, Crowd Psychology, and Low-Carb Diets

The most famous example of a speculative bubble is the "tulipmania" that struck Holland between 1634-1638. As the market reached a frenzied peak in early 1637, people mortgaged their homes and businesses in order to buy bulbs for resale at higher prices. The highest price bulbs sold for more than 3000 guilders...equivalent to the price of a large house. When the market  finally collapsed, many of the powerbrokers of Dutch society were ruined...almost overnight.

Investment history has been littered with the sad stories of market bubbles and manias. Consider:

• the Mississippi scheme that swept France in 1720,
• the South Sea Bubble that gripped England during the same years,
• the Stock Market mania and crash of the 1920's,
• the Dot.Com frenzy of the late 1990's,

Yesterday, I wrote about the Chapter 11 bankruptcy of Atkins Nutritionals, and the long history of dietary fads and trends. Although I am not a Behavioral Economist, I am struck with the parallels between the crowd psychology of market...and dietary...manias.

In this vein, I wonder if this wouldn't be a great topic for a seminar that explores the underpinnings of market...and dietary...manias; and provides common sense solutions to confused investors. Better yet, why not add the following list of invitees to your invitation list, and make it a celebration of the demise of Atkins Nutritionals?

• Potato farmers,
• Bakers,
• Pizza and pasta shops,
• Wheat growers,
• Fast-food franchisees,
• Fruit growers,
• and everyone else who is rejoicing upon the discredit of low-carb mania.

Just a wacky thought for a Friday in August. Have a great weekend!

Manias (Dietary...and otherwise)

Irony...thy name is Americans and their fixation on fat. Two-thirds of Americans are determined to be obese today...yet weight-loss manias have continued to hound Americans for the past 100+ years.

The most recent mania has been the low-carb craze, spawned by Dr. Robert C. Atkins. Last week, Atkins Nutritionals filed for Chapter 11 bankruptcy protection...and declared $301 million in assets and $325 million in liabilities. For the year, Atkins reported a $341 million loss...a stunning decline for a company that changed the face of the American food industry.

"Dr. Atkins' Diet Revolution," was first published in 1972, where weight-loss guru claimed that his diet prompted "ketosis," a metabolic state in which fat is burned more efficiently. Since then, his books have sold 20 million copies in more than 20 languages. Additionally, up to 17% of the US population admit to having tried a low-carb diet at some point. When Atkins was at it's peak, fast-food chain Carl's Jr. pushed their lettuce-wrapped Low Carb Six Dollar Burger, Kraft pitched  low-carb Oreos, and Frito-Lay jumped on the bandwagon with low-carb Doritos, Tostitos, and Cheetos.

The reversal-of-fortune of Atkins Nutritionals and low-carb diets has been precipitous. Some of this may be related to the apparent hypocrisy of Dr. Atkins' own physical condition. He died in April of 2003, following a nasty fall on the icy sidewalks of Manhattan. Subsequent to his death, a coroner's report revealed that he suffered from: obesity (258 lbs. at the time of his death), hypertension, and heart disease.

A Select History of Dieting in America. Dr. Atkins was hardly the first weight-loss guru in this country. He follows a long line of dietary proponents.

• In the 1830's, the Rev. Sylvester Graham, nicknamed "Dr. Sawdust", rails against gluttony, which he says leads to lust, constipation, and indigestion. His answer is a spartan diet of coarse, yeast-free brown bread (including the Graham cracker), vegetables and water.
• In the 1860's, London undertaker William Banting publishes "Letter on Corpulence," which becomes a bestseller by espousing a low-carbohydrate diet that consists of lean meat, dry toast, soft-boiled eggs and vegetables.
• Also in the 1860's, Dr. James Salisbury promotes a diet of hot water and minced meat patties (Salisbury steaks).
• 1876, Dr. John Harvey Kellogg, of the Battle Creek Sanatorium, begins his crusade for vegetarianism, pure foods, slow chewing, calorie counting, colon cleansing, and individualized diets. He invents granola and toasted flakes.
• In 1898, Horace Fletcher begins the slow-chewing movement. After he is denied life insurance because of his weight, Fletcher drops 40 lbs. through a strategy of chewing each mouthful to liquid before swallowing it. His diet is accompanied by the 'Slow Chew Anthem,'..."I choose to chew because I wish to do/The sort of thing that nature had in view."
• 1960's. Mead Johnson introduces Metrecal.
• 1961. Weight Watchers is formed.
• 1960's. Alcohol-friendly, low-carb regimens are touted with the publication of "The Drinking Man's Diet", and "Martinis and Whipped Cream."
• 1978. Herman Tarnower publishes the high-protein Scarsdale diet, of only 700 calories daily. He is killed by his lover in 1980.
• 1992. Atkins publishes a new book that promotes his low-carb, high-fat, high-protein approach, "Dr. Atkins New Diet Revolution."

Although I haven't built a very good case for it today, I find distinct similarities between the manias around dieting and food...and the manias and fads that continue to crop up in the investing world. At some point in the future, I would like to discuss this topic in greater depth.

Enough for today...though. Ciao!