Posted On: 2006-11-01
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Alright, thanks everybody for tuning on in tonight. This is Johannes Ernharth on Vigilant Investor, the live streaming radio show over the Internet via talkshoe.com. We are on every Wednesday evening at 9PM, you can tune on in any time you like. I want to thank everybody who I can see, a handful of people are online tonight with the Talk Shoe interface which is always a great way to get involved and asking questions and so forth. We had some great questions last week from people typing them on in and also if you are a listener out there, and you'd care to give a call on in and ask a question tonight, you can always do that buy dialing on in, and the dial in info. is, [...] click on that ordinarily and I don't have the number up in front of me of me of course, and bear with me for one second while I pull this up. Usually there's the dial on click right here, and it's 724, the number is (724) 444, and then, oh we lost it, I'll put that up for you guys in a second, bear with me. Ordinarily I'm able to click on a little indicator on my, and I don't have the number memorized, go figure, but in any event. We have a lot to talk about tonight and I'll let you know how you can call in, in just a minute. Interesting week out there of course with what's going on in the markets and of course the economic indicators, a lot of people have been asking me questions this past week, you know what's going on with the economy, relative to the markets, why was the Dow cooking along and giving all these indicators on one hand that, you know if you were to, you know, look at what came out of the final report at the end of the week relative to the economy, GDP was much slower that it had been expected. The numbers from the housing sector were just plain old dismal and that finally seemed to knock the Dow off of it's momentum, but it's hardly anything that I found to be all that surprising. Of course if you're a listener to Vigilant investor on a week to week basis, and a daily reader of the vigilantinvestor.com web site, you know for sure that something has been rotten in Denmark for a long while, and we've been predicting recession for the better part of 12 months now. We would even argue that we have been in recession for a little while now. Now, again, ha, somebody actually just typed up the number for me. Thank you, it's (724) 444 -7444 if you want to call in with any questions, that's through the Talk Shoe system, and the talkcast id. for Vigilant Investor is 982, and when you're going to dial on in, you're going to need a, what's called a pin number, if you haven't been registered with the Talk Shoe system you'll need to have a pin number. You can do that by going to register with Talk Shoe, but if you happen to be listening live and you just want to ask a quick question one time, we have a couple of prefab pin numbers you can use to dial on in. One of them is 222-333-4444, that's 222-333-4444. Again, the phone number is (724) 444 -7444, and our talk cast id. for Vigilant Investor, 982. All this of course if available of course through the Vigilant Investor web site, you can dial us on in there, we even have a little tab there that you can get a feel for what goes on with the Vigilant Investor live show, every Wednesday night at 9PM. But, in any event, back to the show. We were talking just a second ago about what's going on in the economy and some of the numbers that came out at the end of last week. And, boy just let me take a look at this, I think it was, let's see homebuilders relieved themselves, this is probably some of the best part of the news, some of the backlog in inventory they relieved themselves about a good bit which I guess is good news relative to all the talk over the past month, has been that inventory and housing has been increasing. So the best news that they came out with saying that you know, all these new homes that they've been building in inventory, some of them got cleaned out, but you got to understand a lot of that came at the price of slashing prices, about 9.7 percent the prices came down from September of 2005. That's pretty major league right there. Also, we take a look at if we were to consider that boy, you go see homebuilders these days, they're trying to offload you homes, they're not just slashing prices, they're throwing in a ton of freebies. And with the freebies comes, you know, free dishwashers, free appliances, all sorts of other freebie type discounts that really get people into houses and get them moving. So, the, otherwise you're talking about at 9.7 percent price discount, year over year. That's pretty extreme. We also look at the, if you look at the economic numbers for GDP, GDP came in at a reported 1.6 percent. Now if you're a regular listener to the Vigilant Investor and reader, you know that we're not really all that excited about the numbers that are coming from the government, that they've been largely politicized over the last 30, 40 years. And they are subject to some rigging, they overstate things to the good side, or understate them if the case may be. We had John William on just a few weeks back, he was on, I think it was the 11th, yeah, the 11th of October, you can download it or stream it yourself if you want to listen to the past episode. But John Williams is of shadowstats.com, Shadow Government Stats is the name of his group there, and what he's been doing for a lot of years is basically reconstituting things like CPI and GDP back to their original intent which was to measure you know, things like inflation more truly, things like GDP which is economic growth. But, anyway I'm getting off on a bit of a tangent there, but the overstated GDP if you will of 1.6 percent is still pretty darn low, it came in well under the expectations of most people, most economists had forecasted it to be a good bit higher than that. And even that number, that official number was overstated, there's a director of economics researcher, his name was Joe Carson, over at Alliance Bernstein L.P. limited partnership out in New York he did a post out there that was picked up by the wires, picked up by Bloomberg where he noted that a statistical anomaly coming out of the auto reporting for the past month pushed GDP ahead by, if you can imagine this seven tenths of a percent. And that is just because they had such an increase in production and that caused the annualized number to go upwards of 26 percent, well over normal. The long and short is that you're looking at an anomaly where the number would be smoothed out over the years so that basically GDP got this huge boost, so really it's coming in at about 0.9 percent GDP. And statistically that figure, according to the people who report it, the bureau of economics statistics and so forth, that number has a varying variable of about 1.25 percent above or below that figure. So you're looking at statistically something that is pretty much in recessionary territory as is stands, but it could even be a negative territory. And, according to John Williams at Shadow Stats he would put that number at negative territory already because of the overstating of growth and the understatement of CPI. But again, we take a look at the markets over the past week, and you can see that the Dow has definitely has come off of its high, it definitely in the news on Friday turned the market there a good bit and the Dow has come down pretty much steadily over the last trading day since this news came out there. But it really hasn't, you know formally corrected. Now, the correction is something we've been talking about being lurking around the corner if only because, boy, I mean the markets continue to go up and it has hit these new highs, of course the highs are really not new highs, they are actually, it's you know, if you look at returns, there's real returns verses nominal returns. The high in the Dow is a nominal return high, but if we were to adjust for real returns according to inflation, you need to have the Dow Jones Industrial hitting close to 13,800 just to get to the same place that it was at its high of 2000. In other if we were to take a look at where the Dow is today in year 2000 dollars we're looking at a Dow that is just barely under 10,000. So, all that said, the Dow hit 11,700 in 2000 with its peak back then and everybody is celebrating this great new high we've hit but really, if we were to adjust for inflation, which is one of those things that if you get into any kind of a finance 101 type course you always know that you get a return and then you have to adjust it for inflation, because inflation basically erodes whatever gain you got. So, inflation is basically erosion of your purchasing power. So, return is 10 percent, inflation is at 4 percent your real return is 6 percent, that applies to the Dow Jones as well. But in any event, the Dow has begun doing a reverse and that's something that we think people ought to be paying a lot closer attention to because of all the structural problems we talk about, pretty much on a day to day basis on Vigilant Investor. Now, I should have mentioned earlier that we have a guest interview tonight, now it was recorded earlier in the week, it's going to be Tony Cherniawski, he is of thepracticalinvestor.com. Tony has his own radio show up in the Detroit and Lansing area in Michigan and he is a little bit of a, what you call a market timer. Now, anybody who has been in investing or has read anything about investing knows that market timing is one of those things that's a four letter word in the investment community. Conventional investing says that you're supposed to basically go out and do, create yourself an asset allocation that fits your own personal style relative to your risk tolerances and you can determine what your risk tolerances are relative to others by going through things like investment questionnaires that are out there. There's tons of web sites that do this kind of thing where you can go out there and they'll ask you, you know if you lost this much money would it make you cry, if you lost that much more would you cry even more and would you sell all of your investments and bail out, that kind of thing. If you're part of a 401K in anybody's company, you've probably been through these questionnaires as part of the enrollment process. And that's generally how the investment industry works, so you go through a questionnaire, and I don't care whether you have 10 thousand dollars or you got 3 million dollars, most people out there who do what I do in private practice will basically run you through a questionnaire to determine what your risk tolerances are, what your time horizon is, how long you have to invest, they put you in this pie chart of investments and the bottom line is that's based on what's called modern portfolio theory that says on average most people can't time when the market is going to go up, when it's going to go down, the subsections of the market, it's pretty much impossible to know when stocks are going to do better than bonds, when large cap is going to do better than small cap, when value is going to do better than growth, all these different areas of investing that you can break down investments into, equities, bonds, international and so forth. Excuse me. No one really knows when anything is going to go up or down, therefore you're better off playing the averages by diversifying and having a little piece of everything in there so you just entirely sink or swim one way or the other. And the worst thing you can possibly do is try to time which one of those areas you should be in. Because on average when they've done studies most people get in to a specific investment style or category at the wrong time. And, a great example of the would have been in the late 1990's when pretty much everybody and their brother was all hoppin', excited about technology stocks. Did you know anybody who didn't have a hot technology stock tip in the late 1990's. I had a lot of people calling up, you know telling me that our portfolios weren't doing as well as they though they should be, because they talked to their buddy in the locker room after working out or after surgery at the hospital, what have you, and you know what, there's a 68 percent return I didn't get and that was just last month and you guys are only doing X percent. And you know I should be getting triple that according to my buddy who I talked to yesterday. You got a lot of those comments in the late nineties and what you ended up having, and 401Ks are a good example of this, we saw a lot of this where investors basically participants in these plans simply would forego and investment that wasn't performing the best. And rather than having a good diversification, what people would do is they would chase investment returns. The look at the funds that did the best over the last year, and they would put all of their money into those investments and then call it a day. And I'd sit down with people oftentimes and see that you know, in their retirement plan they had 2 or three investments, they were all large cap growth, mid cap growth, which primarily tended to be your technology oriented investments. And of course that was a dot com bubble, that was the tech bubble in the late 1990's, and everybody was selling and everything else and, in the late nineties, buying into those kind of things, which is pretty much the worst time to buy in, and what they were doing is functionally a form of timing the market I guess, they were getting into something they thought was exciting and of course everybody knows what happened in 2000, march of 2000 the dot coms blew up, your pets.com your little sock puppet vanished into thin air, it was vaporized by the crash, and you had soon there after all technology getting dragged down, the Nasdaq dropped about 70 percent and while initially we were told, boy that will just be confined to technology and mostly the dot.coms that bled into other areas of the market over the next two years dragging down the S&P 500, dragging down the Dow Jones and everything. To the point where 5 years later the markets have not recovered and again, we're back to the Dow Jones industrial, everybody is celebrating these new highs and hitting a break of the 11,700 and we're now over 12, 000 but, really what does that mean? In any event back to my point about what you're supposed to invest, is definitely don't go chasing returns and try to time the market that way, that's wrong. But, you know back to my point with who we're interviewing tonight which is Tony Cherniawski. Tony does market timing, that is what he does, that is basically considered by most to be completely antithetical to what you're supposed to do. You're supposed to get into your pie chart allocation, you're supposed to buy and hold for the long term, and that's what you're always supposed to do. Now, if you're a regular reader and a regular listener to the Vigilant Investor you know that may not be appropriate for all times and all situations. And of course you know never take what we're saying here as purely investment advice for you situation, everybody has their own personal needs and so forth and personal situation. But we're going to play the interview right now from earlier this week with Tony, and we're going to talk about the pros and cons maybe of market timing and maybe market timing hasn't been maligned or not as a way to go, and again it fits right into where we've been over the past boy, couple of months, we had a show earlier, I think it was in either August or maybe it was in July, probably in August where we talked about some of the problems with basic asset allocation and some of the systems that go hand and hand, so I'm not going to get into that right now, but let's, you know without further adieu let's get into this interview with Tony and you all can listen to what Tony has to say. So, here we go.
Alright we now have our guest on, Tony Cherniawski. Tony, how are you doing today?
Tony: Very well, thanks Johannes.
Well thanks for joining us, we certainly appreciate having you on board. We, Tony, you and I have been talking a good bit probably it's been the last month, month and a half, maybe a little bit longer and gotten to get a little bit of an eye opening experience on a different side of investing that I think you know, from our perspective and regular listeners to the Vigilant Investor show as well as regular readers of vigilantinvestor.com. You know at this point that we are pretty skeptical of what's going on and in the past we've definitely covered a lot about the shortcomings of generally what we call conventional investment methodology and that's modern portfolio theory, buy and hold asset allocation and generally, Tony, what we've concluded and our regular listeners and readers know is that, it's just not something that you know makes a lot of sense for all situations and all environments. Now, Tony maybe you can touch on just a little bit, what are you doing to counter, you know modern portfolio theory. Maybe you can tell me why you're not comfortable with conventional buy and hold asset allocation, buy and hold modern portfolio theory.
Tony: Very good. First of all Johannes, we have to look at history. And history has long periods of time where people made little or no money in the market. And I'll go back, even a hundred years. 1901 to 1920, the Dow started in 1900, at the end of 1900 at 71 and ended in 1920 at 72. A one point gain in 20 years. Okay, so in other words the market did not perform for people for a long period and then all of the sudden from 1921 to 28 it's up almost 600 percent. And then again, we have the crash in 29 to 32 and the market does not recover to it's 1929 high until 1956. So there's another 26 years of market not performing. And we see the same thing again, from 1956 to 1966, the market again went up very substantially over 1000 percent, and then, all the sudden in 1966 it stalls, the Dow stalled at 1000 and stayed there pretty much at or below 1000 until 1982. So another 16 years of flat market here. So the point is, there are long periods of history where the market does not perform, in fact it not only under performs, but if you get out at the wrong time, if you choose to retire for example in 1974, you would have retired at a point just after the market lost 55 percent. So, it makes no sense to buy and hold during hose periods of time. And in fact, let me just finish with the story of my uncle. I became licensed in 1981, and my uncle was one of my first prospects that I went to, and I wanted to talk so badly to him about the market, in fact I had just had a conversation with Sir John Templeton, I was very motivated at that point to get into the market that we looked at it as the bottom of the market, he had already made the prediction that the Dow was going to surpass 3000 in the next decade, and I'm talking to my uncle and my uncle who had lived through the bare market of 1966 through 82 said to me, these were his very words, "Tony, you can talk to me all you want about the market but if you do, you're going to be on the other side of the door on the front sidewalk, I won't listen." So that tells you how bad things can be, even in what is referred to as a flat, bear market. Now, playing devil's advocate here Tony, isn't the whole premise between, you know, of the people who espouse modern portfolio theory, and I always say it's kind of funny that the theory that everybody you know works with it as if it's the law of the universe, but modern portfolio theory, portfolio asset allocation, long term hold, buy and hold strategies, they say, you know look, what you're saying is all fine Tony, but how do we know when we have a 19, you know 66, or 1929, it's impossible to predict these things and, anybody who tries to time the market, timing the market is definitely a four letter word in our business among the majority of the industry, they're going to see, you know, in fact I talk to most people in our industry Tony and you know, you run into it as well, they'll give you a blank stare when you even bring this up as something that's even worth discussing, it's almost like, yeah but it doesn't matter because you can't win. How do you respond to that?
Tony: Unfortunately market timers have gotten a bad reputation, and especially the prototypical day timer who was out to make a fortune in 1999 through 2000, and basically lost it all. They were doing another version of buy and hold basically. They thought that they could find the you know, they thought they had the Midas touch, they mistook luck, you know being in the right place at the right time, for skill. Okay, so when the market turned on them, they didn't have the skills to deal with the negative part of the market. In other words, stocks go up, stocks go down. They only knew the up part and just got wiped out when stocks went down. They couldn't figure it out, they couldn't adjust. Now, part of that has to do with the herding instinct. We all want to feel comfortable together. And as a matter of fact, this is what's really odd, is that people would rather lose money together, in other words, if all of them get together and they commiserate with one another, oh I lost 25 percent, oh I could beat that, I lost 30 percent, oh I can beat that I lost 50 percent. So, in other words they're all sort of commiserating because there's comfort in a crowd as opposed to standing out from the crowd. And that is where the problem is with individuals just about across the board. It's a universal problem of herding, of feeling comfortable despite the fact that you're losing money.
But this isn't just the masses again playing devil's advocate were taught by, you know the Warren Buffetts of the world and Peter Lynch and anybody who has read their work, you know Peter Lynch of Fidelity Magellan fame accrue that to be the most popular mutual fund of the early 1990's, late 80's by its record rates of return. Their premise is, you know you only buy stocks today that you'd be happy to have 20 years from today -
Tony: Oh my gosh. Okay, let's address that. First of all, let's address Peter Lynch's record. His record, and this is public information on Fidelity Magellan. If you can go back you can get the old information and look it up yourself. The average turnover on Peter Lynch's fund was 3 hundred percent per year. Peter Lynch didn't just sit in the daisy field and watch the sun rise and set, he was actively trading. And that's something that we don't hear from Fidelity funds of from Wall Street itself. We don't hear the fact that he has been, he was very much into stock selection and trying to, and as a matter of fact, what's interesting about this is look at the time when he finally retired. He finally got to get out. In my opinion, and this was in the late 90's, he was one of the most perfect market timers when he left Fidelity. Okay, because he decided that the markets were getting too dangerous, but he couldn't say that, so what did he do? He retired. Because the markets were getting too dangerous and he would sully his own reputation by staying on. And we see that over and over again. Sir John Templeton is another example of a man who retired in the mid 90's he saw what was coming and he said, "I want to be long gone, I don't not have my name associated with what's coming next." Michael Price is another example of that. Let's go back to Warren Buffett. What people don't know about Warren buffet is that he has a very interesting history of trading the market. And one of the things that he did was back in the 60's he actually operated a partnership that invested in the market. And he dissolved that partnership in 1966 and he gave his investors back their money. Remember what I said earlier. The stock market topped in 1966. And from 1966 to 1982, we have basically what's known as a flat bear market. Warren did not go public again with Berkshire Hathaway until 1978. He was in the latter part of that bear market and he suddenly saw that there were values out there that he could invest in. And the reason why he picked Berkshire Hathaway is because it was, basically it's a now defunct carpet company, but basically it was throwing off a lot of cash value. With that cash he bough GEICO and basically he found companies that, what we would refer to as cash cows, that generate a lot of cash and that hold a lot of cash and the reason why he chose to go that route, was because then he could, he basically knew that with his skills, he could buy and sell assets and make more money doing that than what was needed to pay the claims on these insurance company policies. So Warren Buffett is another example of one of the most best market timers in the world. And one of the things that you can look at is look at his most recent annual reports to his investors. One of the things, and I'm not sure whether it was in 2006 or 2005 but I'll quote this almost verbatim, what he said was, "I am embarrassed to report that we have about 43 billion dollars in our company that is not invested," but he said, "I would be even more embarrassed to report to you that I've invested it and lost."
Right. Tying back into the, and again on that same theme when I think about it I think is was, you know, Peter Bernstein who is known as one of the you know grandfathers, or you know, founding fathers of modern asset allocation theory and so forth. And I would say it was August of 2003, he created a lot of ripples in the industry and it's something we quote a lot around our place here, he was speaking at an institutional investors conference, I think it was in New York City and boy this thing was reported when he said it in the Wall Street journal and across the media. But he started telling people he said, "you know essentially I just don't see the markets being where they were and you know, all times are not the same they're not all created equal," and I don't have the quote right in front of me but he basically went from being an asset allocation guy to actually use the words market timing saying, "there's now a, you know, environment that just merits doing something different." And that falls a lot in line with what we talked about around here, which is that all times are not even, and not equal. You just can't operate as if the averages are governing everything because you know on average, you know if you have 100 years, yeah everything works out, but like you said from 66 to 82 or from 29 to what was it, 1954 you're looking at periods there where you're well below the averages and so forth. Now, I guess one last question regarding the whole modern portfolio theory and for listeners that aren't aware, modern portfolio theory basically takes a very technical approach, almost a scientific approach, if you will, to determining, you know, there is an appropriate asset allocation for you to consider when you're investing. If you're a moderate type of investor for example, you want to balance your portfolio, your portfolio pie chart if you will between exposures of equities and fixed income and then even within those asset classes break them down maybe by large cap small cap and so forth and your bonds by long and short term and maybe a little international stock and so forth. But the bottom line is that the modern portfolio theory basically quantifies, you know, purports to quantify that you can sort of get a balance between risk and return for an investor in advance of developing that allocation. People go through questionnaires to determine that kind of stuff to fall into. Now, Tony the question I have for you with that as an introduction is nothing you haven't heard of a billion times, you know, this is fairly scientific material, this is, we've gone through studies, you know Brinson Bearborough won a Nobel prize with their asset allocation study that said, you know 92 percent of all returns are you know, to drop out of your asset allocation. I mean how do you respond to something like that?
Tony: Well, let's take a look at that. First of all, and I'll poke a few holes here one of the first things that I want to do is talk about assets being dissimilar in their behavior. And what we're finding right now is assets are all behaving alike. What we're seeing is a situation where, you know instead of bonds going down when stocks go up and stocks going up when bonds go down, we're seeing stocks and bonds rising and falling at pretty much the same intervals. So for example, recently we saw the markets, the stock market bottomed in July, the bond market bottomed in May, and their both on [...] right now, you know for the last several months. So, what we're seeing is that the correlation between these assets is getting closer and closer and closer to 100 percent. And the way that asset allocation works is that when you have the correlation among assets being zero or less than zero, so in other words if you say up and I say down, we have a negative correlation, we will mix together very well as two assets, okay? But if I say up and you say up okay, then there is no, you know there is no positive correlation, and as a result the markets are working in box step. This doesn't happen 100 percent of the time, there is a whole cyclical period where the markets will work against one another for a long time, but eventually all of these cycles kind of come together. We're seeing this in multiple assets are working in a highly correlated fashion, that's number one. What you do is you cannot reduce portfolio risks when your assets are correlated. It's like buying a little bit of stock A verses stock B, verses stock C, it doesn't matter, they're all stocks. Okay, and so the same thing here though, the bond market is now acting a lot like the stock market is acting, a lot like commodities and a lot of other things. Now, the other thing that we find is we're dealing with volatility. And back when we had, first of all let's go through a little history on bonds, because people love to have a certain percentage of their assets in bonds. In fact what the asset allocators tell you is the older you are, the more you should have in bonds. And what they don't tell you is that the higher the interest rates go, the more the volatility is. So for example, what we had in the 70's is bonds and mortgages for example in the mid 70's yielded about 5 or 6 percent, and by 1981 the yields on bonds was approaching 20 percent. There were huge losses, huge. Absolute, people with bond portfolios got devastated. But then what happened from the 80's through the 90's is that interest rates came down, volatility subsided. So what we had is a situation where bonds became, you know, began to look safer and safer and safer and people forgot that period from 1975 to 81 when bond portfolios lost 70 percent of your value.
To interrupt for a second, I think a lot of people recognized that you know, oh boy 82 to 2000 was one of the best equitable markets of all time but people seem to be nearly oblivious to the fact from 82 to 2004 was perhaps the best bond market, bondable market of all time.
Tony: Absolutely. So the two of them, and that goes right back to correlation, the two of them were very highly correlated. But what's interesting is that it's volatility subsided tremendously. And I'll get to stocks in just a moment but what we're seeing now is that we're, we may or may not be near the end of the decline in yields. And if yields start going up, volatility will rise tremendously in bonds. So, the chance of big losses in bonds is now emerging as a very real possibility. Now the same thing in stocks, but the stocks work in shorter cycles. We see what we call four year cycles in stocks. And I'm going to address that for a moment. So, for example every four years give or take a few months, so in other words the average four year cycle is about 47 months, but we've seen some 4 year cycles lasting as much as 60 months. And so, let's go back every four years, 2002 was a four-year cycle low. 1998, 1994 was one of the mildest four year cycles, but 1990 was a very, was a decent decline, about 23 percent on the Dow. Prior to that 1987, prior to that 1982. So we know we can go back over 110 years and see all of these cycles, I believe that there is 27 or 28 four-year cycles on record right now. And the market has not missed a beat, it's taken every one of those cycles and we've seen a 4 year decline, every, you know on average every 47 months. Well what that does is it sets up now, that we're in a situation where we haven't see the four year cycle low, it's now 49 months into the cycle, the average four year cycle low if you want to do the math, if we don't make the 47th month the average is about 54 months, so here we are , we're looking at possibly next spring seeing a four year cycle low. So, what's happening here is the stock market goes through periods of low volatility, roughly about 3 years at a time and then the forth year, or sometimes as little as maybe 3 or 4 months out of that 4 years, we see high volatility where the market just gets creamed. So, one of the things that we need to be aware of is that we have, investors tend to be short sited, in other words we've had three and a half years of extremely low volatility in fact, so low the average year in the market, if we go back to 1896 on the Dow, almost every year there is at least one, and in fact it's average is about 1.7 episodes of a 10 percent decline or more per year, okay, going all the way back to 1896. So, what have we seen, we've seen three years, three and a half years now where we have not had a single 10 percent decline in the market for three and a half years. So, what that means is that the market is building up for a rash of volatility here, not just a mild volatility episode, but a whole string of volatility episodes.
So in the context we'll talk a little bit about what it is that you do Tony at Practical Investor, but in the context of modern portfolio theory, it sounds like what you're saying is that, that's all fine and nice that we have these averages and everybody's worked in relative to you know, buy and hold and you know, through thick and thin and on average the masses may be wrong, but what you're saying is that there are subtrends here that if you're following them, you're paying attention to them, now they're not necessarily all just on auto pilot here, but I guess what you're saying is if you just can't be on auto pilot on anything you have to be monitoring it?
Tony: That's right, and even from one year to the next we have an annual cycle in the market. And some of you have probably heard the expression, sullen man go away. It's very well documented, going all the way back to 1950, that if you sold on May 1st and bought the market on November 1st, you would have eliminated virtually all of the volatility of the year, because the market becomes very volatile in the summer starting with May through October and usually from that point on the markets become less volatile. And so what we see here is a seasonal type of cycle as well, that happens every year, year in and year out.
Tony, you know that our firm, we do it a bit differently. You are, you would say you are in the market timing business, is that correct?
Tony: That's correct.
Okay, now we take a look at it more from a fundamental approach in our firm at Ernharth Group and what we're looking at more, the fundamental trends that we see developing and will have general plays. Now, tell us a little bit about what you're doing at Practical Investor, I mean if you were to sum up, you know what it is that you do differently, than I mean, clearly, we're not buy and hold, but how are you doing it differently relative to, is it recycled, how do you operate? It sounds like you have a good argument for all this...
Tony: Yes I do. I work on a cyclical approach and what we do is we actually break down the cycles into the most elementary form. And, so we have, we can actually map out the year, and for example earlier this year an associate of mine came out actually in January of this year and predicted that the four year cycle low was not going to fall in October as it had 7 out of the last 10 times, he expected that the four year cycle low would occur in the first quarter of 2007. That's highly unusual, but not unprecedented. We have seen for example one of the four year cycle lows occurred in 1987, and if you had tried to mark your calendar by it, you would have thought the four year cycle low was in 1986, which is wasn't. So, and the 97 crash is something that everybody has to, you know, pay attention to. So, the idea is that the market does not work in something that you can mark your calendar by, but rather there is a pattern that we can both interpret and anticipate. So, that's what we're dealing with, and then what I've done is formulated both a strategy and a set of indicators that follow the cycles. So you, there are various indicators that will follow the hourly market, the daily markets, the weekly, or even the monthly markets. What I've done is try to find the best indicators that tell me when the cycles are over, at least the major moves. And so, what I do is deal with that. And, the other thing about it is I am not enamoured with the market. So, for example right now, I'm not particularly, even though the market is making new highs, I have a lot of my invested money in cash right now because I believe that risk is elevated at this point. So, one of the things I do is I anticipate where the market is going, I also know we're nearing, we're approaching a cyclical pattern. We don't know when it's going to come but we know t that it is in this vicinity, we're in the window now, and what we want to do is anticipate, and then we also use what I refer to as bear market or inverse mutual funds to help our investors in a decline.
In other words, shorting the markets when the markets go down, you benefit from that.
Tony: That's correct.
Now, critics might say now on one hand, it sounds like you're taking the emotionality out of the equation. In other words, don't let the emotionality get in the way. One of the big, you read on most anybody who is writing about proper ways to invest will say don't let yourself get emotional because then you'll start making big mistakes. So, on one hand that's great, but when critics also say this is a little bit like reading pee wees, number one, and number two, you know if this were easy to do, or if this had any validity, why wouldn't everybody be doing it?
Tony: Well first of all Wall Street does not promote this in any way, shape or form. Part of the reason is because they want to see your fees. And your fees are only earned by them when your money is with them and they don't have the facility to do this, and in fact they don't want to do this. They would rather see the market go down 10 or 20 percent and still be collecting your fees even on a reduced amount of assets, then expending the energy and time to you know, reverse the trend so to speak. So, there is so much invested in this buy and hold idea, that they don't want to let go of it right now. And on the other hand, at the same time one of the things that you'll notice is that Wall Street at the bottom of the bear market was all you know, they were marching on saying," see I told you so, we knew this market you know, wasn't going to be a good one, we knew that there would be some losses here."
I'm also going to interject there Tony. What I saw through the 2002 environment was one that was almost really a two tiered system. And, what I mean by that is that during that period, late nineties, we were getting opportunities to take a look at what high worth individuals were having on their plate to choose from, i.e. your hedge funds back then, which were you know, you needed to show up with a minimum of a million dollars to get through the door, and that was on the low end. And, what you were seeing in there was a lot of what they call long short strategies, where they're playing not just one side of the market, which is you know, boy, the big epiphany is for me, going through the 200o to 2002 decline was that you know, all this talk of bull, bull, bull you know what, even in the face of obvious things that were incorrect and on top of it in the face of, just denial of reality, I mean every week this was the bottom, every, next quarter we'll see everything being different and these are the reasons why, and none of it added up. And on the flip side, going back to what I was seeing with these hedge funds, these larger institutional products that were not available to the retail client, the general, you know it's almost as if they're viewed as the riff-raff, riff-raff you sit there, you stay long and then, you know you do the portfolio, modern asset allocation stuff, and you know if the market drops by 28 percent, and your portfolio drops by 17 you got a victory.
Tony: Yeah, and it makes you wonder too, because one of the things that I watched and I'll not name the firm, but a very substantial brokerage firm in town that I also knew at the beginning of the bear market had a huge position in semi conductor stocks. At every little rally down, as the market is going down, they are saying buy semi conductors, buy semi conductors, this is the end of the decline, you know, you want to be in on this. And what's interesting is by the time the market had declined, this firm did not have, you know, did not own any semi conductors. When the bottom came in the semi conductor stock, what was interesting is there was a dead silence from this firm. Nothing was being said at all about whether people should buy or sell or whatever, and it turned out that these people were accumulating semi conductor stocks. So, you hit the nail on the head, and there are other people that can tell similar stories where they've actually watched things like this going on. So, it's almost as if Wall Street does not have a parallel interest with what the average investor wants to accomplish and that is to make a profit and to be able to retire with some dignity.
Definitely have concluded on our end, you know on one had I think and not to besmirch, you know people who are the retail advisors on the low level because we used to be in that group ourselves where taking pretty much the industry at its full you know level of honesty that you know what, the information you're getting and projecting onto your client base is totally on the up and then it's exactly what's correct, and what we learn throughout is that you know, the information that you're necessarily getting isn't the full picture, it is largely that Wall Street is bullish by nature. If you talk to a mutual funds chief economist, he's going to tell you up front that it's always a bullish environment, that it's time to invest today, it's the nature of the business.
Tony: As Jim Kramer says, "there's always a bull somewhere, there's always a bull market somewhere."
On one hand, the "bull market somewhere" is I think there's an opportunity always to be had even in any environment, I agree with that. But, what bothers me with coming out of Wall Street is the constant machine saying, always put money with us, always put money with us no matter what's going on and it's always a great time to invest, even in stocks, period, end of discussion. And, how many people are on auto pilot with our 401Ks 24-7, and that money is just getting invested in and in and in and boy, if your pie chart or your asset allocation had mid cap growth or large cap growth in 1998 and 1999, you might find that you had a chance to get the honest scoop coming from that funds manager or that management team, running that particular mutual fund and your 401K, they might have told you point blank that that they thought the market was over-valued, the large cap growth and mid cap growth especially were so crazily over priced that they wouldn't touch it with a 10 foot pole yet, on the other side of the room they're investing your 401K dollars that are automatically going out of your payroll and into those funds.
Tony: That's right.
And it just continues, it's a machine, and it keeps churning and churning and churning.
Tony: And, one of those things that I've done in my practice is that I've kept in touch with mutual fund managers. And, some of the mutual fund managers were doing well because they had a sense of what was going on with the market. Again, I won't mention names but just the idea that, what they would do because they were limited by their own corporate board members, they could not sell the market short for example, you know they had set up rules of the road so to speak that they could or could not do. But they would lighten up and go into cash, and sometimes I'd be talking to these people and ask them their outlook and they were saying, well I'm trying to lighten up, you know and I'm fighting with the board because the board doesn't want me to have more than 5 percent cash in my portfolio and yet I really need to lighten up. And I hear that from a lot of mutual fund managers, the fight that they have, I imagine with their conscience as well as their board as to what's the right way to go? And that's one of the reasons I think why the John Templetons and the Peter Lynchs and the Michael Prices and some of these other people actually retired at very young ages because they, not because they had burned out or worn out, it was because they didn't want to have that fight with their board members.
That's completely understandable. Maybe Tony you can tell people a little bit about the Practical Investor and how the people can reach you and so forth and give a little bit of a brochure spiel about yourself.
Tony: Very good, thanks. My web site is www.thepracticalinvestor.com. I can also be reached because I have a radio show, it's a radio show, it also links in to my web site www.advisortalk.biz, and one of the things you might particularly enjoy is the recordings, I have archives of radio shows where I interview some very prominent people in the business. And what I try to do is find those individuals who might not necessarily agree with Wall Street all the time. And that's part of my mission is to bring advice and to us a perspective that is not brought by the main stream media. So, one of the other things is I have a weekly newsletter that goes out to anyone that requests it. It's free, and you can get my view of the markets every week. And again, you can access the web site and its at contact me and just simply go into that part of the website and just let me know and furnish me with your e-mail address and we'll put you on the mailing list. So, I do appreciate that little plug.
Oh no, not a problem at all Tony, we like to always have different opinions as to what's going on out there and there's great ways to compliment the bigger picture we often say on Vigilant Investor that we try to help people connect the dots and get a broader perspective than they might have otherwise just by going through the conventional media. And I think that guests like yourself Tony are valuable for people to learn about and, yeah you'll find that there's a sense of competition out there amongst some elements of the media where they wouldn't necessarily want anybody plugging their you know, competitor's show or something like that, but I'm really finding that a lot of people come from the alternative side of the investment perspective that's not just in the conventional wisdom, are actually very excited to share this knowledge with people, because I tell you what, you're looking at, you know while, we didn't really touch on this during this interview but the bullish consensus, where is it right now Tony?
Tony: 92 percent.
Tony: And it's been that way for how many weeks now?
What's normal for the bullish consensus ordinarily?
Tony: Well, let's put it this way, this is an historic extreme. The highest bullish percent, percentage of bulls favoring the markets back in 1999 and 2000 was 87 percent, today we're at 92 percent. We have never been this high before. And what happens is when sentiment reaches this type of extreme, this is where you have to sit up and pay attention because this is where the contrarian who goes against the crowd makes the most money.
And that's definitely I think something that's important is that, everybody that goes with the sheep and the herd, the herd mentality goes with, goes where they feel most comfortable and you know, I tell you what, I mean week in and week out at the Vigilant Investor we're always talking about all these other structural problems that we find out there. And boy, I mean the economic numbers that just came through were, I don't know if you saw those Tony, but boy, I'll tell you what they came in well below consensus estimates and then I'm looking at what did they say, 1.6 percent GDP, also was also was buoyed by -
Tony: Well, two quarters of GDP below 2 percent is a recession.
Generally speaking, yes. And then to boot, we were proponents to believe that that number is rigged up politically anyway, it's probably sub zero right now. If you were to go back and calculate it without the rigging, the politicized rigging that goes on in there. But, even that aside, that number itself was boosted by about seven tenths of a percent, Tony, by sort of a statistical anomaly relative to auto production. So really, we're looking at a like a 0.9 percent GDP. And they start getting into statistical, you know the statistical reliability of the figure, you're almost indistinguishable from zero at that point because they always say you know, plus or minus a percent and a half, 2 percent, right? So, you're getting pretty close to zero.
Tony: That is an important piece of information that I didn't know.
Yeah, it's you know, yet again it could be either side of that, but you know it could be above by that same number as well, but you know, we've interviewed John Williams before from shadowstats.com and he points out a lot I think valuable things relative to the integrity of the numbers like GDP and CPI and so forth. And if you were to talk to John Williams right now and take a look at his site, you'd see that he's tracking GDP actually sub zero right now. Actually in contraction, he believes that we'd never really emerge from the dip down of recession in 2001 but rather we're getting into a deep or second leg of a recession right now. Which would make a lot of sense, you look at some of the numbers coming through here especially now that we, all we've done is create a distended housing bubble out of the stock bubble and moreover wrecked more balance sheets than ever, all across the board from you know, the government over to the consumer and in an economic environment where consumers drive about 72 percent of your economy. People better sit up and take note, especially when a lot of that consumption came through the housing bubble and so forth. So -
Tony: And what we're seeing is a lot of hot money, trying to find a home, you know trying to find an upward trend somewhere and so it's moving with a lot more speed now from one group of assets to another.
Which is, it's definitely indicative, it's classic inflationary environment if you go back and study past big inflations where, what happens is that money supply keeps getting increased, it gets moved out of the stable hands and more into the hot money hands and what you also see is that there is a total disincentive towards conventional wealth growth and what I mean by conventional wealth growth is saving, being somewhat conservative, setting the money aside and then taking that money and investing it into you know, small businesses and growing and building and manufacturing because of the uncertainty there. All the signals start getting racked that most people, the entrepreneurs start [...] questioning whether they want to expand with that new money and instead they start putting that new money to more speculative purposes and if you study any of the big inflations and the really bad ones, money gets out of business growth and it goes into speculation and boy it starts moving around and that's really when you start getting the big signs of inflation and so forth. But, Tony we've gone on for about 40 minutes here, and probably out to be wrapping up at this point. I certainly appreciate you're time and everything. Any final comments on where you see, you already touched on it but if you were going to call where the market's going to go over the next you know 6 weeks, 6 months and so forth, thoughts on that?
Tony: Well, first of all, I can't tell you the day or the hour, but what I can say is that we are at the edge of something right here that could be bigger than a lot of people can imagine. And so, my suggestion to investors is lighten up, find a way to be safe with your money and let's not worry about return on but let's worry about return of your assets at this point. The other thing to do is to find somebody that understands and has been successful in prior bear markets. And if you can do that, what you have is you've got a gold mine. Because these are the people will help, not just survive, but prosper during a bear market and there are a number of people out there, so I can't claim to be the sole provider, but there are numbers of very fine individuals out there who can provide investment advice for a bear market.
Well, Tony I certainly appreciate your time thanks for being on, and maybe we can check in with you a couple weeks, couple months down the road and see how things are going.
Tony: I look forward to it.
Alright, thanks Tony, you take care.
Tony: Bye bye.
Alright, that again was Tony Cherniawski of The Practical Investor and interesting stuff there. It's a lot more to it than meets the eye, certainly in this environment when everybody is told, just [...] you know, be loyal to your asset allocations, buy into it and hold with it and stick through it thick and thin no matter what happens, it all works out in the end, well maybe that's not exclusively the answer and, you know clearly I don't think Tony's providing any guarantees that you know, people can be right on every exact situation, but by all means, we don't believe here at Vigilant Investor that all environments are the same and that we should be on auto pilot regardless of what's happening. And I think the bond example is a great example where you know why would you want to be you know, loaded up on tons of bonds in the lowest interest rate environment in 50 years, when historically interest rates average much higher, and in a rising interest rate environment, you're going to get killed with holding bonds, and yeah you may want to hold them to maturity but in the end if interest rates are up at 10 percent and you're holding a 5 percent or something has changed in the economy there that makes you want to rethink maybe having held them in the first place, but in any event, likely in an inflationary situation, which is one of the things that we're predicting around here, we think that based on what's going on in the economy over the last 30 years building up and you look at what's going on in the government, and what goes on at the Federal Reserve, inflation is coming around the bend. And, moreover, I think Tony's prediction, or his warning to be a little bit careful right now in this environment. Boy, there's so many people out there just complacently moving along as if there's nothing to be concerned about and I think that boy you know again, no guarantees but we're pretty far out in the limb in my estimation. But in any event, hey we've gone a full hour again here on the Vigilant Investor, and again I thank everybody for tuning on in. Again, we're on every Wednesday night, 9PM. And you know, contemplating doing the show more frequently, and perhaps even you know dramatically shorter, in tinier bites during the week, rather than just the full hour show only so that it gives all the people opportunity to get maybe smaller doses and, on a daily basis or something along those lines. But we'll kick that around. You can always, always, always contact us through vigilantinvestor.com, we have all sorts of ways that you can send us e-mail, and we welcome that, we will respond to it on air if you do that. But again, the Vigilant Investor, 9PM every Wednesday night, Eastern Time, and we're available at vigilantinvestor.com where you can go to our link through there to talkshoe.com and subscribe to us via iTunes and all sorts of other great Podcast equipment and so forth. But, I want to thank Tony Cherniawski again for being our guest this week. Next week, we're going to have Doug Wakefield on the show. And I believe if not that week the following week we're also going to be having, G. Edward Griffin, rescheduled from a few weeks back, he is the author of a great book, on of the most eye opening books I've ever read in my life, and that is The Creature From Jekyll Island which exposes readers to a little bit of the behind the scenes, what goes on with the Federal Reserve, central banking and the history of it which is crucial. And if you don't understand history, the saying goes, you're doomed to repeat it, and most people, boy they are repeating it left and right making all the mistakes that have happened a thousand times. But, hey, that's it for the show today, take care, hope you enjoyed. Good night.