Discounting the Media Machine and Advanced Fad Avoidance

You may be tempted to ignore the media altogether since what you hear or read is likely wrong or already discounted into current prices. There is some rationality to that view, but it’s wrong. By all means, don’t avoid mass media—it’s your friend and ally on your quest to invest by knowing what others don’t. The media is a discounting machine—you must read (watch, listen to) the media to know what everyone else is focused on so you know exactly what you can ignore and look away from to focus elsewhere.

Whatever they’re fretting, you likely needn’t because they’re doing it for you—a service—and you don’t even have to pay them for it. Such a simple concept is very hard for tribal-oriented humans to get. But anyone can train themselves to do it.

For example, I’ve already told you the collective histrionics regarding the so-called budget and trade deficits are typically misguided. You may not believe it, but I’ve told you. You also know pretty much everyone misinterprets high P/Es. (We debunk more ubiquitous myths in later chapters, but you get the idea.) Paying attention to what the media covers and consequently discarding what is irrelevant will prevent you from being trampled by herd mentality and let you begin fathoming new paths.

Avoiding being trampled by the herd sounds easy enough—look where they are stampeding and get the heck out of the way. However, if it were easy, it wouldn’t be called “herd mentality.” It would be called “calm, noncompelling, no pressure here, join us as we run over this cliff if you please, if not, no problem” mentality. Remember when your mom asked if you’d jump off a bridge just because cool-kid Jimmy did it? Of course you wouldn’t jump, but you might buy small-cap stocks at the wrong time if your poker group pokes enough fun at you for not having done it when they did.

My March 1995 Forbes column, “Advanced Fad Avoidance,” described how best to avoid getting swept away with the herd. It’s still good advice, so I’ll repeat the four steps to fad avoidance here:

Still very true. And lots of people think I’m nuts. It’s ok if people think you’re nuts. It doesn’t hurt. With the evolution of the Internet and blogs, I’ve become used to people reading my articles and columns and writing scathing criticisms of me. (Of course, sometimes they’re right, and that would be when I’m wrong, but either way, what they think of me isn’t any of my business.) I’ve trained myself to ignore what anyone who I don’t already know very well thinks about me or my work. If my wife is upset at me, I take it seriously. She knows me and my strengths and weaknesses and desires my well-being. Family, friends, associates! Other than that, if you’re upset at me and don’t like something I’ve said, feel free to criticize, but know you will run into an emotional desert. You can train yourself to have that same emotional desert, too. What most people think about you is none of your business; and if they think you’re nuts, it might be good.

Even more true today. The Internet has multiplied the venues and speed at which news travels. Now everything moves faster and gets discounted into pricing faster. Compounding the discounting speed, which has been increasing for decades, traders trade 24 hours a day, fully five and a half days a week around the globe. It used to be evening news didn’t sneak up on you until morning. Now, not only does news move across the Internet at night, but someone somewhere is trading extensively while you snooze.

Every year’s hot fear is likely obsolete the next year. It’s the new thing no one expected that has the herd stampeding around your village, not last year’s noise. To think better about this—take any issue and consider when you first heard about it. The older it is, the more certain it won’t affect you much. The older it is, the more certain everyone has had multiple opportunities to discount the price fully. Here is the best single example I can remember. Recall people expected all computers to break down on January 1, 2000, because of a supposed widespread glitch in everyone’s software. The Y2K scare was ubiquitous, and in the fall of 1999, it scared lots of folks out of stocks. I devoted my October 18, 1999, Forbes column, entitled “Greater Fools,” to why Y2K wouldn’t hurt stocks. I said then: “Y2K is the most widely hyped ‘disaster’ in modern history. It is well documented: The only folks who aren’t familiar with it are in the upper Amazon basins, rapidly fleeing the rest of humanity. I need not define Y2K for you to know exactly what I’m referencing. My July 6, 1998, column detailed why Y2K could not hurt the stock market.” Because it was an old argument and well discounted, the S&P 500 in 1999 had a back-end rise during the supposed crisis with a total return for the year of 21%.1 Using this simple rule, anyone could have known Y2K wouldn’t bite. Fear of Y2K was bullish. But few knew because they couldn’t get themselves to embrace the rule. (If you care to read my two Y2K columns, they are in Appendixes B and C.)

Still true—though the actual number of years matters less. Things can be hot for a long time, but they won’t be hot forever. And yet, investors still fall prey to this one. Energy in 1980. Tech in 2000. You can play this game endlessly. That they were hot in the last five doesn’t mean they will be the coldest in the next five or even necessarily cold at all, but no category stays hot forever. And if one did one day, it would be a double warning to seek safer and higher future returning turf elsewhere.

Follow these four steps whenever you are presented with an investment decision, and you’ll be better armed to ignore the noise and see what others find unseeable.

Investment Professionals—Professional Discounters

Another great source of discounted information are investment professionals—stockbrokers, financial planners, CPAs, CFAs, etc. Precious few have access to any information their peers or even a client with a fast modem doesn’t have. Whatever they focus on, you shouldn’t waste time on. If they’re writing about it, focus elsewhere.

Universities teach largely the same curriculum to their students in finance and economics. They’re teaching pretty much from the same playbook. They’re supposed to. The textbooks, methodologies and theories taught are widely available; they contain little many tens of thousands of others can’t read, learn and thereby discount into markets. Decades of students have learned all this and been trained to think in these ways with the curriculum as their guide. It is basic to the craft.

Every bit of what is taught is known by so many people that the curriculum, while fine, offers nothing others don’t know. It offers nothing as a way to process information that isn’t already in prices by the actions of the very large number of market participants who use the curriculum as the glasses through which they see the world. It’s the way they were taught to see the world. Hence, it’s in pricing. One very hard fact for craftsmen to accept is the curriculum itself is widely known and, hence, discounted into pricing.

There is nothing wrong with learning it, but it doesn’t teach you something others don’t know. If professionals as a group have the same education, look at the same information and interpret it largely the same way, where is their edge? What unique information do they think they have? The answer is most often: none. This is why, along with the media, professionals are useful in figuring out what information is priced and can be safely set aside.

Friends Don’t Let Friends Be Contrarians

The media is generally wrong. Professionals likely don’t have an edge because they’re looking at the same widely known information everyone else has. Following the herd is fraught with peril. Does this mean you should do the exact opposite of what you hear from pundits and professionals? Should you become a classic contrarian?

Absolutely not. No, no and no!

I’m frequently called a contrarian. But I’m not—not as that term is generally used. Of course, I’ve been called far worse and will be, but the contrarian label happens to be wrong. Contrarianism has become increasingly popular in recent decades, rendering it priced by the market just as much as the consensus view. We are all contrarians now and none of us are. Being contrarian will get you about as far in the long term as being wholly influenced in your investment decisions by the New York Times and the nightly news.

The word contrarian implies going against the crowd—if folks are bullish, a classic contrarian becomes bearish, and vice versa. If everyone thinks electing a given politician is good for stocks, the contrarian sees it as bad. Technically, a contrarian correctly knows what everyone assumes will happen likely won’t but wrongly assumes the exact reverse will happen.

Let’s wade further into this. The market is a pretty efficient discounter of all known information, so, as we stated multiple times, if people tend to agree something will happen to markets, it typically won’t—something else likely happens instead. But that doesn’t mean the something else that happens is the exact reverse.

Suppose most folks agree the market will go up. That doesn’t mean it will go down. It might, but it might also go nowhere, which would also make everyone wrong. Or it might go up, but a lot more than anyone expects. That, too, would make everyone wrong. Over history, all those things have happened and in about equal proportions.

If you’re a classic contrarian and correctly see most folks agree the market will go up, so you bet it will go down, and then it goes up but much more than most folks expected, you end up the most wrong guy in town. Being a contrarian is better than betting with the crowd, but not much and will still have you being right something on the shy side of one time in three.

Think of this like a compass. The consensus thinks the market will go north. Contrarians think it will go south. But it could just as well go east or west—or northeast or southwest—making the crowd wrong and the contrarians wrong and the discounting mechanism work. Because those other outcomes are less expected than the contrarian position, they actually happen more often.

The key is to remember something else typically happens than what the consensus expects, but not necessarily the reverse. True contrarians these days aren’t much more right than consensus followers. It is surprise that shifts demand, which drives prices. The problem is the surprise could come from any direction.

Patterns, Patterns Everywhere

To know something others don’t, you must focus away from the noise. Ask what you can come to know that others can’t. But how can you know about a thing you don’t know?

There are patterns to be discovered everywhere. Granted, many are simply meaningless. But there is so much out there we haven’t discovered yet, people will make new capital markets discoveries for many decades to come. There is no reason you shouldn’t find your share. If you seek them out, there are many patterns you can discover on your own before the rest of the investing world becomes aware. And there is your edge—your basis for a market bet.

Essentially, you seek one of two things when asking Question Two. First, you want a pattern—some sort of correlation—between two or more variables people generally think are wholly unrelated. Second, you’re looking for a pattern many people see but disregard, deride or misinterpret. We show you two such examples here (and more in later chapters).