Paul Winkler: And welcome. This is “The Investor Coaching Show.”
I’m Paul Winkler, talking money and investing, retirement planning.
Understanding the investing process is important simply just because then it takes you away from blind trust of the investing community.
Blind trust is not a good thing. It doesn’t work.
Just watching financial programs in the mornings almost every day, I am struck by how the industry just doesn’t seem to get it. The media doesn’t seem to get it.
The industry isn’t getting any better. They’re getting worse.
If they’re doing anything, they’re getting worse, is what I’m finding.
They’re not getting any better because there’s no incentive to get better. Why would you get better if you can make lots of money not being better?
And I thought a lot about this.
I was listening to some commercials and listening to interviews with people that were talking about, “Here’s kind of what we’re doing. Here’s how we’re preparing for what’s going on.”
And I can just imagine being an investor out there listening intently to how they’re preparing for what’s coming: what’s going to be down the pike as far as how inflation is affecting markets and how inflation is likely to affect markets, where people are going to get goods for making batteries and for cars that maybe we seem to be ahead of ourselves with this whole thing.
Unpredictability With Sourcing From Outside the U.S.
We want to have this car that runs on a battery, but the problem is where we get the metals. And then you’ve got the bread basket of Europe under attack from Russia.
And you have the suppliers of metals for these batteries, and it’s all outside the U.S.
This one guy was just lamenting the idea. He’s like, “What is it with us? It’s all outside the United States.”
And I’m listening to them and I’m thinking—if I’m an investor, I’m thinking, Wow, this is really pretty scary.
We’re going down this road where we’re going to have to have these metals to make the batteries for the cars that people are buying, and we have to get them outside of the United States.
And there’s a lot of political upheaval in other areas around the world. And we’re not necessarily on the most friendly of terms.
I mean, when you have some countries actually mocking our political system, and then you go, “Well, where does this all end? How does this end?”
And you can only imagine how scary that has to be for an investor. That’s me, thinking, I can only imagine how scary this must be.
And thinking the whole time, if this is really a roadblock and this really becomes a roadblock, how long before our political process says, “Hey, look. The folks in charge, you’re not in charge anymore. You don’t get to call the shots because this isn’t working.”
Should the Government Intervene?
The beauty of it is that I’ve been doing this long enough, and a lot of you listening have been on the planet long enough to notice that nothing lasts forever.
That when we get sick and tired of things as they are, the status quo, and when we get sick and tired of just sitting there watching politicians banter back and forth on things, and when we see Washington trying to push the agenda as far as what is the technology that is going to drive us forward—
And they don’t have a clue.
We talk about—I remember there was a couple of guys that were actually talking back and forth and going, “The government needs to help out.”
And they’re like, “Well, they don’t have an idea.”
But he says, “Yeah, they can get involved to some extent.”
They were talking about the computer world and how there was a need to have the government coordinate an internet so that we could actually make the computer industry work.
And how do we coordinate with electric vehicles and the metals needed? There are certain things they can do and certain things that they can’t do.
And what I find—
And this one guy is just talking about how—he says, “Hey, look, here’s something I did years ago.
“I actually set my vehicle up to not only run on gas, but on natural gas. Pretty doggone clean compared to anything else out there.”
And he says back and forth. He says “You can go watch a YouTube video. I got a YouTube video out there on how you do this.
“Go back and forth. And it’s basically a dual operating system in my vehicle where I can go back and forth between either one of these fuel sources.”
I’m thinking, Hey, look.Here’s a guy that’s just a commentator on a financial channel that’s kind of maybe a little bit nerdy and getting down and dirty and working on his vehicle and coming up with something like that.
But that to me is a possible solution. Maybe something like that.
Maybe it’s other fuel sources down the road, but something tells me that we’re going to figure out something that actually solves the problem, and then it’s not going to be a problem anymore.
And yet all of these financial companies out there are going, “We’re going to tell you how to prepare for what’s coming!”
And all I can help but think is, How the heck do you know what’s coming?How do you know what somebody’s working on?
Investment Firms Can’t Predict the Future
Here’s a guy on a financial channel coming up with a pretty decent solution on how to run a vehicle on a source other than gasoline.
And he said, “I’ll show you how to do it in just a couple minutes. You can do this, and you too can be operating your car on two different fuel sources.”
And I’m thinking, Okay, you got a guy that’s just a commentator …
And he’s a sharp guy. He’s a commentator on a financial channel.
What is somebody doing inside of their garage that is going to be the solution that—I’m sorry, but you may be really smart about how a stock works and how a bond works, but being smart about that and being smart about how to predict the future and what’s going to happen in the future, those are two totally different things.
I don’t see how you do it.
And you know what? The evidence is that you can’t do it either.
And this is a huge firm. Like one of the biggest, absolute biggest out there, and the media people are going, “What do you think’s going to happen?”
Then they say, “Well, here’s a problem with your belief system.”
And I’m going, yeah, this makes good TV. But as an investor sitting there watching this, I can only think, This is really, really confusing.
And the problem comes down to belief about how markets work. It’s really what it gets down to.
And the crystal ball type of thing.
“I got a crystal ball. I can tell you what’s going to happen in the future, and where things are going to go, and what you ought to do to prepare.”
Financial Incentives Mean Every Firm Wants to Get It Right
And the problem is that everybody wants that. And because everybody wants it, and there’s a financial incentive with getting it right, nobody can get it right.
So when I have a financial incentive—think about it.
When you have a financial incentive—somebody’s paying you, or you could be paid a tremendous amount of money for getting something right—you’re going to be as diligent as you possibly can be. Turn over every rock that you possibly can.
And that’s exactly what Wall Street firms do on a day-to-day basis.
If you recognize how stocks are traded, you’ll understand why this is such an important concept to get.
When I buy a stock, I am buying it off of a market maker. And think of market makers as being entities that hold inventories in something.
So they hold an inventory to make a market for it so that I can buy it, just as a grocery store makes a market for milk.
And so what they do is they buy it from dairy farmers, and there are all kinds of dairy farmers out there, and they’re all over the country.
And whoever will sell it to them for a reasonable price—and the lowest price being preferable. There are other aspects to it than just having the lowest price, but that’s a big one.
Whoever can get—because milk is milk, so that’s what I want.
I want milk, and if dairy farmer A is going to give it to me for cheaper than dairy farmer B, then by all means I’m going to dairy farmer A to get the milk.
Then I’m going to mark it up, and I’m going to sell it in my grocery store.
And if somebody else comes back and says, “Hey, you know what? We’re a little bit closer logistically to you.
“Our shipping costs aren’t going to be as high because we’ve got a farm that’s closer to you. And we’re pretty good at cutting our costs on our farm, so we can cut our costs to what we sell you the milk for.”
Then by all means the grocery store’s going to switch to that. It’s the same thing with market makers.
You have market makers that make a market for particular stocks or a particular company’s stocks, ownership of those companies.
And they will go and try to get, procure, whatever inventory they need of that stock as cheaply as they possibly can.
And so what happens is they will research, like crazy, the marketplace.
And then what they will do is they’ll try to get it as cheap as they possibly can because they got to mark it up when they sell it to the next person. And if they’re higher than anybody else, any of their other competitors, then they’re not going to be able to sell their stock now.
So that’s what happens. And especially, this can be particularly important when you’re dealing with smaller companies or stocks that are more thinly traded because there’s not as much of them being sold on a day-to-day basis.
So little cost differences can make the world of difference as to whether you end up with the deal or not.
How News Affects the Market
So you got these market makers, and they study it like crazy. And then you’ve got the buyers, and a lot of them are institutional buyers.
So you’re looking at huge mutual fund companies that are in major competition with each other from not only an expense standpoint, but getting business and getting customers.
So they have to try to keep their expenses as low as they possibly can when they buy and sell stocks. And they don’t want to pay too much for them when they buy them.
And they don’t want to sell them for too little because if they sell them for too low of a cost, their returns are going to be lower than their competitors’. So there’s another financial incentive to get this doggone thing right.
So what happens is that these buyers and sellers come together, and the price that is paid is right as best you can tell.
So when news comes out, you’ll see—and when you watch stock market charts, and if you watch TV, you’ll notice something really interesting.
Now, if you step back and you look at the stock market chart from a long ways away, you see this general trend up from the bottom left-hand corner up to the right. So the market moves up.
But the closer that you move in, and you move in and you look at a year, and you see that you got these jagged—when you look at five years, you see these jagged lines.
Then you look at three years, and you see the jagged lines are more—if you’re only looking at a three-year period, they’re more pronounced.
If you’re only looking at a one-year period, they’re even more pronounced. And if you look at one month, it’s all over the place, and you go, “Good grief, no rhyme or reason.”
And if you look at one day, it may be very jagged, will be very jagged within a day because trades are taking place all day long for those companies.
And it may be down, it may be up, but it looks ugly if it’s down. And it looks pretty, and we love it and all that stuff, when it’s up.
But here’s what happens.
If you look at a stock or any companies, when news comes out—especially the companies that are involved. Now, the overall market may be moved by news on a particular company.
But if you look at a particular company, and news comes out about them, you will see that it is not jagged.
It moves, and then it goes straight up to the new price if the news is good. Or straight down if the news is bad, and then the stock price moves; whatever it’s going to do.
And it’ll start little jagged movements like a saw blade or something like that. Just imagine a saw blade: up, down, up, down, up, down, just little movements, back and forth in a range.
But you’ll have these huge movements when the news comes out. And that is because when that news comes out, both the buyers and sellers are privy to that information.
And this is the challenge of it is this information. All of the news gets built in right away.
And then you have people talking about whisper numbers, which makes it even more complicated. And a whisper number is, in essence, where people are going, “Well, we think that this might be what’s going to happen.”
They whisper. What might be down the pike or what might be going on down the road?
And then that information gets built in. Now, not as pronounced.
When you see news that’s definite news—it has come out, and it is absolutely out there, and this is what’s going on—you’ll see huge jumps or huge drops right away in a particular stock’s price.
Information Is Already Built Into the Stock Price
So what happens is that information gets built in because what we’re doing when we buy a stock is we are paying the present value of all future earnings.
If those future earnings look like they’re going to be higher than what we previously thought they were going to be, then current owners of that stock are going to say, “I need a higher price to forgo those earnings into the future. You’re not getting the stock off of me because I’m giving up those earnings,” and vice versa.
So when news comes out, it gets digested in there. And this is where it gets really challenging.
Because what I may be tempted to do is, after something goes down in value, I might be tempted to sell because I’m thinking, Oh, maybe future information’s going to be even worse.
Because I’m going to hear what made it go down. I’m going to hear somebody coming on the news telling me, “Stocks are down precipitously and the reason is because of upcoming inflation.”
Well, what tells me that it’s going to go down further than where it is right now, even further down? That it’s upcoming inflation?
But what people don’t recognize so often is that the upcoming inflation is already built into it.
So if the inflation is really, really bad, and it’s exactly as bad as they thought it was going to be, the stock price will be unaffected because that got built into the price today.
And what was expected got built in because, remember, it’s the present value of future information that gets brought into stock prices.
Now, if the information comes out, and we say, “Wow, inflation’s really, like, terrible, terrible, terrible, terrible,” and then inflation comes out maybe not quite as terrible as what people thought it was going to be, then what happens is then the stock price jumps.
Now, regardless, if things come out exactly the way we think they’re going to come out, there is a cost to use your money that gets built in. So typically, stocks go up.
Even if we’re exactly right—it’s bad information, bad news, and that information gets built in—what ends up happening is stocks typically go up over time.
But rarely do you ever see that anybody ever gets it dead-on right.
How Often Can We Guess Returns?
So hence, if you go back in history and look all the way back to the 1920s till today, we can say, “Hey, stocks, historic return of large companies, about 10. How many years was the actual return 10?”
Well, actually there were a couple years that it was pretty doggone close, like maybe 10.2.
Now, if we look at small companies, now you got more risk there. There’s more room for error now because there’s more risk, which is room for error.
So if we look at that, we go, “Well, what was the average return of small companies?” It was about 12.
Well, how many years was it 12? Well, the answer is never.
And if you look at it and say, “Well, how close have we ever come in guessing this?” And the year was, like, 1951.
We came pretty close. 14% return. The expected was 12%, but that’s as close as we came.
And you look at it and go, “Well, wait a minute. What happened?”
Well, nobody can figure it out. There are too many stinking moving parts, the number of moving parts that actually go into figuring out what a company’s profitability is going to be.
What Factors Into Profitability?
And you look at it and go, “What are they?”
Well, you got interest payments, you’ve got taxes, you’ve got innovation, you’ve got competition. You’ve got pricing of inputs to the products that we have, what interest rates that they earn on money that’s sitting on the sidelines.
You’ve got decisions being made by the CEOs of the companies and people in the board of directors, and new ideas that come in that, all of a sudden, man, they change the trajectory of the company because that new idea is going to be hugely profitable or it’s going to be a lousy idea, either way.
You can have—companies will maybe reorganize, or maybe a buyout, or a company comes in and says, “Hey, what we’re going to do is we’re going to buy you guys out. And then we don’t have to put money into setting up a service that does what somebody’s already doing out there.”
And that company has a huge marketing presence. A huge company comes in that has deep pockets for marketing a beautiful idea.
And they come in and buy a small company. And all of a sudden that small company shoots up the roof.
It goes way up. Why?
Because all of a sudden, the one problem that they had—which was scaling the idea that they’ve got, which is a great idea, let’s say—is solved.
And hence, this information is something that you just don’t know until it happens.
And if it is known—let’s say somebody knows, “Hey, we’re going to go do this,” and they act on it, insider trading.
Then what happens is you have the Securities and Exchange Commission comes in and goes, “Hey, this stock made a really, really big move. Oh, isn’t it interesting that this person, this person, and this person bought it just before it made that really big move?”
Or sold it or shorted it or whatever.
And then they investigate them for insider activity, and they end up not necessarily where they want to be. Maybe “three hots and a cot.”
So there’s so much that makes this such a hard thing to do. And hence, that’s why markets are so hard to predict and so hard to understand.
And that’s why trying to do that, and listening to these investment firms that are falling over themselves to tell you what’s going to happen in the future—
And 20 years ago when I started this radio show, you wouldn’t have been able to get me to believe that companies would still be doing this junk 20 years later.
And yet they are. It’s rampant.
And it is by far the most common way of managing money out there, bar none, which to me is mind-boggling. But hence, it gets us job security.
I’m Paul Winkler. You’re listening to “The Investor Coaching Show,” Super Talk 99.7 WTN.
I’ll be back right after this. Stay tuned.
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