Monday, April 19, 2010

Three Questions

We have spent ZERO dollars for magazines due to websites like moneysavingmom.com and others. We also have a bunch of airline miles from our days of traveling to China and back so instead of cashing in on it for plane tickets, we've been getting a bunch of magazines. I guess it's kinda like an even trade? Maybe not.

Anyways, for the past year I've been getting Forbes magazine (last issue ending in April) but my wife got me The Economist in its place... I just got my first issue today.

Forbes has a column called "Portfolio Strategy" by Ken Fisher.

In each article he suggests a few stock tips as well as evaluation of past picks and other current events. Recently I read one of his books.

As a money manager, his job is to find the best investment for people's money. His book "The Only Three Questions that Count" he asks the following three questions:

1. What do you believe that is actually false?
2. What can you fathom that others find unfathomable?
3. What the heck is my brain doing to blindside me now?

In looking at investing as a science and not a craft, one is able to test a hypothesis and avoid the trap of doing things that may or may not be adequate for evaluating stocks.

What do you believe that is actually false?

In the Intelligent Investor we saw how Ben Graham used P/E to help determine valuation for stocks. That teaching was made over 50 years ago so Fisher points out that P/E has already been valued in the current price of a stock. All news that comes changes the value of the stock, all information that is public is valued.

He goes through stuff that we believe is actually false including correlation without causation, P/E, what we believe concerning deficit and debt, etc.

What can we fathom what others find unfathomable?

The example he used in finding different correlations with causations, like inverting P/E into E/P and looking at yield curves affecting value vs growth stocks (Fig 2.6, page 67), and presidential term cycle (Table 2.3 and 2.4, page 73).

From 1925 to the present, the stock market had largely positive returns during the president's 3rd year and has largely been positive during a president's second term. The rationale goes something like this: the stock market is volatile because of unknowns. New presidents always have different agendas which causes unknowns and volatility. By the third year, congress, legislation and new initiatives have already been accounted for built into the price and market risk is decreased with increased information.

What the heck is my brain doing to blindside me?

Fisher points out how our brain likes to follow a trend. if stocks are going up, we think it's safe and we buy into things... trends leads to bubbles. On the other hand, when stocks fall, our natural instincts are to get out and be safe, but ideally, we would buy when stocks are cheaper. This section talks a lot about psychology and how the human brain works or how it deceives us, very similar to how Ben Graham discussed in the Investor.

So what does Ken Fisher advise in selecting stocks?

We'll look at it in part 2 of this series.

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