Another mega-trend is the shifting demographic of the United States-we are becoming a browner country. (See Table 5.2.) More immigrants are coming from Latin America, and those immigrants are having more children per capita than previous immigrants. The percentage of Asians is rising rapidly as well. And even if we go into a prolonged economic slump, these demographic shifts won"t alter much.
A third mega-trend is the rise not just of Pacific Rim nations but also of their consumers, led by China. Even if the United States can"t get its act together to sell into that market, China is probably going to be ascendant at least for the early part of this century. And that means, at least for the next decade or so, Chinese consumers will be competing with first-world citizens for scarce resources. Indian consumers will also be bidding for finished goods and therefore driving up natural resources. A prolonged economic slump will have a different effect on those countries than on developed countries. For example, in China, most of the new cars sold go to first-time buyers. In the United States, most cars are replacement vehicles-so when hard times. .h.i.t, Americans are more p.r.o.ne to hold on to their old cars and not buy new ones.
Table 5.2 American Workforce Projections Source: Bureau of Census.
There are funds you can buy that specialize in Chinese stocks, Indian stocks, and/or pan-Asian stocks. If you believe in this mega - trend, and you are a buy-and-hold investor, you might want to add one of those funds to your portfolio.
These are some less obvious mega-trends.
There is the Commodity Super Cycle that I talked about earlier. When discussing the best U.S. stocks and international stocks, I tend to favor natural resource stocks-simply because, along with the cyclical forces that should drive copper, oil, and other commodity prices higher, the world is running low on some important natural resources.
Figure 5.2, from a senior research scientist at TNO Defense, Security and Safety in the Netherlands, shows global supplies of common minerals projected using recent extraction rates. There is less than a 20-year supply of strontium, silver, antimony, gold, zinc, a.r.s.enic, tin, indium, zirconium, and lead. This is in addition to the looming crisis in crude oil.
Sure, we can find new supplies of these resources. But that takes time, energy, and money-and our civilization could face shortages of all three going forward.
Figure 5.2 Years Remaining of Vital Minerals at 2% Annual Primary Growth Source: Andre Diederen, writing for The Oil Drum Europe, May 4, 2009.
However, you shouldn"t limit yourself to just natural resources. Sometimes technology is a better investment, sometimes banks (!) are a better investment. After one bubble bursts, another eventually arises-if history is any guide-not in the investment that was the center of the previous bubble. The implosion of the Tulip Mania in Holland and the South Seas bubble were not followed by reinflation of tulip prices or shares of the South Seas Company stock.
Likewise, after the dot-com bubble burst, the Nasdaq didn "t reflate. There are stocks from the dot-com daze that are far from their old highs, and will likely never see them again. And some-Pets.com comes to mind-disappear forever.
Mega-trends hold a great deal of profit potential for long-term investors. But you have to be able to stomach risk and ride the market"s roller coaster without throwing up.
If your investment style is more short-term oriented, consider the following.
Investment Risk Level #3-Riding the Market"s Waves
Eighty percent of market movements are due to trends and most of the other 20% is due to cycles. If you"re quick, have a stomach for volatility, know when to cut your losses and take gains, you can ride investment cycles, or waves.
I think we"ll see investment waves going forward. A crisis or series of crises will come to a head and send markets crashing. The government will respond by turning on the fire hoses of money and sending broad markets higher. Global demand for commodities will likely ramp up the stocks of hard a.s.set companies, but then the bubble will burst again and send prices spiraling downward.
Remember, recessions begin at the peak of economic activity when all economic data looks its best. On the flip side, things always look worst at the bottom. And thanks to the Central Banks and their fire hoses of money, when economic strength starts to build, the surge can come with the power and swiftness of a tidal wave.
In an economic crisis, we can see waves up and down like a storm-tossed sea. For example, from 1929 to 1933, we saw a ma.s.sive cram-down in the Dow Jones Industrial Average, with declines of 45.4%, 49.4%, and 54.9%. But in the same market, we also saw big rallies of 39.3%, 52.2%, and even 100.7%! (See Table 5.3.) Table 5.3 1929 to 1933 Dow Jones Industrial Rally and Decline One of those rallies-from October 1929 to April 1930-lasted five months and racked up a 52.2% gain. And that was before the Depression really got rolling.
To see a detailed chart of these rallies, go to If you want to sit out the market "s spastic dance, I don"t blame you, not one bit. But if you want to try and ride these waves, you can make some serious money.
Six Things Every Investor Must Know About the Stock Market
There are a few things you should know about the stock market before you decide how you want to invest.
Don"t obsess about catching the market "s tops and bottoms. As Frank Holmes of U.S. Global Investors is fond of saying, the best place to pick real tops and nice bottoms is on Miami"s South Beach. In the market, eh-it"s a bit more difficult.
So traders fall back on other indicators-price action, volume action, momentum indicators, moving averages, and more. For example, depending on your time frame, a simple short-term moving average can tell you when to get in and when to get out. Many technical a.n.a.lysts use daily charts like the 20-day moving average-if it"s trending up and your stock or fund is above it, that"s a good time to buy. If the 20-day moving average is going down, and your stock or fund is below it, that"s a time to sell.
But that"s just one way of judging the market. There are hundreds of others, as well as proprietary buying and selling programs, and they all have one thing in common-none of them work all the time. I think if you can find a buy-and-sell indicator that consistently works more than 60% of the time, you"re ahead of the game.
Be flexible. My hard-and-fast rule is not to have any hard-and-fast rules. The market is changing all the time. What worked yesterday won"t work tomorrow. That"s a very scary thing if you"re not flexible. If you"re flexible, you can start doing whatever works at the moment. It will make your life less stressful.
So, what"s the biggest variable in the market? Other people.
The stock market is a study in crowd psychology. And the fact is, crowds are extremely emotional and not very logical. The emotions of people within the crowd affect the emotions of others in the group. What will make them fearful or greedy one day won"t bother them the next because the crowd dynamic will overwhelm their individual responses.
Now, consider this crowd behavior in the context of a market in crisis. Everything is revved up and accelerated like the market is a kid buzzing on too much sugar. Emotions will shift from pessimism bordering on total despair to optimism, euphoria, and even foolhardiness in a matter of weeks, even days. The emotional mood of the market can do an about face even when the underlying fundamentals don"t change that much.
The hard part for investors is balancing the extreme emotions and the likelihood that they persist against making prudent buys and keeping risks contained. While following the crowd is usually a great way to make money, doing so always becomes costly chaos at some point. We need to respect the crowd but maintain objectivity and be ready to stand aside when they start to shift.
If you want to make money, you have to be ready for more irrational exuberance but you also must be prepared to move quickly when it fizzles.
If all else is equal, choose value. Being a value investor, that is, buying things when they"re relatively cheap, sounds like a no-brainer. But there are plenty of times when value is out of favor with the market, or the market doesn"t agree with you that a certain investment is undervalued. One of the most bitter pills I"ve ever swallowed in the market is to buy something because I thought it was cheap only to see it get a lot cheaper.
So what denotes value? That depends on the investment. What makes a gold miner cheap, for example, is different from what makes a technology company a bargain.
Dividends can be a sign of real value. You buy stocks and funds, why? Because you expect them to go up. When you invest in dividend-paying stocks and funds, you have the added benefit of getting paid a regular fixed amount while you wait for your pick to work out. And if the investment goes down before you sell it, the dividend cushions the blow.
Dividends are not always good; sometimes they"re too good to be true. It"s a market truism that the best yields are paid by the worst performing industry sector. Even within a sector, a dividend yield that is way above the average paid by a stock"s peers shows that everyone knows the company is in trouble and is going to cut its dividend-so they"re already selling the stock.
You can look for sectors and industries where it"s normal to pay out above-average dividends-for example, utilities. But a utility that pays one of the highest dividend yields in the entire industry is probably a utility in trouble.
The thing a value investor should do is look for stocks with steadily increasing dividends, or a fund that holds a basket of top-notch dividend-paying stocks.
A stock doesn"t have to pay a dividend to be of real value. I know plenty of miners, for example that are dirt cheap and in the growth stage of their business cycle. They aren"t paying dividends because they"re using all their cash to grow their companies. But dividends can have a place in a value investor"s portfolio.
Finally, I strongly believe that you, as an individual, are in charge of your own investing destiny. Don "t buy something just because a guy on TV likes it, and don"t buy a fund just because it is mentioned in a book (like this one). I"m going to give some broad investing guidelines and I"ll be using funds as examples, but keep in mind that this wild and woolly market could have reversed a couple of times between when I write these words and when you read them.
The market moves in cycles. As Mark Twain famously said, "history doesn"t repeat, but it sometimes rhymes." If you can spot a sector at a bottom of a cycle, that will make your life easier. Stockcharts.com has a good sector rotation tool that lets you see the money flowing out of one sector and into another. You can find it at Go to www.stockcharts.com. Once there, click on "free charts." Use the navigation bar on the left-hand side of the page to go to PerfCharts. (See Figure 5.3.) Figure 5.3 Sector SPDR PerfChart Scroll down the page and find AMEX Sector SPDRs. Click on that link. This will pull up a chart showing how each of the sectors is performing. On the bottom bar, you "ll see a row of boxes. Click on the second one.
This should bring up a chart that looks Figure 5.4, with columns representing each of the sector SPDRs. By moving the slider on the lower right back and forth, you can see money flow in and out of the different sectors (you can also set the slider for different time frames-30 days works well, but find what works best for you).
If you can identify the best-performing sectors, you can use exchange-traded funds (ETFs) to rotate from one to the next. I"ll talk more about ETFs in just a bit.
There are other cycles as well. For example, there are seasonal cycles. Have you ever heard the phrase "sell in May and go away"? That"s because November, December, January, February, March, and April tend to be the best months for market performance, while May through October tend to underperform.
Figure 5.4 Sector SPDR PerfChart According to the 2009 Stock Trader "s Almanac, in 58 years of ups and downs, the six months of November through April saw the S&P 500 gain 1,098.03 points. The other six months saw the S&P 500 gain only 269.49 points during those 58 years.
If you want to break it out month by month, the chart in Figure 5.5, put together by Plexus a.s.set Management, shows the performance over the past 50 years.
The good six-month period shows an average return of 7.9%, while the bad six-month period only shows a return of 2.5%.
And there are much bigger cycles at work; there are cycles within cycles for individual issues, the broader markets, and beyond. Just like there are zigs and zags in the market, there are ups and downs in the global economy.
One that we"re in right now is the Commodity Super Cycle. Research by Morgan Stanley has shown that commodity super cycles can last 20 to 25 years. The current super cycle started in the late 1990s.
Other commodity bull markets in modern history, roughly spanning 1906 to 1923, 1933 to 1955, and 1968 to 1982, lasted more than twice as long as the current run. They also included some sharp corrections before they ran their course.
Figure 5.5 S&P 500 Average Monthly Total Return Source: Plexus a.s.set Management (based on data from Professor Robert Shiller and I-Net Bridge).
Should You Buy Funds or Individual Stocks?
In the section above, I outlined broad guidelines for investing. Now you"ll have to make a choice between funds and stocks, or choose both.
In a mutual fund, you hope that some smart guy or gal is doing the work or you-going over the books of companies, checking out their position in the industry, getting a feel for the macroeconomic picture, and so on.
In an exchange-traded fund, you buy a basket of stocks that tries to mimic the action of a specific industry, sector, or investing cla.s.s.
In individual stocks, you look for the best companies, the ones that will outperform the compet.i.tion. Individual stocks are a lot more risky than mutual funds or ETFs; if a stock blows up, it can suck all the money you invested in it down a black hole. It "s very hard for a fund to do that.
For casual investors-people who aren"t paying attention to the markets all the time-I think funds are the way to go, especially exchange-traded funds.
If you buy individual stocks, you"ll have to do extra homework, and take some extra steps to protect yourself.
Six Stock Investor Do"s
What do I mean by homework? Here are some things you might want to consider doing with each stock you buy. If you do these consistently, you have a better chance of going to the head of the cla.s.s.
* Call the company. Most publicly traded companies have a designated Investor Relations (IR) representative (or they should have one). This person"s job is to answer questions from doofuses like you and me. Make their day and give them a call. You"ll find the company "s IR contact number on its web site. Call the company, ask questions, make sure you understand management"s strategy and outlook, and see what to expect in the coming months. That should minimize the ugly surprises.If you feel self-conscious about calling, here are a few guidelines:1. Ask for the IR rep by name. You know this because you got this from the web site. This makes sure you don"t get fobbed off on a secretary.
2. Have a thorough knowledge of the company before you call. Know what they do, who the corporate officers are, if they made money in the most recent quarter, and what kind of guidance they gave for this quarter.
3. Know what questions you are going to ask. Nothing puts an IR rep"s teeth on edge like a rambling phone call. If you are already researching a company, you probably have specific questions about: new projects, sales visibility, whether the company is going to have to roll over any debt, and how it is going to spend the cash it already has, to name a few.I find calling a company works best with small-cap companies (which can be treasure troves of value). Most of the interesting stuff about the big companies is already out in the public sphere.
* Scale in to a position. Some traders buy and sell all at once. They find a stock that they like, the stock of which they can afford $5,000 worth, and they put all $5,000 into that stock.A better approach might be to split your purchase into two or even three parts, and make your purchase over days or weeks. That way, if the stock or market tanks, you still have some ammo to pick up more shares when they get cheaper.
Scaling in allows you to keep your options open. It gives you time to think about the decision you made, and maybe rethink what you are doing with the rest of the money.
* Take small bites and be ready to spit it out. Keep your investment size on any one trade small, use protective stops, and exit if your stop is. .h.i.t. Why? Because, Mister Genius, there is always the risk that you are dead, flat-out wrong.If you bet 100% of your money every time you traded, and you were right 99 out of 100 times, you would still end up broke because you put all your money into each trade, and the losing trade flatlines your account.
On the other hand, if your strategy is to invest 10% of your holdings into 10 different stocks, and sell any position immediately if any of these shares drops more than 10%, you will preserve most of your capital even if the market goes completely against you.
Am I saying this 10% formula is the right strategy for you? No! It depends on how much money you have to invest, your stomach for risk, and other factors.
* Be skeptical of the lying liars on Internet message boards. Internet message boards are a great place for investors to get together and share ideas. Unfortunately, they"ve turned into a forum for pump-and-dump artists to fleece the unwary and short sellers to use unfounded rumors and innuendo to scare people out of good stocks.
There are good places to get information on stocks. MSN Money, Yahoo! Finance, Google Finance, Kitco, 321.gold, and I"ll proudly add Weiss Research and UncommonWisdomDaily.com, for whom I work, to that list. There are plenty of other good investment web sites and blogs. But when you"re on the Internet message boards, treat every post you see as if it "s written by a pathological liar. In other words, don"t even believe a h.e.l.lo until you check it out.
* When you"re right, sit tight. The legendary stock operator Jesse Livermore wrote: "Men who can both be right and sit tight are uncommon. I found it one of the hardest things to learn." In other words, don"t sell too soon. Overtrading will nibble away at your account like a flock of rabid ducks.
* Diversify, diversify, diversify. Use your stock portfolio only as part of a bigger investment picture. I talked about splitting your stock portfolio into tenths. You could do that, but only after you"ve already divided up your wealth so just a portion of the whole is in stocks.There are many ways to divide your personal finance pie.
For example, you could divide your wealth into fifths:1. Physical gold and silver 2. Ready cash or short-term treasuries 3. Currencies or currency funds 4. Best U.S. stocks 5. Best international stocks This way, you have the opportunity to profit if you"re right, and also to protect yourself if you"re wrong.
The alternative can be very bad indeed. I know a gal who"s a personal banker, which basically means she handles money for very wealthy clients.
A married couple who were clients of hers, with $35 million or so in the account, came in to the office. They were getting 5% on their money on deposit with her, and they wanted at least 6.5%.
She called all the way up the chain of command, but couldn"t do better than 5.5%. The greedy couple called her some names, withdrew their money, and put it with someone else. This other guy, they told her, promised them at least a 20% return on their investments!
Maybe you"ve heard of this other guy? His name is Bernie Madoff. Of course, his investment plan turned out to be a total fraud, a giant Ponzi scheme, and the greedy couple got a big fat zero return on their money.
The lesson there is that the only people who should invest all their eggs in one basket are chicken farmers, and I"m not even sure how true that is for them.
Let"s talk about diversification and a.s.set allocation a bit more, and how you can use exchange-traded funds to achieve that goal.
Divide and Conquer with a.s.set Allocation
a.s.set allocation is the strategy of dividing your investment portfolio among major a.s.set cla.s.ses-for example, large-cap stocks, small-cap stocks, international stocks, and fixed income. At the same time, you choose your investing style-value or growth. Unless you are going to manage your investments on a daily basis, or have someone else do it for you, it"s likely that proper a.s.set allocation will really make the difference in your portfolio. In other words, the results you are going to achieve will most likely be determined by how you"ve invested your a.s.sets, and not necessarily your ability to pick individual investment winners.
You will have to make some choices. Choices like . . .