Persuasion Time

Today Eastman Kodak (EK), an icon of American capitalism, filed for bankruptcy.   The 100-year-old company had been in trouble for many years as the shift to digital imaging dramatically reduced the demand for its products.  

Early in my Wall Street career, I was a photography analyst.  I was the “guru” for my firm on the photography industry and covered stocks such as EK, Polaroid, Fuji Film and so forth.  I visited Rochester many times and met with EK management on numerous occasions.  EK, in many ways was a victim of its own success.  The silver halide technology which made photography possible also created a very, very profitable product – photographic film.  By all estimates, the gross profit margin on photographic film was around 80%.  EK tried over the decades to use all of its cash flow and profits to fund other businesses.  None were as profitable or stable as the film business.  

After a while it seemed that management was simply trying not to mess up a great business – the goal was not to move on to bigger and better things, but just try to maintain market share and hang on.  By the time the digital threat became serious, EK was already far behind.  It never caught up, and now the reality of the new digital age has caught up to it.

In many ways, EK is a poster child of Schumpeter’s idea of “creative destruction,” which is often used to describe capitalism’s messy way of delivering progress.  Because new, potentially disrupting technology always looms on the horizon, companies must not be afraid to make dramatic changes that may hurt in the short run, but which over the long haul often prove to be a saving grace.  Apple (AAPL) has done this many times over the last decade.  EK did not.

This is one reason predicting the future is so difficult.  The marketplace is constantly changing, and the best companies are prepared to change with it.  Being big or having a dominant market share provides no guarantee for future success. 

I love the idea that some large portion of jobs in the future will come from technologies not yet invented.  Who knew that social media companies would become so big and create so many jobs? 

One of the great pleasures I derive as an investment generalist is researching and analyzing a broad range of companies in many different industries.  Along the way, I learn a great deal about how good management teams run their businesses.  And the dynamism of the markets keeps me ever engaged and looking for the next bunch of really great investments.  So even as formerly great companies like EK fade away, new ones will be born, small ones will get bigger, and investors who can find the gems will be rewarded for their insight, diligence and patience.

To the average citizen, is there any scarier U.S. Government Agency than the Internal Revenue Service (IRS)?  For my entire life I have paid my fair share of taxes, on time, and in accordance with the law (as far as I could figure it out).  Despite a few yellow flags on my returns now and again (high levels of charitable contributions, for example), I have never been audited.  Yet, nothing gets my heart pounding like seeing something in the pile of daily mail from the IRS.  Once they thought I had been a soldier (!) in Iraq (working for the U.S. military, I assume) and was entitled to some kind of combat-related tax break.  It took a few phone calls and letters to convince them they had made a mistake.  One time, they informed me of a mistake I’d made and sent me a check.  I happily cashed it.  Another time, they informed me of a mistake I’d made and demanded more money.  I happily paid them.  In all these cheery exchanges I never really felt threatened or treated harshly by the nice folks at the IRS.

But now, “No More Mr. Nice Guy” appears to be the new theme song of the IRS.

As reported by Bloomberg this morning, the IRS is rolling out a third so-called amnesty program aimed at collecting taxes on foreign accounts held by U.S. citizens and other U.S. residents.  Unlike the first two programs, which by the way were wildly successful (or horribly painful, depending on which side of the deal one was on) – bringing in $4.4 billion in new revenue from 33,000 taxpayers, this one has no stated deadline, but there is no guarantee that the program will be available indefinitely.  The new program does have a higher penalty (27.5% on the highest balance in one’s offshore account) and the ever-consistent threat of criminal penalties for non-compliance.  The IRS has upped the ante in several other ways.  They are also targeting any and all tax-haven banks, bankers and other financial professionals who may have aided taxpayers who failed to disclose information about these accounts.

“Well,” you may be saying, “I have never been a member of an international crime syndicate, a gun runner or drug smuggler.  Surely this program does not and cannot apply to me!”  Much like the big nets tuna fishermen used in the past that would also swoop up dolphins, this program does target anyone who has ever, in the last 8 years  held any kind of undisclosed financial account (saving, brokerage, checking, deposit, etc.) anywhere outside the U.S. or whose name may appear on such account anywhere.  In many countries it is customary for a parent to include the names of children or even grandchildren on bank accounts.  If those children or grandchildren are U.S. citizens or maintain a U.S. address, guess what?  They are potential targets for this program.

Maybe you bought a small piece of real estate outside the U.S. years ago.  When you transferred the money from your U.S. bank to the local foreign bank, did you think to file all the required IRS and U.S. Treasury documents?  If not, you are a target for this program.  If you worked for your U.S.-based company for a few years as an expatriate overseas and opened up a checking account with a local bank for your daily needs, guess what?  You will be targeted by this program, if you failed to file the required paperwork.

“But,” you may be saying, “My company handled all that kind of stuff when I worked overseas.”  Maybe it did, maybe it didn’t, but for certain it will not face criminal penalties for non-compliance. You might.

“Yeah, but,” you may be saying, “I have a tax professional who handles all this stuff.”  I’m no tax expert, but my sense in talking to people who really know this stuff well, is that this program and all of the related regulations reside in the realms of deep esoterica.  Some of the details of the new program are still kind of fuzzy.  The “average” tax preparer may not know this stuff well enough to keep you safe from the growing aggressiveness of the IRS.

The language, tone and scope of this program scare me to death. I sense that many people still feel that somehow, some way it doesn’t really apply to them.  Or they think that the IRS is simply overreaching.  Or that the IRS really doesn’t care about their checking account in the Czech Republic.  I understand these feelings, but they are wrong.  In my view, the program can be summed up this way, “go to them before they come for you.”  If you think that’s hyperbole, consider this quote from Doug Shulman, the IRS Commissioner regarding this new program, “If we catch them [you] involuntarily, it’s going to be much worse for the taxpayer [you].”

Forewarned is forearmed. ‘Nuff said.

To the average citizen, is there any scarier U.S. Government Agency than the Internal Revenue Service (IRS)?  For my entire life I have paid my fair share of taxes, on time, and in accordance with the law (as far as I could figure it out).  Despite a few yellow flags on my returns now and again (high levels of charitable contributions, for example), I have never been audited.  Yet, nothing gets my heart pounding like seeing something in the pile of daily mail from the IRS.  Once they thought I had been a soldier (!) in Iraq (working for the U.S. military, I assume) and was entitled to some kind of combat-related tax break.  It took a few phone calls and letters to convince them they had made a mistake.  One time, they informed me of a mistake I’d made and sent me a check.  I happily cashed it.  Another time, they informed me of a mistake I’d made and demanded more money.  I happily paid them.  In all these cheery exchanges I never really felt threatened or treated harshly by the nice folks at the IRS.

But now, “No More Mr. Nice Guy” appears to be the new theme song of the IRS.

As reported by Bloomberg this morning, the IRS is rolling out a third so-called amnesty program aimed at collecting taxes on foreign accounts held by U.S. citizens and other U.S. residents.  Unlike the first two programs, which by the way were wildly successful (or horribly painful, depending on which side of the deal one was on) – bringing in $4.4 billion in new revenue from 33,000 taxpayers, this one has no stated deadline, but there is no guarantee that the program will be available indefinitely.  The new program does have a higher penalty (27.5% on the highest balance in one’s offshore account) and the ever-consistent threat of criminal penalties for non-compliance.  The IRS has upped the ante in several other ways.  They are also targeting any and all tax-haven banks, bankers and other financial professionals who may have aided taxpayers who failed to disclose information about these accounts.

“Well,” you may be saying, “I have never been a member of an international crime syndicate, a gun runner or drug smuggler.  Surely this program does not and cannot apply to me!”  Much like the big nets tuna fishermen used in the past that would also swoop up dolphins, this program does target anyone who has ever, in the last 8 years  held any kind of undisclosed financial account (saving, brokerage, checking, deposit, etc.) anywhere outside the U.S. or whose name may appear on such account anywhere.  In many countries it is customary for a parent to include the names of children or even grandchildren on bank accounts.  If those children or grandchildren are U.S. citizens or maintain a U.S. address, guess what?  They are potential targets for this program.

Maybe you bought a small piece of real estate outside the U.S. years ago.  When you transferred the money from your U.S. bank to the local foreign bank, did you think to file all the required IRS and U.S. Treasury documents?  If not, you are a target for this program.  If you worked for your U.S.-based company for a few years as an expatriate overseas and opened up a checking account with a local bank for your daily needs, guess what?  You will be targeted by this program, if you failed to file the required paperwork.

“But,” you may be saying, “My company handled all that kind of stuff when I worked overseas.”  Maybe it did, maybe it didn’t, but for certain it will not face criminal penalties for non-compliance. You might.

“Yeah, but,” you may be saying, “I have a tax professional who handles all this stuff.”  I’m no tax expert, but my sense in talking to people who really know this stuff well, is that this program and all of the related regulations reside in the realms of deep esoterica.  Some of the details of the new program are still kind of fuzzy.  The “average” tax preparer may not know this stuff well enough to keep you safe from the growing aggressiveness of the IRS.

The language, tone and scope of this program scare me to death. I sense that many people still feel that somehow, some way it doesn’t really apply to them.  Or they think that the IRS is simply overreaching.  Or that the IRS really doesn’t care about their checking account in the Czech Republic.  I understand these feelings, but they are wrong.  In my view, the program can be summed up this way, “go to them before they come for you.”  If you think that’s hyperbole, consider this quote from Doug Shulman, the IRS Commissioner regarding this new program, “If we catch them [you] involuntarily, it’s going to be much worse for the taxpayer [you].”

Forewarned is forearmed. ‘Nuff said.

Anyone who is a regular reader of this blog will know that I do not make predictions.  I have learned over the years that most predictions are wrong and that the more complex the issue being predicted (the weather, stock market returns or U.S. Presidential elections, for example), the greater the chance the predictions have of being wrong.

Yet, there is something in the human psyche that craves order in the midst of chaos.  Hence, we are all enthralled by any confident “guru” who claims to know where the S&P 500 will be at the end of the year or who the next President will be.  And who am I to not try to satisfy this basic human need?

So, with tongue firmly in cheek, I humbly present my “bold” predictions for 2012.

1)     The World will not end on December 21^st.  I realize that handicapping the Apocalypse is a bit out of my pay grade, but my quick study of the Mayan calendar suggests that they really weren’t predicting the end of the world, just the end of another one of their calendar periods.  It seems that they could not imagine being around after the end of their 13^th big calendar period (which ends on December 21, 2012).  They weren’t.  Despite their prowess at astronomy, they were not able to predict their own demise, much less the end of time.  Feel free to make long-term plans…

2)     The U.S. will either re-elect a Democrat or elect a Republican.  I am not a political “guru,” but I feel pretty confident about this prediction.  The good news here is that according to Ken Fisher, either of these outcomes is good for the stock market.  In fact, his research suggests that the best years for the stock market happen when either one of these things occur.  Feel free to vote for either candidate and buy stocks…

3)     A politician will become embroiled in a scandal.  Feel free to quote me on this one…

4)     The markets will continue to display volatility.  That is, that prices of publicly traded assets will change, fluctuate or otherwise move.  Note that I am not predicting the level of volatility or offering any opinion about the pace or rate of changes in volatility.  And as a nod to my last blog (here), I am not predicting declines in asset prices, just that they are likely to move around.

5)     The S&P 500’s return for 2012 will not be 10%.  Yes, I am aware that 10% is the long-term average for the market, but a quick look at history will show that the market rarely returns its average.  Stock market returns are lumpy and rarely provide the return expected on an annual basis.

6)     Most of the predictions about the S&P 500’s returns this year will be wrong.   It appears that the consensus from the professional forecasters is calling for a 7% return for the S&P 500 this year.  If the collection of forecasts falls into a normal distribution (as it usually does), and if the market tends to surprise the consensus (as it usually does), 7% is also probably not a good guess of the market’s actual return for the year. Consider this, if we only had two predictions, +24% and -10%, the average would be +7%, but this single number would tell us very little about the nature of the estimates from which it is derived.  I much prefer estimates that mention a range or simply a direction rather than a singular, simple number.

7)     Nouriel Roubini will find a compelling reason to be negative.  Okay, this may be a cheap shot, but those who choose to be bearish will always have grist for their mills.  The Utopian “all is well” scenario never exists.  At any point in time, there are significant problems or threats facing any given economy, nation or market.  People tend to believe what they want to believe and disregard any evidence contrary to these beliefs.  One of the most perverse things about the stock market is that pessimism is generally considered a positive.  The market tends to climb the proverbial wall of worry.  The more press coverage Mr. Roubini gets, the more bullish I become…

8)     The Kardashians will completely shun all media and effectively disappear from our view.  This is more of a wish than a forecast =)  Who are these people, and why are they famous?

Here’s to a healthy, prosperous and happy New Year!

Maybe it’s my background as a language major in collage.  Maybe it’s my general penchant for prose.  But, there is something about language that truly fascinates me.  The active math/science part of my brain also seeks for clarity of logic and precision in communication.  So imagine my consternation whenever I begin to hear and read things about the markets that I know is unclear, imprecise and/or just plain wrong.

The latest target of bewilderment is the concept of “volatility.”  Everyone knows [quick aside: whenever you hear anyone say “everyone knows” be on your guard – the words that follow could lead you to a profitable trade – by doing the opposite] that the markets this year have shown unusual volatility.  I have probably heard/read comments along this line hundreds of times (I read a lot) this year.  For most people, hearing something over and over leads them to accept it as true.  To the contrarian, it has the opposite effect – the more I hear something the less I believe it.  In my heart, I believe that the consensus (about most things) is generally wrong.  I can produce reams of research that support this, but I find it nearly impossible to convince anyone of this fact.

So we all (except me, maybe) think that the market has been “extra” volatile this year.  Is there a way to measure this?  Volatility, at its heart, is a measure of the price variation of a financial instrument over time.  Looking at the VIX (which measures the volatility of the S&P 500), we can see that the second half of the year appears more volatile than the first.

Yet, looking at a 2-year chart, we see that even the current volatility is much less than the peak levels of this and last year.  Does anyone remember the worries and “volatility” of last May?  It seems (according to this chart) that last year was as “bad” as this year, and yet no one talks about the increased volatility of 2010.

Looking at the five-year chart of the VIX, we can gain even more perspective on this issue.  The volatility spikes experienced in late 2008 and early 2009 are roughly 3 times the level of the current volatility.  So, one way to say it is that the S&P 500 is 70% less volatile than it was at that time.  While this is true mathematically, this notion seems out of synch with the common knowledge of the day, that the market is somehow “more volatile.”

This is the point where unclear thinking and imprecise language can trip us up.  When I hear “volatility,” I am thinking “variance from the mean.”  I suspect most professional investors would agree.  When others use this word, I sense they take it to mean “the market is down (or a recent variant ’broken’)” or “I am losing money.”  So how much money have investors lost this year, this year marked by this supposed increased volatility?  As of this writing, the S&P 500 is down about 2% for the year, which means the total return (including dividends) is around zero.  Not a great year for stocks to be sure, but not horrible.  Not as bad as one might expect given the “increased volatility.”  Your results may vary.

The key concept here is that volatility affects mostly how we feel about the markets.  Most of us would like the stock market to provide stable, linear returns of 10% or more each year.  But, alas, that is not its nature.  Its nature is to provide an average return of 10% over time with lots of volatility.  The market almost never returns 10% in a calendar year.  To expect this means you almost always will be either surprised or disappointed.  Left to their own devices, the average individual investor tends to sell when things look bad (or “volatile,” if you will) and buy when things have “stabilized” (another imprecise word that usually means “the market has gone up”). I have tons of data to support this premise as well, but well, it’s hard to explain this to anyone who feels bad because the market is “volatile.”

Looking at the performance figures available, this has been a frustrating year for many professional investors.  It’s been a very hard year to “beat the market.” Yet for those investors who thrive on volatility (traders, quants, computers, etc.), it’s been a very good year.  As a long-term investor who does not trade actively, I fit into the former category.  Yet, I am encouraged by the progress individual companies are making.  Economic worries will come and go, but ultimately for stock pickers like me, the fortunes of individual companies will be more important for my returns than the economy, government policy, currency, or even “the market.”  Here’s to a better year in 2012 (historically U.S. Presidential election years are good for the market) and more intelligent commentary (that is to say, commentary that is more intelligent – sorry for being imprecise…) from the “gurus” on television.  Skål!

There is a certain amount of intuitive appeal in the daily chattering of stock market commentary.  We have all been taught from the time we were wee little investors being dandled on our pappy’s knee that there is always a reason for the market’s daily movement.  There are several television channels and countless Internet websites dedicated to explaining the daily “reason” which all seem to have short memories, a limited sense of accountability and a brash confidence that would humble your average high school starting quarterback.

This concept is brilliantly highlighted by the simple daily market commentary headlines on Yahoo Finance.  We often joke around the office that the job of writing these headlines must go to the most junior person on the team, because it is really a thankless job that is nearly impossible to do well.  If the stock market falls 2% at the open, this young go-getter probably calls around to find out why.  The “reason” soon appears front page and center “Stocks Fall on Worries about Italian Debt Plan” (or whatever).  Thirty minutes later the market is up 1% and, lacking a good reason for this turnaround, the hapless intern updates the page with something like, “Stocks Rally Despite Worries about Italian Debt Plan.”  This may seem like an extreme example, but I have seen many headlines like this.

This desperate search for the “reason” would be fine comedy if it weren’t for some poor widow in Minot adjusting her asset allocation based on this kind of chatter.  I realize that I am some times hard on journalists, but I think the real problem for me here is that daily stock movements and journalism are not a good combination.  When everyone was day trading back in the go-go 1990s, it might have made some sense to listen to the market pundits 24/7.  Now, I’m not so sure.

One thing I learned in business school is that companies exist to make profits (profound, eh?).  I suspect that this applies to the media outlets who report exclusively on the markets as well.  As I understand it, these companies are paid by advertisers who will pay based on the size of the audience these outlets can attract.  So, while these outlets may feel obliged to comment on daily market news, they also have a fundamental need to increase viewership.  This may lead to the bad combination I hinted at above.  If one were really dedicated to helping individual investors make money and reach their financial goals, I think they would feature professional money managers who could offer solid, actionable, long-term advice to their listeners.  Instead, we get academics, traders, authors, government officials, economists and a host of other “gurus” who may not be skilled investors and who may not really have our best interests at the top of their priority chain.

Again, I am not a trained journalist, so I may be totally wrong on this, but which headline do you think is “better” for these outlets?  “Roubini: Italy at risk of exiting euro  zone” or “Buffet: Stocks Look Attractive for Patient Investors.”  The problem with the Buffett quote is that he says things like this all the time.  It’s not really newsworthy, but it’s loads more helpful to the individual investor than the other one.  On the other hand, the Roubini quote may lead to a spike in viewership.  Which is better? Hmmm.

The data show (see the work of Dalbar) that the individual investor, in aggregate, is 1) bad at market timing and 2) highly influenced by the sentiment of the moment.  Even a very smart investor with a workable investment philosophy and approach can fall victim to the whipsaw action of sentiment.  Lauren Templeton, a professional money manager (and grand niece of the Sir John Templeton), at a recent conference suggested that there are three ways to “beat the market.”  Better information, better process or better behavior.  These days it is impossible for the individual investor to have better information or a better process vs. the big professional investors.  But, better behavior can still be applied to beat the market.  The problem is most investors behave badly when it comes to the market.  They feel like selling when they should buy and vice versa.

One simple way to improve one’s investing behavior is to not listen to the daily chattering.  If the market is down, maybe it’s because of some Euro problem, or maybe it’s just a lot of people freaking out about the fears they have in their hearts and heads.  The market being down (or up for that matter) may affect how you feel, but it should not change the way you invest, unless of course, you instinctively want to buy when it goes down and sell as it rises.  Ultimately, the stock market cares about three things – earnings, interest rates and sentiment.  Earnings are fine right now, up 12% in the latest quarter (which, by the way, marks the ninth quarter in a row of solid earnings growth) and 2012 should be another good year.  Interest rates remain low and the Fed has promised no tightening before 2013.  Sentiment, which is a contra-indicator, is quite negative now. Thus, from this simple formula, one could conclude that the stock market might be due for a nice rally.  Time will tell.

What I do know for sure is that people who try to trade around their portfolio based on the daily chatter rarely win.

Last week I spent several wonderful days attending the biennial conference of the American Association of Individual Investors (AAII).  Despite their frequent depiction of being unsophisticated or, even worse, blind followers of obvious market trends, the individual investors I met were nothing like that.  They were all intelligent, hard working, successful and experienced folks who shared a deep passion for taking charge of their portfolios and financial wellbeing.  That said, their approaches to getting this done was as varied as their home towns or how they had made their money.

I met people who strictly employed the “do-it-yourself” method of investing.  They were assiduous students of the investment process and market mechanics.  They quoted Buffett, Lynch or Paul Tudor Jones as readily as a high school student can recite the latest Katy Perry song.  Others preferred to use professional managers, but held them to a very high standard of above-market returns.  Yet others had found “the secret” of investment (at least for them) and used it (there were many, many of these “secrets” to be found) exclusively and religiously.  There were some folks just starting out, who seemed a bit dazed by all the volatility of the markets over the last few quarters, and others who had been investing for over four decades.  All in all, I found it to be an exhilarating experience.

The professionals at the conference were there to offer their perspectives on the markets or the process of investing, pitch their versions of “the secret,” move a few newly-published books, opine about a wide range of related topics and/or provide encouragement to the group.  Experts in security analysis, trading, hedge funds, value investing, index investing, behavior science and many other areas all vied for the attention of the attendees.  All of the presentations and workshops I attended were excellent.  It was highly reassuring to hear the time-tested investment philosophies I was raised on praised, reiterated and confirmed time and again by many of the experts there.

Space does not allow a comprehensive summary of the things I heard and learned, but let me share with the reader a few of the pithier quotes I was able to capture.  Attribution of the speaker will be shared only off line, if anyone really cares to follow up with me.

“Looking the history of the market, we see that the November to April timeframe usually offers the best returns for any given 12-month period.”

“You pay a hefty price for a cheery consensus” – someone quoting Warren Buffett, who must be the patron saint of the individual investor…

“Value and dividend paying stocks look poised to do well going forward.”

“People are not rational, they are normal.  That is, sometimes we’re smart and sometimes we’re stupid.”

“Intuition is insufficient alone to invest successfully.”

“Hindsight fools us into thinking that we should have known something in foresight as well.”

“The economy tends to grow at irregular rates.  There has never been an economic recovery that is “regular.”

“Bad behavior is always bad.”

“U.S. Presidential elections are always bullish events.”

“Smart investors create their own luck.”

It was very encouraging to see so many people dedicated to helping individuals make better sense out of the complex exercise of investing.  Well done, AAII!

Because the world needs more “10” lists…

1)     Never Eat Anything Larger Than Your Head.  OK, it’s not really a rule exactly applicable to investing, but I think it’s a pretty good rule for staying healthy.  The healthier you are, the longer you can enjoy the magic of compounding…

2)     Know the Difference Between a “Trade” and an “Investment.” A “Trade” is a short-term “bet” (for the lack of a more elegant term) that something will happen and the result of that something will be good for the stock you bought.  A reasonable trade always has a trigger event and a deadline.  Buying a stock because you think it will report better-than-expected earnings is a classic example.  An “Investment” is something you tend to hold for a longer time.

3)     Don’t Let “Trades” Become “Investments.” So what do you do when the earnings results are disappointing, and the stock you just bought for a trade goes down?  The temptation is to hold on and try to recoup your losses, but the rule #2 dictates that you sell it.  You were wrong.  Move on.

4)     Limit Your Sources of Information.  This may seem a bit counter intuitive, but I think it works.  Listening to too many outside sources can often lead to confusion.  This is especially true of the more popular media outlets dedicated to capital markets commentary.   In my work, I follow closely two or three equity strategists, a like number of economists, one bond market “guru” and a handful of sell-side analysts.  I note in passing a large number of other sources, but usually pay them no mind.  Some popular sources I actually consider potentially dangerous to one’s portfolio.

5)     Always Know Why You Own Something. At whatever point you are not sure why you own a stock, you should get rid of it.  By the way, merely thinking a stock might go up is not really a sufficiently strong reason to hold something.

6)     Never Get Involved in a Land War in Asia.  Again, not exactly a key principle for investing, but it underscores that fact that much wisdom about life in general can be gleaned by simply watching “The Princess Bride…”

7)     Never Buy a Stock on Another Person’s Recommendation. Actually, that’s a bit strong.  The actual rule is don’t do this unless you have considered how that recommended stock fits into your way of investing or into your portfolio.  Understanding the appropriateness of any investment is critical to portfolio balance and risk management.  Buying a stock just because some famous person on television (or your cousin Ned) recommends it is a recipe for randomness.

8)     Never Buy a Stock on “Gut” Feeling. Intuition may serve us well in many endeavors, but in the investment world, it only helps after we have done all the hard work to truly understand the asset we are considering.  Seasoned Wall Street pros will often talk about the importance of gut feeling in their investment making process, but if you press them, they will admit it’s only about 5% (or less) of the total work required to find, analyze and select a successful investment.

9)     It’s Better to be Disciplined Than Smart. The most successful investors I know have lots of rules that they have crafted over many years of experience.  They also follow them more or less religiously.  Sometimes your particular investment approach will not be rewarded by the markets.  That is no reason to abandon it.  Successful rules will more often lead to outperformance than trying to guess what approach will work next.

10)     Sometimes the “Right” Thing do to is to do Nothing. Many people fall into the trap of feeling they must react to events affecting their stocks or portfolios.  More often than not, simply taking a deep breath and re-evaluating the merits of the investment is a much smarter approach than simply selling (or even buying more).  Understanding whether you are using your emotions or your cognitive abilities when approaching a key investment decision is a critical key to success.

Last week my granddaughter, Taylor, was born.  As I reflected on the miracle of birth, I began musing about what kind of life Taylor might expect to have.

Despite all the negative talk about the United States, I suspect that Taylor will be grateful to live in this country.  The U.S. economy is still the world’s largest by a large margin, and per capita GDP is still envied by most of the world. She will likely live in a home most of her life that is warm in the winter and cool in the summer.  Her father sells insurance, a product that will likely be in demand for the entirety of her lifetime.  Her mother has chosen to stay at home and focus her efforts on the rearing of her children.  I suspect that Taylor will benefit from both of her parents’ career choices.

The Greek crisis, which seems to be the key driver for the U.S. stock market these days, will probably be little more than a footnote in some history book Taylor reads in a class someday.   Even the “Great Recession” may become a near non-event in the trajectory of Taylor’s life.   She will likely attend public schools and, if she works hard and gets good grades, may attend a university.  It is likely that her careers choices will include jobs in industries that don’t even exist yet.

If she follows the example of her parents, she will likely fall in love, get married and start her own family, experiencing all the joy, pain and promise that family life can bring.  She will likely cry when her grandfather dies, but will have numerous occasions to remember him fondly, his corny jokes, his dry wit, his unshakable belief in value investing…

During her lifetime, the expansion in innovation and technological gains is hard to imagine.  Consider that when I was born, the world had no knowledge of color television, cable television, 24-hour news programs, MTV, manned space flight, personal computers, CDs, heart transplants, GPS, reality TV shows, Bill Gates, Steve Jobs, moon landings, the Beatles, etc.  Taylor will be able to compile a similar list in her 50s that will likely seem like science fiction to us now.

In spite of the notion of diminished expectations we hear constantly now, I suspect Taylor’s life will be full, rich and fulfilling.  The big picture issues we fret and fuss about now will likely have little impact on her ability to find happiness and contentment.

Taking a longer-term view allows one to see things as they really are, apart from the sometimes myopic view we see through the prism of the present.  Sentiment and the markets will swing around as they will, but truth and true principles (either of investing or other areas of importance) will persist and resist all our attempts to invalidate them.

As an old Japan expert, I recall chuckling to myself whenever the Japanese government would release its quarterly GDP numbers.  Inevitably, the announcement would include a phase something like, “This quarter the Japanese economy grew at 2.0145%…” suggesting that somehow that last three decimal places were of critical importance for the world’s second largest (at the time) economy.  Someone somewhere in the vast bureaucratic machinery of the government had decided that the public really, really needed to see those last few decimals.

Clearly a case of precision without accuracy.

Lately, I find myself similarly amused as the “gurus” who appear frequently in the media discuss their outlook for the economy.  Most of those featured as of late appear to be in the bearish camp (negativity sells, maybe?) and gravely opine on their chances that the U.S. could slip into recession.  One will say “a 30% probability,” only to be followed by someone the next day upping the odds to 50% (or whatever).  As if these figures were bids in some kind of morbid auction game, the spotlight forecasters begin to move their estimates around trying to underscore the direness of our straits – “It was 35% chance, but now I see 47.398% chance of a U.S. recession…”

Another exercise in precision without accuracy?

In my simple way of thinking, either we will have a recession or we won’t.  The notion of the “odds” of a recession makes sense only if we could run a number of iterations of today’s conditions and see what happens.  Absent a time traveling machine, we can’t do that.  The probability of a recession is either 0% or 100%, not 30%, 50% or 47.398%.  I realize that speaking of the “probability” of a recession is actually a measure of confidence the forecaster is using to color the tone of his or her opinion.  But at the end of the day, everyone who wasn’t forecasting a recession with either 0% or 100% probability will be wrong…

I’m not an economist, but I do follow their work closely.  It’s interesting to note that for all the discussion about the possibility of a recession in the U.S., the consensus for 2011 still shows positive growth for the economy.  The consensus also calls for stronger (albeit still modest) growth for 2012.  So, why all this strum und drang about the economy?  Well, for one, the stock market has fallen from its recent highs.  Whenever that happens the economy tends to get the blame.  We have seen estimates of economic growth falling and we are painfully aware of the current problems in Europe (although drawing a direct line from these troubles to the U.S. is a bit of challenge given the paucity of European exports from the U.S.)  Yet, sequential growth, at a slow pace, is the consensus view.

Also, we are in the middle of an intense political debate within the U.S. about what to do about the economy.  Whether one thinks the government is the solution or the problem, the debate seems to be negatively impacting consumer sentiment.  The key point for me here is that job growth is somewhat different than economic growth.  Clearly there is a link between to the two, but I would submit that politicians care much more about job growth than does the stock market.  So, while 2.0% GDP growth may be “low” for job creation, it may provide adequate earnings growth for the stock market, especially if the so-called emerging economies continue to grow.  Recall that 50% of S&P 500 earnings come from outside the U.S.

In my view, the stock market ultimately cares most about earnings growth.  Nearly every one of the companies I follow closely expects to grow revenues and earnings next year.  We can debate about how much growth might be needed to get the stock market excited enough to return to previous highs, but I would submit that any growth in earnings for next year should be viewed as a reasonable agreement against a recession.  Or said better, the bottom up consensus view about earnings supports the notion that a recession is very unlikely, regardless of what the “experts” on television are saying.

So, what’s to be done now?  I suggest we simply hunker down during this storm of negativity and do nothing dramatic.  In the coming weeks or months the clouds will likely dissipate and we will probably have a clearer vision of what’s to come.

For someone looking for a simple data point that is a clear positive for the equity market consider this:  the dividend yield on the S&P 500 is currently 2.06%.  The current yield on the U.S. Treasury 10-year note is 1.919% (please note my precision here…).  Rarely (if ever), in my career have I seen the yield on stocks higher than on bonds.  This suggests to me that if stock prices were to be flat for the next 10 years, stocks would still outperform treasuries.  Said another way, investors who would sell stocks now and buy treasuries are betting that stocks will be at a same level or lower than they are now.  Does this seem like a “safe” bet to you?