Trading Depth Interview #18. Longshortorflat: Decoding the Markets
Our interviews serve the objective of sharing knowledge and cutting the learning curve of aspiring traders. As a result, some of our #TradingDepth guests come with diverse backgrounds, and provide our readers with different views and unique experiences. Today, we sat down with hedge fund manager and Registered Investment Advisor, LSF, to learn about his views on the markets and investing. As requested by our interviewee, we have used his alias LSF (Longshortorflat).
I’d like to begin with how you originally became interested in the securities markets. Did anything in particular cause your motivation?
It was a combination of things. From early on, I was fascinated with stock prices and how they moved—especially why. Without belaboring the point, I’ll just say that I didn’t exactly have a storybook childhood and I think the biggest result of that was that I became very self-reliant. In the markets, I saw an opportunity to work on something I thought was intriguing, hopefully make a good living, and not have to answer to a boss. Those three things checked all the boxes on my dream career list in a way I thought had a lot of potential.
When I was growing up, my parents subscribed to Newsweek magazine and I always liked to read about people’s careers. I’ll never forget seeing an article about a guy who was in “the stock market.” At the top of the page was a big picture of a beautiful swimming pool in the backyard of one of the biggest houses I’d ever seen. Sitting on the back porch was a guy in shorts, staring intently at a computer screen.
It took me about two seconds to figure out that’s exactly where I wanted to be.
I couldn’t believe that someone could not only make a living—but be exceptionally successful—working for himself and not having to deal with corporate politics. The independence, the intellectual challenge of “decoding” the markets and creating a new firm around that idea seemed to me a perfect combination. From then on, I never really thought about doing anything else.
Please, describe your company. How did you come to start it?
I spent the first ten years of my career in institutional fixed income; that is, U.S. Government bonds. To start with, I did whatever I could to get hired in the industry, calling people I knew who were in it, searching for information on local brokerages in the library—whatever. I eventually got hired by a small securities “firm”—and I use that term quite loosely. Actually, it was more like a cross between the bucket shops in the movies Boiler Room and Glengarry Glen Ross, as I later came to realize. Let’s just say it was excellent training—but that I didn’t exactly want to have a long-term association with any of the people I worked with.
Fortunately, I became successful and persuasive enough working there to get hired by a very respectable, well-established regional brokerage firm. From there, I continued to work on expanding my knowledge of the markets and build my institutional client book, and was eventually recruited to work at one of the major wirehouses. I actually got the idea to start my firm after that. I had just gotten married and was on the way back from my honeymoon and stopped in Los Angeles, and was staying at one of my favorite hotels in Century City. Late one night, I was flipping television channels and came across a show on investing and saw Warren Buffett being interviewed. He was explaining how much he loved his job and practically “tap-danced to work.”
I was fascinated, and felt like someone had just opened the curtains in a dark room to let the light in. That was about all the encouragement I needed. I figured if I didn’t venture out then, I never would. I devoted the next two years preparing full-time: studying securities analysis, developing my investment approach, researching investing, reading about legendary investors, structuring my new firm and jumping through regulatory hoops.
Boiler Room movie (2000)
I ended up creating basically two sides to the new business: the first was a private investment partnership, our Fund, in which we had the latitude to invest in just about any publicly-traded securities anywhere, for accredited high net worth investors; the other side was individually-managed accounts using our proprietary Model Portfolios, for clients who preferred the simplicity or who wouldn’t qualify for the Fund. Using either, or both, we covered the financial waterfront for clients and were able to provide whatever it was they needed.
Now, after nearly 20 years, the structure continues to work perfectly. Over the years, we’ve become more of a “boutique” firm, focusing on providing a high level of service and responsiveness. We work with clients and their families on their specific needs. We have developed a network of accountants, attorneys, third-party administrators and other vendors that we use to take care of most everything a client would need financially. And if they have an issue we can’t solve, I’ll find a way to get it done.
Could you please share some stories on how you deal with your clients? Do you work with them through letters and correspondence or do you also meet with them in person?
Sure. It usually takes several visits with a client at the beginning of our relationship, to find out exact what kind of help they need and what their goals are and answer any questions. My goal is to get them comfortable with the way we work and what to expect from us. I believe we approach this differently than other advisors: our view is “you tell me what you’re trying to do, we’ll evaluate it, create a unique plan for you, then we’ll discuss it again and make sure we’re all on the same page.” I’ve found taking the extra time up front, before we invest a single dollar, gives clients a better understanding and more accurate expectations. I want to make sure that we understand one another.
As we continue to work together, I ask clients to keep us up-to-date on their financial affairs, and not worry about their investments, which is our job. We’re always here whenever they need us. There are obviously a lot of other firms that offer investment management, so it’s very important to me that we’re accessible. It probably sounds corny, but I put myself in a client’s position, and work to treat them as I’d want to be treated.
Finances can make people anxious enough, and not being able to get a quick answer from your advisor or have your call or text returned in a timely manner is just inexcusable.
As far as meetings, over the years I haven’t found it particularly helpful to have conferences scheduled on some arbitrary preset date. I’ve found it much more efficient to work on whatever a client needs whenever they need it, and not make them sit through the typical dog-and-pony show that most advisors use to try to convince clients how smart they are. I’d much rather have clients comfortable knowing they have a plan, their advisor is paying attention to it and is there whenever they need. I’ve never liked the “come on up and we’ll buy you some lunch” offer. Personally, I think that’s artificial and insincere.
I’d much rather have clients who are with us because they value the way we work, not because we have great tickets to some sporting event. And as far as keeping them up-to-date, we do that through the quarterly letters I write, the regular account reports we provide and our periodic newsletters. I try to stay as close as possible to the old saying that “simplicity breeds elegance.”
I like your approach. I think it’s very important to build this type of relationship with your clients.
Definitely. It’s a partnership. I’m proud to say that I still work with folks who started with me on Day One, which will be 20 years ago this May. Also, I believe the way we’re compensated as a firm, which is based on the value of an account, makes our goals more aligned with our clients’. If their account value increases, then we both benefit, so it’s in both our best interests to make that happen. We don’t charge commissions, and we’re completely independent. During my time at other firms, I saw a lot of broker/client conflicts. For example, many brokerages have a list of “preferred” mutual funds and other investments they push to their clients.
So, there are probably 15,000 publicly-traded mutual funds—and they limit it to 30? Those firms will have a tough time convincing me they don’t get extra compensation from the vendor for recommending only those 30. That’s why I purposely set up our firm as independent: we can buy anything, anywhere, anytime—with no one requiring us to choose from a handful of investments on some curated list. This always reminds me of my first job at the bucket shop. They had a big blackboard on the wall and when a salesperson sold something, they’d write the amount of the commission and put their initials next to it. And that’s putting the client first? That just rubbed me the wrong way. It’s far more equitable to structure compensation based on the growth of clients’ accounts in my view.
Do your clients benefit from diversification long term? Could they invest by just using one type of tool, and it would be the same or even better? Statistically speaking.
That’s a great question. Much of conventional finance is based on the Efficient Markets Hypothesis (EMH), which basically promulgates the notion that all securities are always and everywhere priced efficiently; and that current prices reflect all available information known about every security. Needless to say, I’m no believer. I just disagree with this on so many levels. Look at great investors like Buffett, Benjamin Graham, Peter Fisher, Sandy Gottesman, Paul Tudor-Jones, Michael Steinhardt, Peter Lynch, Stanley Druckenmiller and a slew of others who outperform the market indexes by a large margin over many years and easily disprove EMH.
Also, there are plenty of times securities sell for significantly more, or less, than their “intrinsic value.” I could offer a ton of examples but that’s likely to be a very long discussion. But to paraphrase Buffett, there’s a big difference between securities being priced fairly all the time, and being priced fairly most of the time. I’d bet more fortunes than you’d imagine have been made on that thesis alone.
Glengarry Glen Ross movie (1992)
I know dividends are important to some investors. How does that work? Does a company pay through a broker or just through a bank account? What if an investor wants their dividends to be paid, and not reinvested?
First, let me put that in context. On our managed-accounts side I construct a series of Model Portfolios that range in risk tolerance from Income to Very Aggressive. In the conservative models, we do have a large allocation to dividend-paying securities. In terms of individual stocks that pay a dividend, we often have more flexibility than in mutual funds that own many companies that pay a dividend. This is because we can choose specific companies and invest in them based on their dividend policy and other factors specific to that firm, which might be more closely-aligned with a client’s goals than investing in a similar mutual fund.
On the other hand, dividend-paying mutual funds are often more cost-effective for smaller accounts. But above a certain size account it’s often more efficient in terms of tax considerations, and control, to own a company’s shares directly.
In practice, dividend investing works like this: companies that pay dividends do so out of a portion of their earnings which is based on the policy set by their Board of Directors. For example, a company might have a dividend payout rate of 5%. If they earn $10 per share, they would pay $.50 to an investor for each share they own. Brokerage firms typically allow an account owner to decide how they want to receive that dividend: it can be paid to them directly in the form of a check; it can be credited to their brokerage account; or they can choose to have it reinvested directly in the shares of the particular company. But focusing on dividends is mostly done in more conservative accounts; clients investing for longer-term growth usually prefer trying to increase the value of their accounts rather than focus on income. But figuring out which dividend strategy is more suitable for a client depends on factors like risk tolerance, years to retirement, etc.
Further, the tax treatment of an account needs to be considered too. Often, investing for growth is preferable in a retirement or other tax-advantaged account because those accounts are typically taxed at a later date, presumably at a lower tax rate. This is just one of the topics we cover when we first begin to work with a client.
It seems that experienced investors are more prepared when an economic decline happens: they diversify or hedge their portfolio and buy valuable stocks/assets almost at the bottom. Why don’t the majority of people follow suit? In your opinion, is it a lack of investing education or a question of psychology?
Terrific question. In my opinion the investors who are most successful at doing this are those who are the most experienced, and have the understanding, discipline and temperament necessary to buy at fire sale prices. But why most investors do the exact opposite is probably one of the biggest mysteries in investing, and I’d bet it’s hands-down the one that’s the most costly to average investors in the long run. And it’s very peculiar in a way: ask anyone how to make money in the stock market and what do they say? Almost to a person, it’s always “buy low and sell high.” But when that actually happens, when there’s “blood in the streets” as the old Wall Street maxim goes, people are usually so terrified and frozen that buying is about the last thing they’d do.
I’ve often joked that if I wanted to get kicked out of a cocktail party early, all I’d have to do is say the word “stock” after a sharp market decline. I think one of the biggest attractions to the securities markets is often lost on many retail investors—that it’s precisely at the times the stock market declines that it’s almost always safer to buy, than when the markets are skyrocketing in price. It’s fascinating to me, and one of the focuses of investing psychology, that whenever a stock is expensive and everyone wants to buy it (and often the more money the company loses, the better) everyone clamors for it. “If it’s expensive and everyone wants it, it’s got to be good, right?”
But take a boring company with a solid balance sheet, a profitable income statement, holding tons of cash and that’s temporarily out-of-favor or overlooked… and nobody wants it. Buying assets in this manner has been repeatedly proven historically to have superior returns over the long run—and it’s precisely this philosophy that allowed us to far surpass the market indexes in successive years in our Fund.
This is one of the areas in which professional investors are very often better money managers than their retail counterparts. They understand that “investment is most intelligent when it is most businesslike” as Benjamin Graham, the father of value investing, wrote in his watershed book “The Intelligent Investor” in 1949. Graham had been through the Great Depression as a Wall Street money manager in the 1920’s and was determined to understand and develop a framework to avoid unnecessary losses and protect capital, a concept based on what he called a “margin of safety.” So yes, the human brain is a very powerful thing and often doesn’t act in a rational manner. And no question, doing the most logical thing when you feel like doing the opposite is a learned skill. It’s counterintuitive and certainly not easy—but it works—and it’s necessary.
Your firm makes transactions with publicly-traded instruments including equities, options, futures, foreign-exchange securities and real estate in any country and any market, worldwide. Which are the hardest to predict? Which tend to be the most (in your case/experience)?
Overall, I think it’s much more of a question of making a judgment about the most probable outcome of an investment proposition and choosing the best tool for the job. Each of the categories you mentioned has its own characteristics. After I form an investment thesis, I consider what instrument is the most appropriate to use in the particular circumstance. But first, there are more relevant questions:
- What is my time horizon for the investment?
- Do I need to have availability to the markets for the full 24-hour session?
- Does it need to be in a regulated market?
- Is leverage beneficial?
I think one of the most important considerations most investors fail to take into account when they contemplate committing their capital is: “at what price would I be wrong?”
And based on that, the next question should logically be: “how much am I willing to risk that my investment thesis is correct?” Once you’ve figured that out, you then can look for the most appropriate security to use. Answering these questions creates a clear plan, and forces an investor to answer beforehand how they will interact with the markets. Unfortunately, most people don’t take the time to do the homework and define their risk parameters, and instead, just launch head-first into slinging around whatever security they feel like trading. That’s not the way professional investors operate.
Which of the instruments we use are the most profitable? I wouldn’t say any one is inherently more profitable than another. It’s more a question of: “Given the investment idea, and the other considerations I’ve just mentioned, which security under these conditions would have a greater tendency to effectively express your view and offer the most favorable risk/reward scenario?”
Let’s talk about your research methods. How do you approach analyzing investments?
Sure. In general, there have historically been two main approaches to evaluating investments: Fundamental analysis and technical analysis. Both are essentially backward-looking and try to anticipate what prices are likely to do in the future. The former uses the study of financial statements, publicly-available corporate filings, economic forecasts and other analytical methods. The latter uses the study of chart patterns, historical prices, volume and statistical measures to evaluate securities’ movements. There are hybrids and other methods, but fundamental and technical analysis are the two most widely-used.
About 10 years ago, I had the good fortune to stumble across another method. The time was just after the “Great Recession” in 2008-2009. Before then, I was using the methods I’d developed, focusing on financial statements, with a mix of technicals and other tools and tricks I learned along the way. Just before the financial crisis, there was a notion in the markets, indeed among many professional managers, that prices were high but that everything was “fine.” Long story short, it wasn’t. The subsequent decline in securities prices around the globe was the most serious it had been since The Great Depression, with many investors’ portfolios declining 60%, 70%, 80%. At the time, there indeed was “blood in the streets.” Without reciting the litany of household-name public companies that subsequently went bankrupt, were bought out or otherwise suffered serious financial damage, the extent of the decline in the markets was almost unimaginable to many investors. For students of statistics, the time of the six-sigma, thin-tailed distribution event had arrived.
Having been affected by the magnitude of the decline along with many others, I had my own “Graham moment” and was determined to improve our ability to protect capital the next time it happened. I had deep experience in the medium-to-long term timeframe by that time; but I was looking to add other tools that would help us competently, and confidently, invest in all timeframes. I began to focus on understanding short timeframe trading, and other investments that were available but that we didn’t trade. In addition to the list of other securities licenses I had, I passed the commodities test and our firm became licensed as both a Commodity Trading Advisor (CTA) and a member of the National Futures Association (NFA).
That was when I came across a relatively new method of explaining short-timeframe price movements. This concept, Market Profile, was developed by Chicago Board of Trade member Peter Steidlmayer in the 1960s, and advanced by James Dalton and others in subsequent years. The theory came about as Steidlmayer was looking for a way to better evaluate the movement of prices during the open outcry Pit trading sessions. Since a bell would ring after each 30 minute period of trade, he began to plot price movements during each time segment of time on a vertically-oriented standard distribution bell curve. The basic concept attempted to explain among other things, where prices were too expensive, where they were too cheap, where they were considered fair and what tended to happen in between. At the time, I thought the idea was interesting, but it wasn’t quite the piece of the puzzle I was looking for.
At the time, social media was starting to get popular, and I found it very useful to discuss trading strategies with other managers and traders online. On Twitter, I came across Futurestrader71, a professional trader who posted extensively about something he called Volume Profile. His approach was somewhat similar to Steidlmayer’s but with one very important distinction: he focused almost entirely on volume rather than time. Intuitively, this made a lot more sense to me and answered many of the questions I continued to have about short-timeframe trading. It was clear that FT71’s years of success trading futures products and the exhaustive amount of research he had done to support his concepts was impressive. I don’t think I’d be exaggerating to say that in my view, he developed Volume Profile into the third method of analyzing the movement of securities.
One neat thing about Volume Profile is that it can be used on just about any product, in any timeframe. It has a simple premise: that securities (or anything else, for that matter) trade in an auction; and that in the normal course of trading, prices give important information: at some prices, nothing trades; at others, they’re facilitated easily. One of the biggest attractions of Volume Profile to me was that it focused on the live auction on the hard right edge of the chart—unlike Fundamental and Technical analysis that were essentially backward-looking. That made a lot sense to me and helped explain much of the price behavior I had seen during my career. It’s taken me a while to reach an advanced level of competence with Volume Profile, but now, I don’t think I’d trade a single security without using it.
And though it might be a bit off-topic, I’ve found FT71 to be one of the most exceptionally-talented professional traders I’ve ever seen. He doesn’t just cover price action—he discusses trader psychology, applying statistics, the importance of mindset, preparing homework, taking losses, developing a plan, executing trades, offering webinars and about a hundred other things that traders need to give trading professionally their best shot. I’ve continued to follow FT71 over the last ten years, and I’m glad he’s come to have the recognition he deserves. Last March, he opened Convergent Trading, which in my view is the best place an aspiring or experienced trader could be in the online world of trading. It’s been a great pleasure to be there with him from the first day, and be one of the three head traders commenting with him live on the markets.
As far as other research tools, we subscribe to a number of vendors, in each of the three methods of analysis I discussed. Some of these include Value Line, Morningstar, various stock screening software, analyst research reports, market opinion vendors, Investor R/T—and of course, Bookmap.
How do you process all that data?
Now, there’s the $64,000 question. Over the last 30 years, I’ve developed a certain way of putting it all together. For example, if I’m interested in shorting a stock, I might read through the company’s balance sheet, review its financial ratios, check on its earnings history, scan the message boards about what people are saying about it, check their public filings, review the trend of short interest, find which firms that have the largest percentage ownership, etc.—and see how it looks on a Volume Profile chart. I know exactly what I’m looking for and where to find it.
Sometimes I’m asked “with all the securities available, how can you possible know what to buy or sell.” The thing is, if I’m screening for value, I can set the parameters pretty strictly, to find just what I’m looking for. I can take the stock universe, tens of thousands of public securities and whittle it down to maybe 50 with just a handful of keystrokes. In all the books I’ve read about investing, which is quite a library in itself, I remember reading a story about Warren Buffett answering a similar question. He said something like “Well, you know, I can look at a balance sheet, and after about two or three minutes tell you whether it’s something that interests me.” And I agree. I thought that was pretty funny. That’s exactly how I feel. But like the old saying goes: “It’s simple—but it’s not easy.”
The invention of modern credit gave an incredible boost to our economy and, eventually, lifted our standard of living. Today, however, corporations can borrow heavily, and the banks often rely on bigger banks and/or Central Banks (in most countries). Do you think the system has turned bad, and we may witness a new harsh recession in the next decade?
I’m on record via our quarterly client letters, periodic newsletters and discussions with our clients that I view the spike in the stock markets over the last decade to be due to the excessive amount of liquidity the Federal Reserve Board has force-fed into our economy. To be clear, in my opinion, it was essential that they became involved to support the financial markets in the Fall of 2008. In fact, based on the articles I’ve read, there was a certain Sunday in October 2008 during a meeting between the Fed Chairman and the heads of major financial institutions, that there was an extraordinary amount of concern that the markets would actually not open the following week. Think about that. The fear was that the severe decline in the markets that had crippled Bear Stearns, Lehman Brothers and other hard-hit institutions would cause a snowballing global financial catastrophe. And I think it’s very likely that’s exactly what would’ve happened were it not for the Fed.
And in my view, it’s to the Federal Reserve Board’s credit that they stepped in to provide essential liquidity and unwavering support to the markets. In fact, that was probably the turning point that began the market recovery. However, the Fed’s commitment was essential for several months, and helpful for a few more. But after many more months and years, the Fed’s continuing massive historical injections of liquidity into the economy were excessive in my view, and subsequently created artificially-high asset prices. Just like in 2008 when far-too-easy credit was one of the main causes of The Great Recession, I find it hard to imagine that central banks’ policies of massive amounts of liquidity in the form of Quantitative Easing and negative interest rates in some countries have repealed the laws of economics. I’d bet that at some point in the future, market historians will evaluate the massively accommodative monetary policies of the time and not look favorably upon it.
Has the system “turned bad?” I think it’s more a disregard the fundamental laws of finance. Every once in a while, when I hear investors complain that their returns aren’t double-digits or the market isn’t skyrocketing anymore, I wonder if they can remember what they felt like about 10 years ago when the quickest way to induce nausea was to talk about the stock market. Investors have been very spoiled in recent years. All you need to do is go back and look at historical stock market returns in the last 200 years and see that single-mid-digits are more the rule than the exception.
Regardless of what the Fed and other central banks or other market cheerleaders say, the laws of finance haven’t been repealed.
They may be forgotten, or misremembered, or overlooked; but eventually, valuations do matter.
In this regard, what is money to you then: a simple mean of exchange, an IOU, or something else?
To me money represents a store of value. It’s a way to show the worth of the work you’ve done or the value of an asset you own. And the largest influences on that it are how a country has treated its currency. What’s it doing to maintain the value of its medium of exchange? Issuing more of it? Expanding or contracting its budget deficits? Trade imbalances? Inflation rates? Conducting its fiscal and monetary policies? This is one of the reasons cryptocurrencies became so popular: they eschewed reliance on a government’s currency and tried to create a more level playing field. Unfortunately, in my view, cryptos have introduced far more problems than they’ve solved.
I could probably list about a dozen reasons that they’re at best not practical, and at worst, just plain dangerous. Why? They’re completely unregulated; their ownership is often concentrated in the hands of an unknown few; they have no supporting assets or guarantee; they facilitate certain illegal activities; they’re not matched through any central exchange or clearinghouse, etc.. The idea of cryptocurrencies is very interesting, actually intriguing, and I’d bet that at some point in the future these issues will be sorted out and actually make them a legitimate alternative to hard currencies. But until then, as I wrote in one of our newsletters last year, I honestly wouldn’t be surprised to wake up one day and see that most cryptos just evaporated into digital thin air. But that’s a topic for another time.
Earlier you discussed FT71’s Convergent Trading, and your participation. I’m interested in what you do there and whether you have any goals with it?
I’d say my main goal there is to help as many traders as I can, who really do want some guidance, time permitting. I’ve made just about every mistake someone can make in trading. I’m not proud of that but it’s true. I don’t think it would be an exaggeration to say that I could’ve bought a princely vacation home or two in the Caribbean with the losses I took on stupid trades. But I tell you what—I’ve learned. I mean, I’ve always been somewhat—no, probably very stubborn—and I’ve had to learn things for myself. I’ve had to convince myself and see the evidence to believe something’s true. It’s not enough to have some ethereal idea that I shouldn’t be fading a trend or moving a stop or trying to pick a top. I’ve got to know.
So, when I suggest that a trader review the day’s price action before they close their trading platform, or consistently write in their Daily Trade Journal, or just go take a walk after a series of bad trades—I’ve been there. And If I can help at least some of them avoid the litany of mistakes I’ve made, that’s very worthwhile to me. Remember, my training and experience was in the mid-to-long investment timeframes before I followed FT71 and I’ve spent literally years learning to trade in the short timeframe. So I’ve been there—and it wasn’t that long ago. There’s a great quote I read by Thomas Edison, responding to someone who asked why it took so many years for him to invent the light bulb. Edison looked up and said simply, “I just ran out of ways it didn’t work.”
How would you preserve capital? How do you secure it for the decades ahead?
The first, most important step is to evaluate your risk tolerance and goals, in the context of your age, available assets and other important criteria. Creating a plan for someone young, with their entire career ahead of them is very different from a person who’s recently become widowed, and is trying evaluate what the rest of their life will look like in terms of where they’ll live, the amount of assets they have to work with and the expenses they anticipate. That’s why I put such an emphasis on taking the time with our clients when we first begin to work together, so we can understand what unique challenges they might face.
And in terms of our business, that’s where the asset allocation Model Portfolios we use work so well. After we have a client’s complete financial picture, we can then use a Model, or a derivation of it, and revise it as a client’s needs change. In the most simple terms, our Models are structured on a scale of 1 to 10 in terms of aggressiveness, with 10 being the most aggressive and 1 being the least aggressive. We tailor the type of mutual funds that comprise the Models, and choose from asset classes that include growth stocks, government, corporate and high-yield bonds, dividend payers, international securities and real estate.
Many people think they can just buy an index fund and they’re set. I don’t agree. What if Europe’s equity markets are more expensive relative to the U.S.? Commodity shares in Australian are dirt cheap? Small cap stocks are extremely overvalued? When you buy an index fund, you buy everything it owns, regardless of whether the companies that comprise it are cheap or expensive. The Model Portfolios give us a lot of flexibility, so we can be very selective. Many index funds do have low expense ratios—but in my view, you get what you pay for. The idea is to invest for the maximum return with the least risk amount of risk for your particular situation. You can’t do that in a one-size-fits-all index fund or in the newest robo-advisor fad. The value is in knowing not just what to invest in, but when and why, so you can really focus on growing what you have.
Basically, people started to come back to your firm shortly after the crisis. Did any trends change? Do you suggest the same stocks and strategy?
That’s a good question. It seemed like there were two main types of investors during the Great Recession. The first group included those that regardless of what the stock market did, were just not going to sell out. They understood the long-term benefits of staying in the stock market or for whatever reason, they weren’t going anywhere. Others sold near the bottom at exactly the wrong time, when they should’ve been buying. And some missed the bottom entirely and are still trying to figure out “when to get back in.” If you held, depending on how you were invested, your accounts are probably orders of magnitude higher. Remember that in 1929 some people made outsized fortunes. And I’m sure there’ve been some fortunes made in 2008 and 2009. But it’s at the time people feel sick looking at their retirement accounts and are stuffing their unopened monthly statements in a drawer, that buying and holding has paid off so handsomely.
What do you think of the markets today? Are they going to plunge again due to all these trade wars, etc?
I’m not sure about a “plunge,” but I do think in many cases there are a lot of securities that are egregiously overvalued. And it’s not just the trade wars you mention; there are a lot of serious issues investors already know about, and seem willing to ignore. In terms of monetary policy alone, given the massive amount of liquidity that central banks have forced into the system over the last ten years, it’s logical to expect some type of comeuppance. It’s easier to say that it will happen, but not so easy to say when. Just as in 2008-2009, I think many investors are ignoring important warning signs. It seems to me nonsensical events are pushing the risk markets higher. It’s just not reasonable to have the Atlanta Fed downgrade their expectation for GDP and have the markets react—by going higher, which is exactly what happened recently.
Also, there is more than one poster child for the excesses: take for example a certain very popular upstart electric car company I won’t name, with overburdening debt, that loses money nearly every quarter, has a controversial owner who has been fined by the SEC for manipulating its share price, produces what is quickly becoming a commoditized product, has ongoing manufacturing issues, faces strong competition from experienced companies with deep managements that have been in business for decades, etc. But their share price continues to climb. It’s a terrific product. But that’s far different from a terrific investment. Day trade it? Maybe. Own it for longer than a day? No thanks. And there are plenty of examples just like this one. There is a huge difference between price and value. Price is what you pay for something. Value is what you get. I’m still surprised by how quickly some investors forget how they felt during the depths of 2008.
So, compare that to looking at boring old value securities. One of my best trades in the early days, when markets were at reasonable valuations, was in a well-know semiconductor manufacturing company that was out-of-favor due to some unexpected earnings disappointments. If I remember correctly, this company was the quintessential value investment: it had something like $10/share in cash, no debt, tons of liquidity and you could’ve bought it for around $12/share. So, basically, you were getting the company with its excellent track record, great prospects and well-established reputation for about $2. If they had any chance to ever again turn a profit, you were buying all that potential for a pittance. In other words, if the company were liquidated, its shareholders would basically get $10 per share. You were taking extraordinarily little risk of permanent loss of capital; you were buying assets and not hopes.
Not long after that, I recall within two years, shares were trading somewhere north of $100. At certain times, in certain markets, that’s not unusual. The downside is that you weren’t able to brag at cocktail party how “smart” you were by buying the latest hot tech company that everyone was fawning over and bragging that they owned. But considering how it turned out—well, that’s something that wasn’t too hard to live with. That’s value investing.
Are you still looking at fundamentals today when you decide where to invest money?
Yes, but those opportunities I just described are not as plentiful because of the overall spike in market prices. When the market goes up it tends to drag a lot of things with it, regardless of quality. So yes, fundamentals are still important. In markets like we have now, investors get sloppy; in fact, I’d say in general that the higher it goes, the sloppier they tend to get. Many think that that just because something goes up, it’ll continue to go up or its a great investment. But just like you can escape gravity for a short while, or even a bit longer, gravity eventually wins. It’s an immutable law of nature. So how long will this market continue to go up? Simple. It will continue until doesn’t. But I think it’s smart in any market to be well-grounded in understanding the fundamentals. And to be prepared for any outcome.
What is the minimal amount you require for your partnership or a managed account?
Usually $250,000. It’s about as much work to meet with a new client, discuss their goals, evaluate their situation, develop a suitable plan and manage the account regardless of size. I try to help whomever I can, but it’s just the best use of our time to set a reasonable minimum threshold. Most of our clients are referred in to us, primarily by word-of-mouth. Obviously, I’d love to build our business much larger because I believe we offer a very unique and effective value proposition but I just won’t do it solely to grow the size of our assets under management. It has to be quality growth. This business is my life’s work, and I want to make sure we do the best job possible for our clients.
If you don’t mind me asking, why do you use an alias online?
No worries. I do it for two main reasons. At Convergent and any other social media outlets I participate in, I want people to focus on what I have to say and decide whether they think it’s valuable to them. I want them to objectively consider my views, my opinions, and decide for themselves what does or doesn’t have merit to them. That’s one of the benefits of the growth of technology and having an online presence, although there are a lot of things that aren’t good like having no accountability. I think making someone concentrate on thinking, on learning something without regard to who I am, where I live or what color my hair is, creates a concentration on the ideas that can be helpful.
The second reason is because of the current regulatory environment. There are strict rules about giving investment advice, not just personally but in the public media as well, and drawing additional scrutiny by securities regulators isn’t at the top of my list of fun things to do. We’re already regulated by almost a half-dozen government and industry-based entities and I’d rather do what I love, than have to explain to them why someone made or lost money based on my opinions. It’s not any intention of being secretive, just my way of offering to help traders and not run afoul of any regulations.
If you had to list a few current influences on your business, what would you say they are?
I’d say two main ones. First, continuing to learn and strive to be better every day. I believe you have to constantly keep up with new ideas, new concepts. So I subscribe to a bunch of securities-related publications, like in-depth analyses of the economy, macro trends, and new securities and strategies. And it’s not just investment-related reading. I continue to come back to books like Napoleon Hill’s Think and Grow Rich, which is a tremendous book with a bad title. It’s all about the cornerstones of success and relating to people, and the importance of character, honesty, commitment, determination and most of all, a positive mental attitude. I don’t think it would be an understatement to say reading that book was a turning point in my life.
And although I’ve gotten further away from following Warren Buffett, mostly because the markets are much different now than when he started, he has a great philosophy about investing and life. He and his partner, Charlie Munger, have a very down-to-earth way of distilling what’s really important. Second, I’d say meditation. That’s something FT71 got me on about six years ago and I can’t imagine not doing it. I do Transcendental Meditation but you can really do any form of it. I thought it was a joke when I started and pretty much couldn’t sit still when I did it. But after a month or so, I started to see profound benefits. Taking that 20 minutes twice a day really does center your mind and give you clarity and calmness. And I’ve noticed the effects are very beneficial to trading and in other areas, too. Let’s just say that on days I don’t do TM, the people around me can tell in about 10 seconds. And not in a good way.
Finally, how would you sum up your overall views on business and life?
I feel grateful that things have turned out as they have. I’m in a fortunate place. I work with some great people; I’m building a business I love that helps others and provides for my family; and I do just about “tap dance to work” (well, most of the time). Overall, I believe it’s important to devote time to deciding how you want to live and what’s important to you. In business, I think the most important things are to do what you say you’ll do, be fair, and do your best. As far as personally, those same things are paramount, too.
I tell my two teenage daughters that they should try to do three things each day:
- do something fun
- learn something new
- and help someone
No question I’ve made plenty mistakes and have had to learn too many things the hard way. But I think those types of experiences contribute to making a person who they are, and influences how they decide to live. And if at the end, I can look back and know that I’ve made a positive impact on as many people’s lives as I could—then that will be a very worthwhile legacy.
Thank you. We and our readers appreciate it greatly.
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- The fundamentals of investing are always important.
- No amount of outside influence can permanently repeal the laws of economics.
- Markets always eventually reflect fundamental value in the long-term.
- Investing is all about value. Price is what you pay; value is what you get.
- Continue striving to improve.
- Do something fun, learn something new and help someone every day.
- Consider practicing meditation or another discipline that gives you clarity and calmness.
- Practice gratitude.