Formula Investment Plans

1. In the early years of the stock market rise that began in 1949-50 considerable interest was attracted to various methods of taking advantage of the stock market's cycles.
2. These have been known as "formula investment plans."
3. The essence of all such plans - except the simple case of dollar averaging - is that the investor automatically does some selling of common stocks when the market advances substantially.
4. In many of them a very large rise int he market level would result in the sale of all common-stock holdings; others provided for retention of a minor proportion of equities under all circumstances.
5. This approach had the double appeal of sounding logical (and conservative) and of showing excellent results when applied RETROSPECTIVELY to the stock market over many years in the past.
6. Unfortunately, its vogue grew greatest at the very time when it was destined to work least well.
7. Many of the "formula planners" found themselves entirely or nearly out of the stock market at some level in the middle 1950s. True, they had realized excellent profits, but in a broad sense the market "ran away" from them thereafter, and their formulas gave them little opportunity to buy back a common stock position.
8. (Many of these "formula planners" would have sold all their stocks at the end of 1954, after the US stock market rose 52.6%, the second-highest yearly return then on record. Over the next five years, these market-timers would likely have stood on the sidelines as stocks doubled.)
9. There is a similarity between the experience of those adopting the formula-investing approach in the early 1950s and those who embraced the purely mechanical version of the Dow theory some 20 years earlier.
10. In both cases the advent of popularity marked almost the exact moment when the system ceased to work well.
11. We have had a like discomfiting experience with our own "central value method" of determining indicated buying and selling levels of the Dow Jones Industrial Average. (Note that, in referring to his "discomfiting experience," Graham is - as always - honest in admitting his own failures.)
12. The moral seems to be that any approach to moneymaking in the stock market which can be easily described and followed by a lot of people is by its terms too simple and too easy to last.
13. (Easy ways to make money in the stock market fade for two reasons: (1) the natural tendency of trends to reverse over time, or "regress to the mean," and (2) the rapid adoption of the stock-picking scheme by large numbers of people, who pile in and spoil all the fun of those who got there first.)
14. Spinoza's concluding remark applies to Wall Street as well as to philosophy: "All things excellent are as difficult as they are rare."

Ref: Intelligent Investor by Benjamin Graham

Buy-Low-Sell-High Approach

1. We are convinced that the average investor cannot deal successfully with price movements by endeavoring to forecast them.
2. Can he benefit from them after they have taken place - i.e., by buying after each major decline and selliing out after each major advance?
3. The fluctuations of the market over a period of many years prior to 1950 lent considerable encouragement to that idea.
4. In fact, a classic definition of a "shrewd investor" was "one who bought in a bear market when everyone else was selling, and sold out in a bull market when everyone else was buying."
5. This viewpoint appeared valid until fairly recent years.
6. Between 1897 and 1949 there were ten complete market cycles, running from bear-market low to bull-market high and back to bear-market low.
7. Six of these took no longer than four years, four ran for six or seven years, and one - the famous "new-era" cycle of 1921-1932 - lasted eleven years.
8. The percentage of advance from the lows to highs ranged from 44% to 500%, with most between about 50% and 100%.
9. The percentage of subsequent declines ranged from 24% to 89%, with most found between 40% and 50%. (It should be remembered that a decline of 50% fully offsets a preceding advance of 100%.)
10. Nearly all the bull markets had a number of well-defined characteristics in common, such as:(1) a historically high price level,(2) high price/earnings ratio,(3) low dividend yields as against bond yields,(4) much speculation on margin, and(5) many offerings of new common-stock issues of poor quality.
11. Thus to the student of stock-market history it appeared that the intelligent investor should have been able to identify the recurrent bear and bull markets, to buy in the former and sell in the latter, and to do so for the most part at reasonably short intervals of time.
12. Various methods were developed for determining buying and selling levels of the general market, based on either value factors or percentage movements of prices or both.
13. But we must point out that even prior to the unprecedented bull market that began in 1949, there were sufficient variations in the successive market cycles to complicate and sometimes frustrate the desirable process of buying low and selling high.
14. The most notable of these departures, of course, was the great bull market of the late 1920s, which threw all calculations badly out of gear.
15. Even in 1949, therefore, it was by no means a certainty that the investor could base his financial policies and procedures mainly on the endeavor to buy at low levels in bear markets and to sell at high levels in bull markets.
16. It turned out, in the sequel, that the opposite was true.
17. The market's behaviour in the past 20 years has not followed the former pattern, nor obeyed what once were well-established danger signals, nor permitted its successful exploitation by applying old rules for buying low and selling high.
18. Whether the old, fairly regular bull-and-bear-market pattern will eventually return we do not know.
19. But it seems unrealistic to us for the investor to endeavour to base his present policy on the classic formula - i.e., to wait for demonstrable bear-market levels before buying any common stocks.
20. Our recommended policy has, however, made provision for changes in the proportion of common stocks to bonds in the portfolio, if the investor chooses to do so, according as the level of stock prices appears less or more attractive by value standards.
21. (This policy, now called "tactical asset allocation," is widely followed by institutional investors like pension funds and university endowments.)

Ref: Intelligent Investor by Benjamin Graham

All those who forget are doomed to be reminded

1. Without bear markets to take stock prices back down, anyone waiting to "buy low" will feel completely left behind - and, all too often, will end up abandoning any former caution and jumping in with both feet.
2. That's why Graham's message about the importance of emotional discipline is so important.
3. From October 1990 through January 2000, the Dow Jones Industrial Average marched relentlessly upward, never losing more than 20% and suffering a loss of 10% or more only three times. The total gain (not counting dividends): 395.7%.
4. According to Crandall, Pierce & Co., this was the second-longest uninterrupted bull market of the past century; only the 1949-1961 boom lasted longer.
5. The longer a bull market lasts, the more severely investors will be afflicted with amnesia; after five years or so, many people no longer believe that bear markets are even possible.
6. All those who forget are doomed to be reminded; and, in the stock market, recovered memories are always unpleasant.
   
   

Ref: Intelligent Investor by Benjamin Graham

The famous Dow theory for timing purchases and sales

1. The famous Dow theory for timing purchases and sales has had an unusual history.
2. Briefly, this technique takes its signal to buy from a special kind of "breakthrough" of the stock averages on the upside, and its selling signal from a similar breakthrough on the downside.
3. The calculated - not necessarily actual - results of using this method showed an almost unbroken series of profits in operations from 1897 to the early 1960s.
4. On the basis of this presentation the practical value of the Dow theory would have appeared firmly established; the doubt, if any, would apply to the dependability of this published "record" as a picture of what a Dow theorist would actually have done in the market.
5. A closer study of the figures indicates that the quality of the result shown by the Dow theory changed radically after 1938 - a few years after the theory had begun to be taken seriously on Wall Street.
6. Its spectacular achievement had been in giving a sell signal, at 306, about a month before the 1929 crash and in keeping its followers out of the long bear market until things had pretty well righted themselves, at 84, in 1933.
7. But from 1938 on the Dow theory operated mainly by taking its practitioners out at a pretty good price but then putting them back in again at a higher price. For nearly 30 years thereafter, one would have done appreciably better by just buying and holding the DJIA.
8. In our view, based on much study of this problem, the change in the Dow-theory results is not accidental. It demonstrates an inherent characteristic of forecasting and trading formulas in the fields of business and finance.
9. Those formulas that gain adherents and importance do so because they have worked well over a period, or sometimes merely because they have been plausibly adapted to the statistical record of the past.
10. But as their acceptance increase, their reliability tends to diminsh.
11. This happens for two reasons: First, the passage of time brings new conditions which the old formula no longer fits.
12. Second, in stock-market affairs the popularity of a trading theory has itself an influence on the market's behaviour which detracts in the long run from its profit-making possibilities.
13. (The popularity of something like the Dow theory may seem to create its own vindication, since it would make the market advance or decline by the very action of its followers when a buying or selling signal is given. A "stampede" of this kind is, of course, much more of a danger than an advantage to the public trader.)

Ref: Intelligent Investor by Benjamin Graham

Timing is of no real value to the investor unless it coincides with pricing

1. There is one aspect of the "timing" philosophy which seems to have escaped everyone's notice.
2. Timing is of great psychological importance to the speculator because he wants to make his profit in a hurry. The idea of waiting a year before his stock moves up is repugnant to him.
3. But a waiting period, as such, is of no consequence to the investor.
4. What advantage is there to him in having his money uninvested until he receives some (presumably) trustworthy signal that the time has come to buy?
5. He enjoys an advantage only if by waiting he succeeds in buying later at a sufficiently lower price to offset his loss of dividend income.
6. What this means is that timing is of no real value to the investor unless it coincides with pricing - that is, unless it enables him to repurchase his shares at substantially under his previous selling price.

Ref: Intelligent Investor by Benjamin Graham

Comment:

For the investor who sold at the high of the market, "timing" is of no real value, unless it enables him to repurchase his shares in the future at substantially lower than his previous selling price.

Many good quality stocks, badly sold down during the recent severe bear market, have risen above their previous highs.

Those who sold good quality stocks in the recent severe bear market would not have benefited unless they have also bought these shares back at substantially lower prices during the depth of the bear market.

Pros and Cons of Market Forecasting

1. A great deal of brain power goes into this field, and undoubtedly some people can make money by being good stock-market analysts.

2. But it is absurd to think that the general public can ever make money out of market forecasts.

3. For who will buy when the general public, at a given signal, rushes to sell out at a profit?

4. If you, the reader, expect to get rich over the years by following some system or leadership in market forecasting, you must be expecting to try to do what countless others are aiming at, and to be able to do it better than your numerous competitors in the market.

5. There is no basis either in logic or in experience for assuming that any typical or average investor can anticipate market movements more successfully than the general public, of which he is himself a part.

The forecasts of "market strategists" became more influential but not more accurate

1. In the late 1990s, the forecasts of "market strategists" became more influential than even before. They did not, unfortunately, become more accurate.

2. On March 10, 2000, the very day that the NASDAQ composite index hit its all-time high of 5048.62, Prudential Securities's chief technical analyst Ralph Acampora said in USA Today that he expected NASDAQ to hit 6000 within 12 to 18 months.

3. Five weeks later, NASDAQ had already shriveled to 3321.29 - but Thomas Galvin, a market strategist at Donaldson, Lufkin & Jenrette, declared that "there's only 200 or 300 points of downside for the NASDAQ and 2000 on the upside." It turned out that there were no points on the upside and more than 2000 on the downside, as NASDAQ kept crashing until it finally scraped bottom on Octorber 9, 2002, at 1114.11.

4. In March 2001, Abby Joseph Cohen, chief investment strategist at Goldman, Sachs & Co., predicted that the Standard & Poor's 500-stock index would close the year at 1,650 and that the Dow Jones Industrial Average would finish 2001 at 13,000. "We do not expect a recession," said Cohen, "and believe that corporate profits are likely to grow at close to trend growth rates later this year." The US economy was sinking into recession even as she spoke, and the S & P 500 ended 2001 at 1148.08, while the Dow finished at 10,021.50 - 30% and 23% below her forecasts, respectively.

Comment: We cannot predict with certainty what the future will bring, but we can take some comfort that in the long run, it will be alright.

Market Fluctuations as a Guide to Investment Decisions

1. Since common stocks, even of investment grade, are subject to recurrent and wide fluctuations in their prices, the intelligent investor should be interested in the possibilities of profiting from these pendulum swings.

2. There are two possible ways by which he may try to do this:

• the way of timing and
• the way of pricing.

3. By timing we mean the endeavor to anticipate the action of the stock market – to buy or hold when the future course is deemed to be upward, to sell or refrain from buying when the course is downwards.

4. By pricing, we mean the endeavour to buy stocks when they are quoted below their fair value and to sell them when they rise above such value.

5. A less ambitious form of pricing is the simple effort to make sure that when you buy you do not pay too much for your stocks. This may suffice for the defensive investor, whose emphasis is on long-pull holding; but as such it represents an essential minimum of attention to market levels.

6. We are convinced that the intelligent investor can derive satisfactory results from pricing of either type.

7. We are equally sure that if he places his emphasis on timing, in the sense of forecasting, he will end up as a speculator and with a speculator’s financial results. This distinction may seem rather tenuous to the layman, and it is not commonly accepted on Wall Street.

8. As a matter of business practice, or perhaps of thoroughgoing conviction, the stock brokers and the investment services seem wedded to the principle that both investors and speculators in common stocks should devote careful attention to market forecasts.

9. The farther one gets from Wall Street, the more skepticism one will find, we believe, as to the pretensions of stock-market forecasting or timing.

10. The investor can scarcely take seriously the innumerable predictions which appear almost daily and are his for the asking. Yet in many cases he pays attention to them and even acts upon them.

11. Why? Because he has been persuaded that it is important for him to form some opinion of the future course of the stock market and because he feels that the brokerage or service forecast is at least more dependable than his own.

Ref: Intelligent Investor by Benjamin Graham

Price Changes in Common Stocks

This is an important subject.

Through historical survey of the stock market's action over the past many years, we hope to learn what the past record promises the investor - in either:

• the form of long-term appreciation of a portfolio held relatively unchanged through successive rises and declines, or,
• in the possibilities of buying near bear-market lows and selling not too far below bull-market highs.

The Investor and Market Fluctuations

The investors in these assets need not take market fluctuations into account.

1. To the extent that the investor’s funds placed in high-grade bonds of relatively short maturity – say, of seven years or less – will not be affected significantly by changes in market prices, and need not take them into account.
2. This applies also to his holdings of US savings bonds, which he can always turn in at his cost price or more.

The investors in these assets need to take market fluctuations into account.

1. His longer-term bonds may have relatively wide price swings during their lifetimes, and
2. his common-stock portfolio is almost certain to fluctuate in value over any period of several years.
3. The investor should know about these possibilities and should be prepared for them both financially and psychologically.
4. He will want to benefit from changes in market levels –

• certainly through an advance in the value of his stock holdings as time goes on, and
• perhaps also by making purchases and sales at advantageous prices.
• This interest on his part is inevitable, and legitimate enough. But it involves the very real danger that it will lead him into speculative attitudes and activities.
• It is easy for us to tell you not to speculate; the hard thing will be for you to follow this advice.

Let us repeat what we said at the outset: If you want to speculate do so with your eyes open, knowing that you will probably lose money in the end; be sure to limit the amount at risk and to separate it completely from your investment program.

Ref: Intelligent Investor by Benjamin Graham

The Intelligent Investor: The Investor and Market Fluctuations

Chapter 8 - The Investor and Market Fluctuations

Right off the bat, Graham argues that attempting to play market timing games is a fool’s game. One can never predict true market bottoms or peaks in advance - they can only be seen through hindsight. Graham also points out that some of the “markers” of a bottoming-out market won’t necessarily hold true for the next bottom, and that same effect holds true for peaks as well. In a nutshell, don’t bother trying to time things based on what you think the overall stock market is going to do.

However, for individual stocks, Graham thinks that timing can actually work well. In this case, though, Graham is referring to detailed study of a company: knowing that the company is sound, knowing how it compares to the competition, and knowing what a reasonable value of the stock should be. Once you’ve identified a good, quality company, then you should keep your eye out for the right price on that stock - when it goes below a certain number without any change in the nature of the company itself, then you buy.

This, in essence, is the key of the “buy low, sell high” idea. You don’t try to time the market at all. Instead, you merely seek out bargains in the things that you know, and you wait for them patiently.

What about selling? For the most part, Graham encourages people not to sell into fluctuations, either, and instead hold onto those steady, dividend-paying stocks. The only time Graham seems to encourage selling based on market conditions is if the prices you would get today are significantly out of whack with the long term history of the stock. For example, if the stock has pretty consistently held near a 12 P/E ratio, but is suddenly selling for 20, it’s probably a good time to sell it.

What’s the end result of all of this? A person who diligently follows Graham’s advice is going to almost always be doing the opposite of what everyone else is doing. When the bull market is roaring and everyone is buying, you’re likely to be holding or selling stocks. When the bear market is afoot and everyone is selling, you’re likely to buy up those value stocks.

What about bonds? Graham generally advocates buying bonds when there are no values to be had in the stock market. In other words, if you have money to invest and the stock market is roaring like a freight train, Graham suggests increasing the portion of bonds in your portfolio. Similarly, when the market is down, one may want to decrease the portion of their portfolio that is in bonds if there are appropriate value stocks out there for purchase. Again, it’s the opposite of what seems to be the convention on Wall Street.

Commentary on Chapter 8
Zweig spends most of the commentary ruminating on Graham’s “Mr. Market.” For those unfamiliar, Graham often liked to imagine the stock market as a person he called Mr. Market. This individual was essentially a manic depressive - when the stock market was rocketing, he’d offer to buy or sell you stocks at a price way beyond what the company was worth, but when the stock market was down, he’d only buy or sell at prices far below what the company should fetch. Graham argued that the way to deal with Mr. Market was patience - wait until he quoted you prices you liked.

Zweig uses several modern examples of irrational exuberance to show this “Mr. Market” phenomenon at work - and the dot-com boom certainly gave us a lot of examples. Zweig discusses Inktomi, which went from a peak well over $200 in 2000 to being worth a quarter a share in 2002, even though the fundamentals of the business actually improved over that time frame. In 2002, it was a bargain, and eventually Yahoo bought the company lock, stock, and barrel for roughly seven times that much.

So how can you avoid situations like Inktomi? Know what you’re buying, be patient, and only buy when the getting is good. Not only does this ensure that you get actual bargains, it also reduces the brokerage fees that a more frenetic buyer and seller would accumulate.

Zweig picks out a great quote from Graham that I think bears repeating here.

The investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage.

That, right there, is most of the lesson of this chapter in one sentence.


Ref: The Intelligent Investor: The Investor and Market Fluctuations