4/5/20

Chicken Little's Criteria for Buying Stocks

When will it be time to buy stocks?  

From 1982 until 2000, I was at least 100% invested in stocks. My Chicken Little persona is temporary. I am looking forward to returning to 1980's style Mega Bull. In this post, I revisit the criteria for a major stock market buying opportunity from Mean Markets & Lizard Brains.
Chicken Little will become Mega Bull



Strategy

Conviction is necessary for investment success. All investments face volatility and weak hands will be shaken out. In order to know when to buy stocks in 2020 and beyond, investors need to have conviction regarding the situation and the goal. Place yourself in the following diagram. 


I believe that the coming Depression will be worse than the 1930s Depression. Additionally, I am not looking to make a tactical purchase for a few months of time, but rather searching for the long-term bottom. At that point, I will be a buyer of stocks for the long-run, meaning years or decades. 

The recent decline from Dow 30K to Dow 21K could be another buying opportunity. Every market decline since October 20, 1987 (the day after 'the crash') has been met with the Fed loosening monetary policy. Now that we are at zero percent interest rates, this extra loosening of monetary policy takes the form of e-printing. That is buying up assets with newly created electronic entries. 

Every stock market dip has been a buying opportunity, and this one may be as well. However, because I believe that loose money is bad, I cannot participate in any of these rallies. Rather, I have to sit around a wait for the big collapse. For others, buying dips can be fantastic. Depends on your style and beliefs. 

My criteria for buying are listed below. Before the criteria, a repeat of the explanation for why most people are terrible at investing. 

Why do people systematically lose money in markets? 
Our brains are powerful learning machines shaped to solve the problems faced by our ancestors. For our ancestors, and for most aspects of our world, the correct approach today is the same as the correct approach yesterday. We get better by mimicking or repeating successful behaviors. 


Hunting success requires repeating what has worked

Financial markets are dangerous for brains that predict the future based on the past. Here is the summary from my Lizard Brain book. 

Financial markets are frustrating because our brains are built to look backwards. Our lizard brains will never want to buy the investments that will go up, but rather continuously select investments that have gone up. This equation for frustration is as old as the markets, and will not change.

While the lizard brain will always frustrate us, the specifics of market meanness will reverse. Today, most of us want to buy risk even though it is overpriced. When risk becomes a good buy, most people will be disgusted with risk and cowering inside financial bomb shelters. The good news is that irrationality provides a never-ending supply of opportunities for those equipped with self-knowledge and the courage to be different. 


Stock Buyer's check list

Here is the Lizard Brain stock buyer's checklist as published in 2008. 

Perhaps rather than predict the duration of the current malaise, we should focus on three signals that will give us a green light.

Low Exposure to Risk
When it is time to buy risk, people will generally not have risky financial positions. Stocks are riskier than bonds. So when it’s time to buy risk, stocks will be a small percentage of people’s portfolios.

Similarly, being a debtor is risky, so a sign of a turn will be low levels of debt. This will be evident in a high U.S. savings rate, high levels of home equity, and a current account surplus.

2020: Risk exposures are at historic highs. 



Low Prices to Buy Risk
When it is time to buy risk, the price will be low. This will include low equity valuations and equity dividends that exceed bond market yields. Real estate should produce positive cash flow without any assumption of appreciation.

2020: Prices are high for risky assets. 
US Stock Prices are far above historic buying opportunities


Popular Sentiment against Buying Risk
There is no surer indicator of profitability for an investment than scorn. When it is time to invest in risk, the folk wisdom of the day will tell us that only fools take risks. Perhaps the most salient, recent example is U.S. home prices. Just a few years ago, real estate was considered a “can’t lose” investment. Beware of “can’t lose” investments, as they are the ones that invariably lose.

Rather than look for “can’t lose” ideas, we should look for ideas that are considered idiotic and “can’t win.” This is true for specific investment classes, as well as for financial risk in general. We should buy risk when financial safety is in vogue. For example, a general belief that debt is evil would be a good sign for strong returns to risk. Similarly, look for a time when standard financial advice says that we should eschew stocks. 


At "the" bottom, people will hate real estate and stocks


Is it time to buy stocks on April 5, 2020? Chicken Little says not yet for people who are looking for a long-term buying opportunity and who believe that the world is heading for something worse the 2007-2009. 

The "don't buy yet" conclusion may seem obvious given that US stocks dropped 50% in 2007-2009, and so far in 2020 the decline is 30%. However, the value add of the checklist is that I intend to apply the same criteria over time. The checklist may not help today, but perhaps may in the future 










Dow: 21,000
10 year treasury: 0.60%
Gold: $1,600
Bitcoin: $6,800 

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