Investing – Forget What You Know, Here Are the REAL Guiding Principles

Now that I’m retired, I finally have some time to spend researching topics for which I was previously ignorant. Investing is an excellent example and one where I’ve spent quite a bit of time recently catching up. Here’s what I found.

Anyone who has become wealthy by investing in the stock markets or financial markets is no more intelligent than you or I; they are simply luckier. The reason this is true is that I’ve found that financial investing has nothing to do with logic or intelligence.

As explained to me recently by a friend of mine – who once read one of Warren Buffett’s annual reports and should know – my lack of success as an investor is the result of a failure to grasp three fundamental, underlying principles that guide all action in today’s financial and investment markets:

1. Good news means bad news.

2 Bad news means good news.

3. No news means everyone is waiting for the Chairman of the Federal Reserve Bank to mumble something publicly.

These three paradoxical statements apparently make perfect sense to the major stock brokers, a group that excludes anyone living west of Chicago and everyone who thinks in a calm, rational manner.

Since these principles seemed a bit nonsensical to me, I asked for an explanation from another friend of mine – who once read almost an entire issue of the Wall Street Journal and should know – and will now share the secrets to understanding the art of investing. No experience is necessary, only a highly refined sense of the absurd.

Principle One: Good News is Bad News

This applies primarily to the Federal Reserve Bank, an organization that collectively always seems to have a sour stomach.

For example, when we enjoy good economic growth and low unemployment, logic tells you this is good news.

That is unless you are the Fed.

Then it’s bad news because to them it means the economy is overheating and this can lead to higher inflation, the control of which seems to be the Fed’s sole reason for existence.

So, the Fed raises interest rates, which lowers the prices for existing bonds and causes bond investors to go berserk as the prices of their portfolios drop.

Since rising interest can also cause stock prices to drop, as more people buy high-interest-rate bonds, equities investors are also gulping hard as the value of their portfolio goes south.

Everyone desperately hopes for some bad news to improve their fortunes. This brings us to principle number two.

Principle Number Two: Bad News is Good News

Okay, let’s say the leading economic indicators show that the economy is taking a nosedive. Unemployment is going up rapidly and the University of Michigan’s Consumer Sentiment Indicator reads “pathetic.”

This certainly is bad news from the rational person’s perspective. Not so in the financial markets. Indeed, this is extremely good news. It means low inflation is likely, which means the Fed probably won’t be raising interest rates.

This bolsters bond and stock prices, making investors overall very happy, although the average consumer probably feels a bit differently.

When there is no news about the direction that interest rates will take, principle number three comes into play.

Principle Number Three: No news means everyone is waiting for the Chairman of the Federal Reserve Bank to mumble something publicly.

When the Fed remains silent as to interest rates, the investment community gets nervous and both stocks and bonds can go either up or down depending on if the prevailing opinion is optimistic or pessimistic.

Optimistic investors may think that no news is good because interest rates will remain the same. Pessimists may think no news is bad because the longer the Fed remains silent, the higher the inevitable rate hike will be.

Actually, if you refer back to principles one and two, it really doesn’t matter which way the Fed goes.

The bottom line here is that what matters seems to be not so much the actual news that makes a difference, but rather what investors expect the news to be.

For example, if a particular company’s earnings report shows a net increase of 10% but the stock market was expecting 15%, the stock price will very likely go down.

Conversely, if earnings are down 10% but expectations are for a 15% drop, the stock price will likely go up.

This bears a disturbing similarity to beating the point spread in a sports event, where you can win money betting on a losing team that loses by less than the point spread or lose money betting on a winning team that wins by less than the point spread.

For the hapless small investor, such as myself, I guess all we can do is invest in large aggregate funds and hope for good news.

But wait…that would be bad news. We can’t win.

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