Ken Fisher on Market Analysis
April 7, 2006 • Posted in Individual Gurus
Guru Grades ranks a group of 29 stock market experts according to our assessments of the accuracy of their stock market forecasts. Since Ken Fisher, CEO of Fisher Investments, has been at or near the top of the list since inception, we asked him to encapsulate his thinking on anticipating financial markets. He graciously agreed. Here is Ken Fisher on market analysis:
Forecasting (Macro and Micro) and Future Concepts
by Ken Fisher
When Steve LeCompte asked me to explain how I work, I was flattered. As background, at 55 years old, I have been in the investment advisory world all my adult life, founded a firm that runs more than $30 billion with 800+ great employees and written the Forbes “Portfolio Strategy” column and its predecessor for 22 years. I have written three books — the first one also 22 years ago — and published many other things in many different places. It’s not like the world needs a lot more words from me.
So, what I decided to do here is try to summarize what I think are the most important elements of market analysis. My experience tells me that the only basis for making a bet is believing somehow, some way, that I know something other people do not know. If I make bets based on things others widely believe, I will end up being wrong/unlucky as often as I am right/lucky, with transaction costs leaving me worse off than if I made no bets at all.
The Value of Knowing Something Others Do Not Know
Pretty much everyone would agree that knowing something others do not know is worthwhile. But how do you get there?
Most investors treat investing as a craft. Craftsmanship is an age-old human modality based on passing skills from generation to generation in fields as diverse as the building trades, blacksmithing, medicine, accounting, law and jewelry making.
Professional investors and investment advisors typically go to school and then extend their learning via apprenticeship with a master craftsman focused on a particular investing style (value, growth, small capitalization…). Once they learn the craft, they “practice” like a doctor or a lawyer. They seldom try to change the craft, and the rare changes they introduce are minimal because they believe the craft basically sufficient to the task at hand. Craftsmanship is fine. I want any doctor hacking into me to have had one heck of a lot of mentoring and practice. But craftsmanship assumes the existing body of knowledge is sufficient, and that kind of complacency does not support outperformance in investing. Markets discount all widely known information, including the traditional craft.
We do not know much today about how capital markets work compared to what we will know 10, 20, 30 and 50 years from now. One way to know something that others do not know is to be the first to envision the capital markets technology of the future. I focus on building capital markets technology that explains parts of the investing world never understood before.
The Three Questions
When I envision the future, I try to answer three basic questions. In fact, I am in the process of writing a book about these three questions that I hope to have out in early 2007. Briefly, the three questions are:
1) What do I believe that is actually wrong?
2) What can I fathom that others do not?
3) What is my brain doing to mess me up right now?
I used to read the media and see something posited that I thought wrong. I would run off to do the statistics to prove that I was right that there was no correlation there and without correlation there could be no causality. Some years later I realized I was doing the wrong thing. I should instead monitor the media for ideas with which I agree, and then check to see whether these ideas are actually wrong. I am better trained, apprenticed, educated and practiced as an investor than the average person, so if I believe something is right when it is actually wrong, most of the world is probably about to get snookered. Suppose I, along with most people, believe X causes Y. But through systematic self-critique, I determine that my belief is wrong. X does not, in fact, cause Y. Then X happens, and most people bet on Y, but I bet against Y. I have an edge, what finance theory calls the rational basis for a bet, because I know something others do not know. That takes care of question one.
Suppose no one has a clue what causes Q, and most people therefore pessimistically think it is a waste of time to try to figure out what causes Q. To me, such an abandoned field is fertile ground for exploration. I start contemplating what variables might generate causality. I seek correlations, and then look inside them for causality consistent with fundamental economics and capital markets theory. Invariably, I try to link any conclusions back to shifts in supply and demand for securities. I have had successes with this approach. In this website are snippets from columns of mine going back some years including timely warnings that the technology bubble was about to burst, even though I had previously been favorable toward technology stocks. That prediction came directly from prior securities supply and demand analysis I had done on the bursting of the energy bubble in 1980. The supply-demand dynamics for the two cases are almost identical! I have done many such analyses, the most recent on the supply-demand dynamics underlying the current stock buy-back and cash-based takeover explosion. If you make a commitment to fathom the unfathomable, you can go farther than most people think. That takes care of question two.
The third question is steeped in the post-1970s emergent field of behavioralism, which exposes and examines the dilemma of framing. When we experience problems (opportunities) presented or framed one way, we cannot see a solution; but when the problem is framed another way, we see the solution clearly and quickly. Framing is important in all fields, but solutions to financial market problems seem to be especially blinded by an endless array of bad frames. So I try to look at things upside down, backwards and inside out! I make a point of finding new perspectives. That’s how I first cooked up the Price/Sales Ratio decades ago and why I think in terms of E/P instead of P/E. Further, I always test in other countries everything that we believe works in the United States, because foreign perspectives might present better frames. That takes care of question three.
Simply Unbelievable, and Supposed to Be
Over the course of my career, I have learned many things that a lot of people do not believe. Differences in beliefs are fine with me. How else could I know something that others do not know?
For example, it is easy to prove that current account and trade deficits are not bad for an otherwise healthy economy. I know that fact and have publicly covered it a fair amount. The United States and most of the western world are not over-indebted but, in fact, markedly under-indebted and need more debt of almost any type. That assertion elicits an almost religious hostility from many people, but their anger does not negate the truth. They just do not want to believe it. I like that. When I see people freaking about a big current account deficit, I can bet against them. Understanding that we need more debt changes the way I think about many other things.
I know high P/E stock markets by themselves say nothing at all about market risk. I know if most people forecast something, whatever it is, it cannot happen, and I have learned how to forecast against the consensus with the bell curve technology I talked about in Forbes many years ago. And, as the years have gone by, I have learned how to adapt that technology to a variety of obscure markets always trying to do something new and assuming that what I have done before will soon be obsolete. I aim all this effort at simply trying to know something that others do not know. The crazier others think my beliefs are, the better I like it. It means they will work longer. I find that rejection of seemingly offbeat views stems from a lazy reliance on market mythology. I repeat, I like that.
Within this framework, I always think globally. A global perspective helps me see my home markets better, as it would for anyone from any country. Because I spend a lot of time in Great Britain, I often compare supposed truisms in both countries and translate them from one market/economy to the other to test consistency. Both commonalities and differences teach me lessons. Britain is the best single laboratory for validating the U.S. frame of reference, although many other countries provide good tests.
For perspectives on stocks, I always think in terms of the MSCI World Index or the MSCI All Country World Index before I ever think of the S&P 500 Index. I think about the S&P 500 Index no more often than I think of the FTSE 100 or the Topix 150. I never think in term of the Dow haven’t in decades. Our long-term interest rates are fully set in global markets, so I think in terms of global money supply growth, global interest rates and global yield curves. My firm is nearly unique in systematically maintaining a set of all those global statistics, rather than domestic ones, as a decision-making framework. Late in 2005, as the yield curve in the United States inverted, lots of folks assume that bad times lie ahead. Because of the adequately steep global yield curve, I am unconcerned. Major banks will just borrow in one country and lend in another. At worst, the inversion of the yield curve in the United States argues for underweighting domestic securities in comparison with foreign stocks. Most people see my view as simply unbelievable. And that’s fine with me.
It’s Boring, But It’s Boring Down
Next, I think in terms of sectors and countries, looking deeper via the three questions for what I can know that others do not. For example, I have learned that, other things being equal, federal budget deficits are great for future stock returns. Therefore, I look for countries where deficits are worse than expected, with investors illogically recoiling in fear. I bet against that fear. Ultimately, I progress from selecting countries and sectors to picking specific stocks within them. I want to own individual securities, because it is way too expensive in the long term for active investors to own packaged financial products. (Packaged products are OK for passive investors who accept not knowing something that others do not. Just not my style.)
When Graham and Dodd prepared the third edition of Security Analysis, the last revision they did themselves, mutual funds and other packaged products were well known tiny by today’s standards but still well established. That edition appeared 11 years after the Investment Company Act of 1940, in large part a regulatory reaction to the emerging world of mutual funds. Yet Graham and Dodd purposefully did not include mutual funds in their book not even a mention. They considered them to be artificial securities unworthy of real security analysis. They would look askance at the degree to which current investors use expensive packaged products today in preference to primary portfolio building blocks. I want to hold the underlying fundamental securities.
So, I am finally down to picking individual securities. Stocks! Bonds! Primary instruments! It is easier to do this now than it was 25 years ago. Back then, there were so few securities in most categories that it was hard to find stocks (except those of tiny firms) not completely picked over by everyone else. Today, with over 20,000 equities around the world you can find many relatively ignored opportunities. All I do is choose those with underappreciated attributes and good relative pricing from within the categories I like.
We’re All Still Blind and Seeing the Wrong Frames
I am sure I do not see myself accurately. None of us do. Our mental machinery was not built to do this stuff. We got our brains from thousands of generations past, and our brains are little evolved from their brains. I have a neo-stone-age information processor in my head trying to deal with a post-industrial information explosion in extremely complicated capital markets that my great, great grandfather could never have contemplated. The biggest advantage I have over most people is I know I am blind. But even if I screw up a lot, and I do, I have been getting by using the approach described above for more than a third of a century. My time is running out fast, with less ahead of me than behind. I am not yet quite adjusted to that fact.
Meanwhile, I like what I do. I like looking for new things. I like trying to figure out the next new thing. I like it when I shift frames and discover something that was right in front of me the whole time that makes me feel really stupid. It is awe inspiring. Developing new things is the most important, exciting and contributing part of being alive at this point in human evolution. It is a lot more fun than applying, with a few minor modifications, some craft I learned 30 years ago. If I were a doctor or accountant, I would get bored fast. I hope to have some more years to have fun.
I hope this description of how I work is useful to you and that maybe you even enjoyed reading it. Thanks.
Thanks to Ken Fisher for providing this piece.