In a confusing market, I turn for advice to Shoeshine, who works the chair in the basement of that old hotel. He knows me only by my pseudonym, Mark Depp of Marketdepth. On a quiet afternoon last week I found him at his post…
Mark Depp: Shoeshine! Am I ever glad to see you. Is it the right time to get back in the stock market?
Shoeshine: Why do you think this is the time?
MD: Well, Shoeshine, all last year people were selling stock and there were no buyers. So prices got crazy low. But now, things haven’t turned out as bad as we feared, so everyone’s sitting on a big pile of cash. When that cash starts buying stocks it’s going to drive up stock prices maybe higher than they were in 2007!
Figure 1: Why is now the time? asked Shoeshine
SS: With all due respect Mr. Mark, I think you may misunderstand certain market mechanics. When “people” were selling last year, to whom were they selling?
MD: Well to other buyers, of course.
SS: And from whom will this year’s optimistic buyers make their purchases?
MD: Um…From other sellers, I suppose.
SS: So you see, Mr. Mark, the amount of buying is always matched equally by the amount of selling. And so, it is not the transactions themselves that move the prices, but changes in the market participants’ estimation of fair value.
MD: Hmm, you know Shoeshine, I had never really thought of it that way. Of course you are right. So I guess I should rephrase my question. Should I switch my cash into stocks because I have realized today that the stock market is trading below fair value?
SS: My poor Mr. Mark. Your life must be so difficult, trying to find moments when the entire market is over- or undervalued.
MD: What other approach is there, Shoeshine?
SS: Have you ever thought about making smaller decisions on which you have more complete information?
MD: Well, the other day I was offered an $800,000 two-bedroom apartment in Yaletown, but I didn’t buy because I thought the price was too high. And the week before that there was an end of season sale at the pool supply store so I stocked up on Floaties at half price.
SS: Very good, Mr. Mark. You see, in your day-to-day life you make relatively rational decisions about whether to be a buyer or a seller based on an understanding of prices and value. Why don’t you take that same approach with your investment book?
MD: But Shoeshine, if I could be either a buyer or a seller of any particular investment on any particular day, then…then…every day I would be facing the same opportunity!
SS: And so you do, Mr. Mark.
MD: Ooooooh, my head is spinning!
SS: As you find overvalued assets, like the Canadian banks, be a short seller. And whenever you unearth bargains like silver or Coastal Contacts, be a voracious buyer. Your life is better in two ways. First, you avoid the need to make an overall market call. But more importantly, you will convert a book of speculative positions into a balanced portfolio that earns the spread between over-valued and under-valued assets.
MD: Ah, Shoeshine, I believe I finally understand. Now I notice an interesting picture hanging beside your booth. There are three men standing in front of a pot of vinegar. They have touched the vinegar and are now sucking the sour taste from their fingers. The first two men’s faces are all contorted, but the third man – he looks a lot like you – is calm and smiling. Why is he smiling?
Figure 2: Three Investors Taste the Market
SS: He is smiling, my friend, because is following the way of the Tao. He recognizes that the vinegar tastes as sour as it is supposed to. Therefore he is calm, even happy if you will.
He has made peace with a market that sends hoards of new real estate agents to chase commissions just before a housing crash. He smiles as honest analysis is ignored while manias are fanned by improbable claims. He understands that men can no more prevent the loss of fortunes from bursting bubbles than bacteria can prevent themselves from declining after a period of exponential growth. He realizes, Mr. Mark, that the universe has been around forever. Therefore he knows that if problems of this nature were solvable, they would already be solved.
MD: And the other two men, I have seen before, but where?
SS: Mr. Mark, you will see these tortured faces everywhere and at all times. You will notice that the first man looks a lot like Mr. Bernanke. From his face you can see his intelligence. From his demeanour you may observe his power. Yet his face is screwed against the bitterness of a reality he cannot manipulate. For all the money he can print, he creates no wealth. For all the good news he can manufacture, he is powerless against simple truths that sprout like weeds on an empty field.
MD: And the other man?
SS: When is the last time you looked in a mirror, Mr. Mark? For this other tortured soul...It is you.
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