By John Mauldin
Reviewed by James Altucher, author, Trade Like a Hedge Fund in the Stock Trader's Almanac Investor newsletter.
Editor's Note: Bull's Eye Investing (Wiley 2004) is one of the Year's Top Investment Books in the upcoming 2005 Stock Trader's Almanac. Mr. Altucher's Trade Like a Hedge Fund is the Best Investment Book of the Year for the 2005 Stock Trader's Almanac. After reading his reference to Bull's Eye Investing in his TheStreet.com commentary we asked him to review it for Almanac Investor. Available at www.stocktradersalmanac.com at a 15% discount.
John Mauldin writes a popular e-mail newsletter which I have been fortunate enough to receive for the past year, so when his book came out I wondered whether there would be anything new. Unfortunately, there's so much new in it that I have to read it for the third time, every now and then stopping to check the extensive third-party sources and research he references in backing his claims. I don't always agree with him on everything but this is a must-read for the investment professional and individual investors. The Wall of Worry, the mythical structure that must be created first before it can be climbed by a raging bull market, is alive and well in the pages of Mauldin's book, and perhaps is so tall as to be intractable for the next 10-15 years.
John's premise is simple: there are a lot of factors that go into making a bull market. Just as this last bull market took 17 years to build to its crescendo, this bear market has probably only just begun. A little sputtering out from 2000-2002 won't satisfy the claws of this bear. From 1964-1981, he notes, the market was essentially flat while from 1981-1999 it rose over 1200%. So one would expect that the economy would reflect what happened in the market? He points out that GDP grew over 300% during the first period and only 174% during the second period. Although over the long-term the market and the economy tend to grow together, don't expect a rising economy to necessarily reflect itself immediately in a rising market.
Ultimately, he contends, returns in the market should roughly be described by the following equation: dividend yield + growth in earnings and dividends + inflation + P/E expansion. He notes that with dividends at all-time lows and growth in earnings and dividends not very impressive compared with inflation that most of the growth in the market over the past decade has been a result of P/E expansion, and he suggests that there is not that much more room to expand with P/Es already greater than 20. Nor is the "E" of P/E all that is cracked up to be. He suggests that if in 2001, you take the top 15 Nasdaq 100 companies, back out option expenses as almost assuredly FASB will do and add back other "one-time" charges that all the companies use to form their pro-forma earnings, and you end up with a P/E of 1789. Ok, this ratio is only one measure for valuing a company or a market but he is simply pointing out that the numbers we hang our hats on every day are suspect. This is the sort of analysis he does on almost every page of this book.
Again, I don't always agree with Mauldin but the arguments, the facts he uses to back them up, the history he frames his conclusions in are all fascinating and merit a through understanding for any investor or participant in these markets.
Even if you assume the earnings picture is not as bleak as Mauldin thinks it is then have no fear, that is only one brick in this wall of worry. In several chapters he details (and I can't stress this enough - he DETAILS) his concerns on pension funds being under funded, the demographics of age in the United States, the effect of a widening trade deficit on our economy and on all the economies we trade with once we start to falter (if we start to falter), and why the psychology of the average investor prevents him from taking appropriate action (i.e. right now).
For instance, with pension funds he observes that most companies make the assumption that they will earn 9% a year. He notes that most companies then base their earnings estimates on this number, further skewing (or skewering) the assumption that the "market P/E" is anything but a fiction. Then, he breaks down what this number means in terms of expectations from bonds and stocks, and why, step by step, the assumptions are unreasonable. And, finally, what happens to us all (and God help us) if these assumptions are in fact unreasonable.
Finally, it's not all bad. Free enterprise ultimately finds its creative solutions. But these solutions don't happen overnight. In the meantime, he has chapters to help the investor value stocks (and he makes a strong case for value in the value vs. growth perennial debate) and for the more sophisticated investor: hedge funds. I think this is where his true love lies as he describes each hedge fund strategy and the methodologies he uses when doing due diligence on a fund.
If I were to summarize the main message of each chapter it would be: don't believe the hype. The hype in earnings, the hype in the economy, the hype from Greenspan, the hype from those selling advice (and avoid systems-sellers if the systems return more than 10% a year, avoid the mutual funds and academics who tell you the market always goes up 6-7% a year in the long run, avoid gold bugs (but not completely) and growth stock fanatics and...) and most of all don't believe your own hype.
Editor's Note: James Altucher is author of Trade Like a Hedge Fund and a partner at Subway Capital, a hedge fund focused on special arbitrage situations and short-term statistically-based strategies. He writes for TheStreet.com, StreetInsight, and StreetView.
