The Rude Awakening
Wall Street, New York
Tuesday, November 21, 2006 ------------------------- - War, women and all the other things we know nothing
about, - What if you could turn all you don't know into great
investments? - Your inside track, gold on another run and plenty
more...
------------------------- Eric Fry, reporting from Laguna Beach, CA... "There are plenty of things in this world of which we are
fairly ignorant - global warming...peak oil...K-Fed and
Britney," the editors of the Daily Reckoning recently
admitted. "But then there are things of which we are fairly
certain - specifically, the advantages of private investing
over public investing." Your Rude Awakening editors are not so different. The
catalogue of subjects about which we know nothing would
fill an encyclopedia. In fact, it already does. The more we learn, the less we know. And, sadly, experience
does not always promote knowledge. For example, our 47-year
study of women...and war...and warring women...has produced
more befuddlement than knowledge. Women and wars both
continue to confound us. But this seasoned ignorance of ours is often quite
valuable. Knowing that we know next-to-nothing, we do not
ever trust completely the objects we esteem. At the same
time, we do not ever dismiss completely the objects we
scorn. Experience has taught us that promise and potential
often produce failure. We have learned that the world's
brightest lights often flame out the fastest, while
smoldering embers sometimes set the world ablaze. In other words, we have learned that "you never know." A man who knows that he knows nothing, knows very well that
he should not expect love to result from a series of
expensive dinners; he also knows that he should not expect
a productive day to result from a night of drinking; and he
knows very well that he should not expect capital gains to
result from paying a rich price for a common stock. Knowing that he cannot trust pricey market valuations to
remain pricey, and that he cannot trust the CEOs of public
companies to remain honest (if they ever were in the first
place) and that he cannot trust politicians to uphold
promises not to change tax laws, he seeks a margin of
safety. He seeks a discount against the unknown. He seeks
to buy good companies at great prices. And when he can't, he doesn't buy, as Bill Bonner explained
last week to the attendees of the New Orleans Investment
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http://www.isecureonline.com/Reports/SCI/ESCIGB42 ---------------------------- What We Don't Know
by Bill Bonner We stand before you a profoundly ignorant man...What we
don't know is almost everything. We don't know which
investments will go up. We don't know what will happen in
the world. We don't know if global warming is a farce or a
fact. We don't know if Peak Oil is something to worry about
or something to ignore. As Donald Rumsfeld put it, there
are known unknowns; and there are unknown unknowns; and
then there are things about which we don't have a clue. Still, that didn't stop the Bush Administration from
launching the biggest foreign policy blunder in U.S.
history...nor does it stop us from having opinions and
ideas about things. In fact, as we get older, the less sure
we are that we know about anything. And there are people
who think we already know nothing at all. But the less we know for sure...the more important it is to
have rules and principles you can follow. So as we become
more ignorant about what is going on, we become more
stubborn in our opinions about things. Now, imagine that
there were no Barron's...no Dow...no financial
commentators...and no one writing books such as 'Dow
36,000.' If that happened, you'd have to rely only on your
own eyes and ears...and your own ability to put two and two
together. Investing would become a private matter. The
public spectacle of the whole thing - where you get Abby
Cohen telling people how much 'The Market' is going up -
would disappear...because there wouldn't be any public
market - just millions of private transactions, each one
made on its own merits. In our private lives, by the way, that is the way we tend
to do things anyway. For example, if you were in the
publishing business, as we are, you would look around to
see how to invest your money without much thought to 'The
Market.' You know you can get about 5% risk-free by buying
U.S. Treasury obligations. And you know you can borrow at
about 7% or 8%. So, in everything you do, you have to be
sure that it will give you a return of more than that.
Otherwise, it's not worth doing...unless you're doing it
merely in an effort to learn something or to gain
prestige...or to accomplish something else with a non-
financial purpose. 
But when we look for acquisitions in the publishing field
that fit this objective we see that they are hard to find.
We have to spend a lot of time talking to people,
researching companies, studying bits and pieces, looking at
a lot of publishing projects in order to find the one or
two that make sense for us. And guess what, rarely are
these investments available to the public. They tend not to
be listed on the public markets. Out there in the public -
where stocks are quoted on Wall Street - publishing
businesses tend to be just too expensive. In fact, in only
one case did we find a publicly traded company that was
cheap enough to consider. And that was the case of
TheStreet.com...but only after it crashed. And even then it
was only interesting to us and to a small handful of other
investors from the industry who thought they knew what to
do with it. In other words, even though it was available to
the public, and even though it looked cheap enough to meet
our criteria, a regular public-market investor probably
still should have stayed away from it, because he wouldn't
have known what to do with it to make it profitable. Well, as it turned out, TheStreet.com figured that out for
themselves too, and their share price rose to the point
where it was no longer a good investment for us. But how
could it be that a stock could be too expensive for those
of us in the industry who best understand it? Why is it
that public market investors believe they know more about
our industry than we do and are willing to pay higher
prices than we are? We've been in the business for thirty
years. How does the casual, public-market investor think he
can do better with this company than we can? We just bring
it up to be provocative. We all know there's a big difference between what goes on
in public and what goes on in private life. A guy can make
a fool of himself...most do...but it takes a crowd to make
a real public spectacle. Because in public...in a
crowd...in a stock market, for example, a guy will do what
he would never do on his own. This includes paying more for
a company than it is really worth. In private, he looks at
the situation as we do when we are making an acquisition;
he figures out what it will cost and what it should be
worth to him. But in public, he gets pushed along by
slogans, headlines, collective fears and impossible dreams
that he wouldn't possibly take seriously in his private
life. So, we give you our first general rule: you will do better
investing privately than you will investing along with the
public. Why is that? Because, a private investor is more
likely to know what he knows and what he doesn't. And by
getting close to his investments - by really knowing the
industry and the business - he is able to eliminate some of
the unknowns and make a better decision. Generally, that
means he pays less for his investments and works harder to
get them. And now, another rule - the further you get from the facts
and from the consequences of any action, the worse the
results. This is true for individuals as it is for groups.
In politics it is obvious that a town meeting in New
England is a long way from the U.S. Congress. Both are
collective activities; both are, broadly speaking, forms of
democracy. But the folks voting on where to put the new
town dump are acting on information that is very close at
hand. They know the area. And they don't want to put the
dump in the wrong place, because they are the ones who will
have to live with it. If they put it upwind of the town,
for example, the rest of the town will regard them as
idiots and probably tell them so. And they will be very
attentive to the costs, too, because they are the ones that
will have to pay for it. The U.S. Congress, on the other
hand, is usually far removed from both facts and
consequences. Members of Congress routinely vote on legislation that they
haven't even read. Not only do they readily vote to spend
other people's money, they often spend money that hasn't
even been earned yet by taxpayers who have not yet been
born. And recently, they went along with a war in a country
they'd never been to, for reasons they didn't understand,
paid for with money they didn't have, and fought by
soldiers who were not their own sons and daughters. In
ancient Rome, engineers were forced to stand under the
arches they had designed when the scaffolding was removed.
And in ancient Greece, not only did the sons of the
assemblymen go out to fight, so did the leaders themselves.
Not only that, the oldest veterans were put on the front
lines! If Americans wanted to make their government more
responsible, they would force congressmen to put all their
wealth in U.S. dollar bonds...and serve in every war they
start. How long would American troops remain in Baghdad, we
wonder, if each member of Congress were forced to serve a
tour of duty there? Our general rule works for investments
too. The further you get away from them...and the less you
suffer the consequences...the worse your investments will
be. That's why 'collective' investments are usually so bad.
The investor himself does not take the responsibility for
making decisions - removing him entirely from the facts -
and managers do not suffer the consequences. These
investments - index-linked funds, mutual funds, hedge funds
- are just ways of being 'in The Market,' - not ways of
making serious investments. And since the rate of returns
you will get are always reduced by the managers' fees,
you'll always - over time and on the average - get less
than the market itself. And as we pointed out, getting 'The
Market' is not getting much. Stocks go up and down. You go through a complete cycle -
paying fees, taxes, commissions and adjusting for inflation
- and you are usually about where you began. Hedge-funds
are a special case. Their 'I win, You lose' fee structures
are so aggressive that the average hedge fund investor is
almost bound to lose money. Even when the fund makes money,
the manager takes a large chunk of the winnings. And, of
course, when it loses money, he takes none of the losses.
Since the average fund is likely to get average results,
the average fund investor is likely to end up with less -
not more - money. Felix Dennis, publisher of Maxim magazine among other
things, has a house on St. Barts. The luxury island is a
playground for the rich and famous. Felix says that when he
got to know his neighbors, he found that they were almost
all hedge fund managers. 'Where are the hedge fund
customers?' he wanted to know." After we made this speech,
our old friend, John Mauldin came up and corrected us:
"You're all wrong about hedge funds," said he. "Some of
them do make a lot of money. But they're like stocks. The
best ones are not available to you. And as you pointed out,
you would have to work pretty hard to find the ones that
will do well. The average hedge fund is no different from
the average stock. On a good day, it will probably lose
money for its owners. On a bad one, it will wipe them out." [Joel's Note: The question, then, for all of us know-
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