10-Investing Axioms Every Investor Should Learn

Martin Tarlie of GMO just recently wrote a great piece on the issue of the current U.S. Stock Market Bubble asking the question of whether or not it has finally burst. To wit:

“A new model explains this dichotomy between price action and fundamentals by suggesting that a bubble in the U.S. stock market started inflating in early 2017, and continued to inflate through the third quarter of 2018. In the fourth quarter, however, indications were that the bubble had started to deflate. And when bubbles deflate, they generally do so with a volatility bang.” 

The primary premise is one of “mean reversions” particularly from elevated levels of valuations. These reversions are simply the liquidation of the excesses built up during the previous bull market cycle. The chart below shows the secular cycles of the market going back to 1871 adjusted for inflation. As Martin notes, current valuations, while lower than the 2000 peak, are still at levels seen only rarely in history. As I discussed just recently, new “secular” bull markets are not launched from such lofty levels.


As Martin concludes:

“The Bubble Model teaches us that bubbles form when times are good – high valuation – and expected to get even better – changes in sentiment are positive. Bubbles burst when changes in sentiment – not level out – turn negative. 

Given that valuation is still high, our advice, consistent with our portfolio positions, is to continue to own as little U.S. equity as career risk allows.”Since Martin is most likely correct in his assumptions, here are 10-basic investment rules which have historically kept investors out of trouble over the long term. These are not unique by any means but rather a list of investment rules that in some shape, or form, has been uttered by every great investor in history.

1) You Are A “Saver” – Not An Investor


Unlike Warren Buffet who takes control of a company and can affect its financial direction – you are speculating that a purchase of a share of stock today can be sold at a higher price in the future. Furthermore, you are doing this with your hard earned savings. If you ask most people if they would bet their retirement savings on a hand of poker in Vegas they would tell you “no.” When asked why, they will say they don’t have the skill to be successful at winning at poker. However, on a daily basis, these same individuals will buy shares of a company in which they have no knowledge of operations, revenue, profitability, or future viability simply because someone on television told them to do so.

Keeping the right frame of mind about the “risk” that is undertaken in a portfolio can help stem the tide of loss when things inevitably go wrong. Like any professional gambler – the secret to long term success was best sung by Kenny Rogers; “You gotta know when to hold’em…know when to fold’em.”

2) Don’t Forget The Income


An investment is an asset or item that will generate appreciation OR income in the future. In today’s highly correlated world, there is little diversification left between equity classes. Markets rise and fall in unison as high-frequency trading and monetary flows push related asset classes in a singular direction. This is why including other asset classes, like fixed income which provides a return of capital function with an income stream, can reduce portfolio volatility. Lower volatility portfolios will consistently outperform over the long term by reducing the emotional mistakes caused by large portfolio swings.

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Disclosure: The information contained in this article should not be construed as financial or investment advice on any subject matter. Real Investment Advice is expressly disclaims all liability ...

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