Editor's note: There's one simple way to help make sure you're not on the wrong side of big market trends: Run away from the crowd.
In today's edition of our weekend Masters Series – previously published in the January 13 issue of the free e-letter Investment U – Alex Green reminds us about the importance of being a contrarian investor.
Going along with the conventional wisdom can feel reassuring... But Alex, the chief investment strategist of our corporate affiliate The Oxford Club, shows that it's usually a good way to lose money...
Want to make a lot of money in the stock market? Then ignore conventional wisdom. Or better yet, do the opposite...
Five years ago, for instance, investors were told to adjust their sails and get ready for "the New Normal." This proclamation, issued far and wide and trumpeted by market pundits as well-known as PIMCO bond king Bill Gross, claimed U.S. stocks – which had returned roughly 10% a year for the past two centuries – would start returning considerably less, perhaps half as much.
Conventional wisdom said stocks simply weren't worth the risk.
So what has happened the past five years? The S&P 500 has returned 16.1% a year – a whopping 60% more than the average – and turned in its best performance last year since 1990. If this is the new normal, I'm bullish on normalcy.
Another example: In the years leading up to the financial crisis, investors were told that they should "buy and hold" stocks for the long run. This is indeed a viable strategy for those with a very long-term horizon (measured in decades) and a cast-iron stomach.
But this approach turned horrifying as the stock market plunged more than 50% from its 2007 highs to its 2009 lows. Buy and hold was a good way to get flattened. It's far better to buy and use a trailing stop. That gives you unlimited upside potential with strictly limited downside risk.
Fourteen years ago, stock traders were told that we were in a "new era" for technology and that "the Internet changes everything." They promptly bid the technology-laden Nasdaq index up to more than 5,100. Not only did this sector crash and burn, declining more than 75%, but – nearly a decade and a half later – it hasn't reached that nosebleed level again. The Internet changes a lot of things, but not the truism that investors who buy into bubbles end up taking a bath.
Today's "Wisdom"
I mention these things only to provide a little perspective on the current conventional wisdom that the U.S. economy is likely to experience slow growth and the stock market is likely to go up only about 8% to 10% this year.
Don't bank on it. While the long-term average of the stock market is 10.1%, not once since 1926 (when modern data on the U.S. stock market began) have U.S. stock markets returned between 8% and 10% in a single year. That's right, not once in 88 years.
As Jason Zweig noted in the Wall Street Journal, "Many investors believe that financial markets exist to facilitate the efficient allocation of capital. That's a myth. The purpose of financial markets is to humiliate anyone who thinks he can predict how they will perform in the short run."
So while conventional wisdom is calling for modestly positive stock returns in 2014, the reality is we could be in for a shocker. Third quarter U.S. economic growth is reportedly up more than 4%. Unemployment is coming down. Inflation and interest rates are low. Profits are up. And so are profit margins.
So rather than a middling single-digit return, U.S. stocks could have another banner year in 2014.
Or not. After all, my guess isn't the result of divine inspiration, either. And you shouldn't be running your money based on economic forecasts, market calls, guesses, theories, or hunches anyway, but on proven investment principles.
However, we all have to place our bets somewhere. And history shows you're better off placing it almost anywhere other than conventional wisdom.
Good investing,
Alex
Editor's note: "Conventional wisdom" tells us this is a good time to add gold and resource stocks to your portfolio. But as Alex says, following the conventional wisdom is not a recipe for investing success. That's why The Oxford Club just made a very bold (and potentially very lucrative) move. To see what it has done... click here.