The Biggest Lesson of My Investment Career

How I learned Lehman was going under before almost anyone else... The biggest lesson of my investment career... Numbers can't tell you everything... Why you should attend high-quality investment conferences...

Editor's note: The Digest team is in Las Vegas this week for the 2018 Stansberry Conference and Alliance Meeting. We'll return to our usual fare on Thursday. In the meantime, we're sharing a special Digest series from three of Stansberry Research's top analysts.

The first essay in the series comes from senior analyst Matt Weinschenk, who helps lead the research efforts for Doc Eifrig's Retirement Millionaire, Retirement Trader, and Income Intelligence advisories. Matt holds a master's degree in applied economics from Johns Hopkins University, as well as the prestigious and extremely difficult-to-obtain chartered financial analyst ("CFA") designation.

In today's essay, Matt shares the big lesson he learned from his first investment conference more than a decade ago...

I (Matt Weinschenk) was one of the first people to know that Lehman Brothers would go bust...

But I didn't figure it out for myself. I was just a 25-year-old kid sitting in the right place at the right time (the 2007 Value Investing Congress in New York City, to be exact).

I was in the room when then-regarded short-seller David Einhorn walked the audience through his thesis for why the investment bank would go bust.

Einhorn didn't regale the audience with a gripping story. He just talked accounting numbers. The shocks had already started to show in the banking system. Lehman looked like it had one of the worst loan portfolios of the banks, but it hadn't written off any losses yet.

Something didn't add up. And Einhorn knew an earthquake was coming.

Later, billionaire hedge-fund manager Bill Ackman shared his research on monoline bond insurers. These companies sold insurance on mortgage-backed securities for a few bucks and paid out hundreds if the bonds defaulted. Ackman argued they'd go bust. They had already started to crater, but they went on to lose another 90% within four months.

It was November 2007, and the financial crisis was looming over Wall Street and all of America. But the market hadn't crashed yet.

At that conference, I learned the biggest lesson of my investment career...

As investment conferences go, the Value Investing Congress represented the best of the best at that time. Every speaker managed billions of dollars. Even in the crowd, you could find yourself sitting next to hedge-fund royalty.

However, what I learned those two days had nothing to do with what the speakers said on stage, the investments ideas they presented, the charts they shared, or the balance sheets they studied.

The mood in the room was fearful yet constructive...

Between every session, folks would get on their Blackberries to check in on the stock market. Whoever got an update would yell it out in the hallway.

Several speakers made good cases to buy stocks. After all, these were value investors. And you had to have guts and buy when "there is blood in the streets." They didn't know it, but the streets were about to get a lot bloodier. See for yourself: During the conference, we were right here in the market...

We were on the precipice of the greatest financial crisis in 60 years. Everyone was worried... But we had no idea how far the market would eventually fall. The S&P 500 was about 6% off its peak. The financial sector had already fallen about 20%.

I take a data-focused approach to investing...

Rather than drawing lines on charts like some of my colleagues who specialize in technical trading, I focus on economics and fundamental data. I've run more economic regressions than I care to count.

But at that conference, I learned that numbers will never tell you everything you need to know.

The market has a certain feel to it. You can only pick it up by talking to investors, hearing hedge-fund managers speak off-the-cuff, and listening to candid conversations that aren't supposed to leave the room.

In November 2007, an uncomfortable, grim humor filled the room.

The people in the room stood to lose billions in investor money, and many would lose their jobs. Even so, they weren't panicked. They joked and laughed. They assumed the other guys' portfolios would fall apart, but not theirs.

When a presenter pitched a long stock idea, he'd finish up with a winking disclaimer like, "That is, if you're brave enough to buy any stocks right now." Other speakers made similar jokes: "This is a buy... if there even is a financial sector tomorrow." The crowd reacted with nervous laughter.

What I realized later was that in the depths of a real crash, nobody is cracking jokes...

It's pure fear.

Had the speakers sensed that, they could have avoided some disastrous calls. I remember hearing a presentation from Tom Brown, who runs a website called Bankstocks.com and a hedge fund focused on bank stocks. He basically threw up his hands and admitted it's hard to figure it all out when everything kept moving so fast.

I do remember one bold claim he made, though...

I think we're really close to, if not at, the bottom for the financial services industry. There are many opportunities in the most battered sectors.

That same day, news service Reuters reported his fund was down 50% for the year... Yet, the S&P Financial Index would go on to fall another 80% from there.

Portfolio manager Richard Pzena of Pzena Investment Management gave a talk claiming that Freddie Mac was the cheapest stock he had ever seen. (Fortunately, Stansberry Research founder Porter Stansberry saw right through that baloney.) After that, Freddie shares went from $35 to around $1, and nearly brought down Pzena's investment firm in the process.

Today, everybody wants to be the person who calls the market top...

That will happen once we reach a frenzied euphoria – what my colleague Steve Sjuggerud has coined the "Melt Up." Only then will the market roll over. But I don't see that happening just yet.

Investors are still scarred from the financial crisis. This has been the most hated bull market in history. On Doc's team, we've tried to quantify this and turn it into a single number we can watch.

The following chart shows the S&P 500 and its rolling six-month return...

When the market really heats up, the two-year moving average (green line) tends to spend some time at an elevated level. That indicates a "blow-off top," or the end of the Melt Up. But as you can see, even with the market at new highs, we haven't seen that yet.

The old saying goes, the most dangerous words in investing are 'this time it's different'...

That's catchy, but it's not precise enough to tell you anything.

In one sense, every time is different. We've never had a nine-year bull market with ultra-low interest rates, unemployment below 4%, massively profitable and fast-growing technology companies, and the specter of trade wars all at the same time. Of course it's different.

But what has never changed are investors' mindsets. They are always driven by the same fear and greed. They are likely to let their emotions lead them into doing the exact wrong thing at the exact wrong time. And eventually, they will bid the market up to unsustainable levels before the whole thing comes crashing back down like a house of cards.

As Edwin Lefevre wrote about trader Jesse Livermore in his classic 1923 biography, Reminiscences of a Stock Operator...

There is nothing new in Wall Street. There can't be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again.

That will never change. As a Stansberry Research reader, you're already far more informed than most investors. But well-run, high-quality investing conferences – like the Stansberry Conference in Vegas and the Value Investing Congress in New York – can take your investing to the next level. Look at as many charts as you want... But make sure you're listening to what investors are saying, too.

New 52-week highs (as of 9/28/18): Cisco Systems (CSCO), Disney (DIS), Fidelity Select Medical Technology and Devices Portfolio (FSMEX), ProShares Ultra Health Care Fund (RXL), ALPS Medical Breakthroughs Fund (SBIO), and Service Corporation International (SCI).

Are you with us in Vegas? Let us know what you think of the event by sending a quick note to feedback@stansberryresearch.com.

Regards,

Matt Weinschenk
Las Vegas, Nevada
October 1, 2018