Be Careful About the Stories You Tell Yourself

Hedgehogs, foxes, and African white-bellied go-away birds... The one trait all 'investor animals' have in common... The 'comforting market buoys and trail signs of stories'... Be careful about the stories you tell yourself... When to tell the right story... Sell bubbles, buy 'anti-bubbles'...

In last Friday's Digest, I (Dan Ferris) asked if you're a hedgehog or a fox...

The question is based on a 1954 essay by philosopher Isaiah Berlin. In it, readers learn that "the fox knows many things, but the hedgehog knows one big thing."

After introducing the essay last week, I noted that many of the most successful investors in history are hedgehogs. Their "one big thing" is simple to see... Each of these hedgehogs has created his own simple, powerful method and stuck with it for the long term.

I also said that true investor foxes are rare... But with his strategy of going anywhere in the world for a firsthand look and buying anything he likes, Jim Rogers qualified as one.

We concluded that the hedgehog-fox dichotomy is more about self-reflection and self-discovery for investors. In the end, it doesn't really matter which one you are... But it makes your financial endeavors – and life, in general – easier if you know.

We don't need to rehash all the details of last week's Digest. Let's face it... Success is success whether you're a hedgehog, a fox, or even an African white-bellied go-away bird.

So this week, instead of contrasting different styles, we'll focus on a single attribute that cuts across all varieties of "investor animals." It's something they all have in common...

All successful investing is a long-term proposition...

Let me be clear from the start... My statement doesn't refer to the average length of time an investor holds his or her positions. Some people hold stocks until they die... And plenty of folks only hold their investments for hours – and rarely, if ever, overnight.

My point is that... to be truly successful, you must be focused on the long term.

Yes, I'm talking about all those successful short-term traders, too. It's easy to see how that's true...

Even the best short-term traders probably don't make money on more than half their trades. And they don't typically risk much on each trade, either. So they must stick with their system for a long time to compound significant amounts of wealth.

Trading is a craft that must be studied and honed over many years – often even decades. So yes, even in this short-term arena, the best traders are long-term-oriented individuals.

That's what I mean by "long term."

It still takes time to amass wealth in the financial markets, no matter your strategy. Being in a hurry to make "big money" in the markets is a massive, all-too-common mistake.

A genuine long-term investment perspective ultimately refers to how long you stick with your strategy...

Even the best strategy will take years to perfect and years more to generate a lot of wealth.

Warren Buffett and Charlie Munger have been looking for businesses they understand... with sustainable competitive advantages... run by good managers... and available at an attractive price... for nearly 50 years. And before that, both nonagenarians spent decades using other strategies before trying that one.

Most of the subjects interviewed in Jack Schwager's early Market Wizards books have been at it (if they're still alive) for several decades... And remember, those gurus are almost all traders with short holding periods for individual positions.

All of those successful long-term investors have created their own pockets of order amongst the seeming randomness and chaos of financial-market fluctuations. You might say they've written their own stories about how markets work, which they keep repeating to themselves day after day for their whole careers...

Humans are natural storytellers – and their favorite audience is themselves...

In his 1983 novel, Waterland, author Graham Swift wrote...

Man... is the storytelling animal. Wherever he goes he wants to leave behind not a chaotic wake, not an empty space, but the comforting marker buoys and trail signs of stories. He has to go on telling stories. He has to keep on making them up. As long as there's a story, it's all right. Even in his last moments, it's said... he sees, passing rapidly before him, the story of his whole life.

The world just doesn't make sense to us unless we can weave enough of what we learn into a coherent narrative. And to achieve great skill at a complex task, we must be able to simplify its complexities... We must write our own stories about it.

The problem, of course, is that life – especially life in the financial markets – isn't a story. It consists of many random, unpredictable events. And we live with much uncertainty.

In other words, storytelling is good as far as it goes... But there's a lot of territory it simply doesn't cover effectively (if at all). The financial markets are places where you better be careful about the stories you tell yourself...

The problem is, humans aren't naturally wired to handle financial-market fluctuations well...

Most of the time – as the markets bump along from week to week, month to month, and year to year – you don't notice this deficiency.

You simply contribute to your 401(k) through each paycheck... and get on with your life.

But this deficiency is present all the time... It's just lurking in the shadows, waiting to trip you up when some seemingly random event happens that you're not ready to handle.

In his excellent book The Storytelling Animal, author Jonathan Gottschall reports on more than 50 years of study by split-brain-research pioneer Michael Gazzaniga. As Gottschall writes...

The storytelling mind is simply allergic to uncertainty, randomness, and coincidence. It is addicted to meaning. If the storytelling mind cannot find meaningful patterns in the world, it will try to impose them. In short, the storytelling mind is a factory that churns out true stories when it can, but will manufacture lies when it can't.

Much of what happens from day to day in the stock market is random. But that doesn't stop us from telling ourselves stories about it...

Any day of the week, you'll find the Wall Street Journal saying something like, "Markets fall as traders reassess inflation." The market might've fallen less than 0.5% that day... That's the type of movement that's well within the boundaries of randomness.

Explaining such a move is impossible.

We're often fooled by randomness in this way... As Gazzaniga might say, we insist on telling ourselves untrue stories about random events, even though they're unexplainable.

Being "allergic to uncertainty, randomness, and coincidence" makes succeeding in the stock market about as normal as leaping out of a fully functioning aircraft mid-flight... Even with a parachute on, it's still an unnatural act.

Obviously, plenty of folks make money in stocks. They contribute to retirement plans for decades and accumulate enough wealth to maintain a good lifestyle when they stop working. Maintaining a long-term view is relatively easy when it's automated in your weekly paycheck.

But a lot of people are active, self-directed investors, too... They're using a large chunk of their own money to buy and sell individual stocks, bonds, options, futures, and other financial instruments.

If you're one of these people, you absolutely must learn an important skill to maintain the healthy long-term view that's necessary to succeed at that difficult task...

You must learn to tell yourself the right story at the right time...

I shared a good illustration of this point with listeners of our Stansberry Investor Hour podcast earlier this week...

It comes from Dot.Con: The Greatest Story Ever Sold by journalist John Cassidy. As you might've guessed from the title, the 2002 book is all about the dot-com boom and bust.

In the book's prologue, Cassidy briefly describes the dot-com-era saga of Priceline.com – which is now known as Booking Holdings (BKNG)...

With its original gimmick, the now-popular online-travel website allowed customers to name their prices for airline tickets. So how did that go?

Priceline sold $35 million worth of airline tickets in 1998, the year it began operating. But it paid $36.5 million for those tickets. And after factoring in costs for marketing, website development, and $60 million in stock options to airlines to entice them to sell its tickets, the company totaled a $114 million loss in 1998.

In the throes of the dot-com boom, Priceline.com's stock went public in March 1999 at a split-adjusted $497 per share... It peaked at $974 per share in April 1999. Then, it crashed to less than $8 per share by December 2000... recovered for a couple of years... and ultimately plunged back below $8 per share again in February 2003.

In his book, Cassidy noted that, at its peak valuation, the company was valued higher than the entire airline industry. And when Priceline.com's stock crashed from that peak the first time...

The entire market capitalization of Priceline.com would not have covered the cost of two Boeing 747s.

Cassidy nailed his job... As a journalist trying to sell a book, telling the tale of Priceline.com as an overvalued, money-losing company that wiped out over-optimistic investors during the incredible bust following a massive speculative bubble was the right thing to do in 2002.

After all, it was near the bottom, a time when all anyone wanted to do was cry over the spilled milk of investment bubble losses. So it was a phenomenal time to sell such a story.

But the right story for journalists to tell at any given moment is usually the wrong one for investors...

At the height of the dot-com bubble, the right story for investors about Priceline.com was the one that Cassidy told at the bottom...

This is a money-losing company valued at $23 billion – roughly 19 times sales. It's going to lose hundreds of millions this year. It went public in the biggest equity bubble since 1929 and rose nearly 10-fold in a few months. There's no way I'm buying it.

But as the stock started crashing along with all the other hyped-up dot-com stocks that year, investors should've changed their story about it. The original story was now wrong for investors...

You see, the company's operating results were strong throughout the dot-com crash and beyond. At the very least, it was worth keeping an eye on the stock.

Priceline.com's sales eclipsed $1.2 billion in 2000 – roughly 35 times its 1998 sales. The company went cash-flow positive in 2001 (when the September 11 terrorist attacks hit the airline industry hard). And it reported positive earnings per share in 2003.

As I said earlier, the company is now called Booking Holdings. And it's a real cash-gusher...

Booking Holdings generated $4.5 billion in free cash flow in 2019. That, of course, was the year before governments shut down the global economy in response to COVID-19.

The stock trades today around $2,180 per share – or roughly 270 times its split-adjusted 2003 bottom of just less than $8 per share. The company's revenue grew 428-fold over the past two-plus decades – from $35.2 million in 1998 to just more than $15 billion in 2019. And its earnings per share rose 256-fold from 2003 through 2019.

Clearly, the correct long-term view on the company's business and share price was an insanely bullish one... no matter what was happening in the overall economy.

While Cassidy was publishing the right story about Priceline's previous woes for journalists in 2002 (near the bottom of the dot-com bust), investors should've started telling themselves a different one at that point... They should've changed the story to one about a rapidly growing company with a value proposition that customers couldn't resist... and great long-term investment potential.

The time to tell yourself a story about an overvalued, money-losing business is while it's still overvalued and losing money...

And the time to look for positive stories to tell yourself is when a company's share price has fallen from speculative manic highs to post-speculative bust lows. As long as the business itself has continued to perform well, you could have a great long-term bet on your hands.

In other words... when markets hit extremes, find reasons to think the opposite of the herd when making new investments.

It's the classic contrarian mindset. But with that said, let's get something straight...

I'm not talking about a company like AMC Entertainment (AMC) today...

AMC's whole industry – movie theaters – has been in decline for more than a decade. It's nothing more than a "meme stock" whose value has been artificially inflated by a bunch of Robinhood clients and other novices who have no idea what they're doing.

The stock is now trading almost 50% below its 52-week highs... And yet, it's still drastically overvalued. Given that AMC's underlying business is deteriorating, it's unlikely that I'll be looking to tell myself any positive stories about it.

It would have to get super dirt-cheap for that to happen... And even then, I still might pass.

AMC is still a bubble stock. So is Robinhood (HOOD), the now-publicly-traded brokerage app used by all those neophyte day traders to buy AMC, GameStop (GME), and the other meme stocks. By the way, here's the right story to tell yourself about Robinhood...

Robinhood went public yesterday. Its shares closed down 8%, valuing the company at about $29 billion. That's roughly 21 times its trailing 12-month revenue. And Robinhood lost $1.3 billion over those 12 months.

When the wildest casino of the wildest speculative mania in history goes public, you don't buy it.

You might be tempted to sell its shares short... but even that's risky in a world full of hungry day traders looking to spend their cash. Just avoid it altogether for now... and maybe keep an eye on it to see if the business continues to perform well even after the mania has completely busted (and half of its clients leave because they're out of money).

That always happens, eventually.

That's the right story to tell yourself about many stocks today, but not all of them. You should tell yourself bearish stories about bubbly assets like AMC and Robinhood...

However, you should be telling yourself bullish stories about 'anti-bubble' assets...

In his 2017 book The Anti-Bubbles: Opportunities Heading Into Lehman Squared and Gold's Perfect Storm, investor and author Diego Parrilla gives two definitions of the term "anti-bubble"...

First, he describes it as the process through which asset prices become artificially deflated. It's the opposite of a bubble, which is when asset prices become artificially inflated.

Second, an anti-bubble is a defensive tool that investors can use to protect themselves from bubbles. It's similar to how antimissiles can be used to protect against missiles...

For example, a couple of weeks ago in the Digest, I described the process through which oil and oil stocks got cheap...

Governments and environmentalists have cast fossil fuels as the villains in their story about the "emergency" they claim global warming to be. That's the anti-bubble process in action.

In that Digest, I also told you to buy oil and oil stocks... It's one of the clearest anti-bubble investment tools that investors can put in their portfolios today – an anti-bubble tool for defense against bubbles in other assets.

Now, think back to the point we made to start today's Digest...

All successful investing is a long-term proposition.

I can't tell you when the current equity bubble will burst... I can't tell you how long it'll take for oil stocks to outperform... Heck, I can't even tell you that I'll be right about either claim.

That's because, as I explained earlier, life in the financial markets isn't a story...

We don't know what will happen next. Many random, unpredictable events can occur. And because of that ongoing uncertainty, you must be careful with the stories you tell yourself.

But at the same time, as I often say... we can prepare for any number of outcomes.

Right now, I can tell you that the S&P 500 has never been this expensive before. I can tell you that any time stocks have been anywhere near this expensive throughout history... they've generated poor returns for years into the future.

And when talking specifically about oil and oil stocks, I can tell you that despite the constant negative press about fossil fuels and the constant hype about "renewable energy" (a meaningless term filled with hype)... fossil-fuel demand is rising and will continue to rise.

Like all bubbles and anti-bubbles, the current trends could take years to play out... That's why we must all have a long-term perspective to navigate them successfully.

And remember, the same long-term viewpoint is necessary whether you're someone like Buffett, whose favorite holding period is forever... or you're someone like a Market Wizards trader who only holds on to positions for a matter of hours or days.

In the end, there's no way around it...

Investors must be careful about the stories they tell themselves. And when it all comes down to it, they must focus on what's needed to maximize success over the long term.

New 52-week highs (as of 7/29/21): ABB (ABB), AbbVie (ABBV), Automatic Data Processing (ADP), Brown & Brown (BRO), CBRE Group (CBRE), Costco Wholesale (COST), Dropbox (DBX), Dollar General (DG), Fortescue Metals (FMG.AX), ICICI Bank (IBN), Lynas Rare Earths (LYSDY), Cloudflare (NET), NVR (NVR), Invesco S&P 500 BuyWrite Fund (PBP), ResMed (RMD), ProShares Ultra Health Care Fund (RXL), S&P Global (SPGI), Stamps.com (STMP), TFI International (TFII), Thermo Fisher Scientific (TMO), and Trane Technologies (TT).

In today's mailbag, some "small world" feedback on Mike Barrett's Digest about investing lessons learned from a great football coach. Do you have any comments or questions? As always, you can e-mail us at feedback@stansberryresearch.com.

"The Bill Walsh essay [from Thursday] brought back fond memories for me.

"I was a black-car driver in the late '90s and early 2000s and was fortunate enough to drive Coach Walsh many times. Our conversations will remain private, but...

"What wasn't mentioned in the essay was how meticulous he was. Always the perfectionist.

"And he was one of the most humble 'famous' people I ever met. He insisted on no sign with his name on it when picking him up at the airport, and always shipped his luggage so that he wouldn't have to wait at the luggage carousel, to eliminate the chance of being noticed.

"Genius." – Paid-up subscriber Michael A.

Good Investing,

Dan Ferris
Eagle Point, Oregon
July 30, 2021