Be Like Max Planck

Chauffeurs versus arithmetic... Jaws hanging open everywhere... Be like Max Planck... Money and intelligence... A good year to learn painful lessons...

As 2022 began, we couldn't have predicted what lay ahead...

Everywhere you looked this year – geopolitics, crypto, bonds, stocks – some new unforeseen event left our jaws hanging open...

Even with Russian President Vladimir Putin's army lining up on the Ukraine border, people I know who lived there at the time weren't worried about him invading. They didn't think it would happen and were shocked to be awakened on the morning of February 24 by the sound of exploding shells.

It didn't just catch the rest of the world by surprise. It caught most of Ukraine by surprise.

Bitcoin started the year around $46,000. Would you ever have thought it would be trading for around $16,000 now?

I told Extreme Value subscribers to exit our position in bitcoin in May for a 193% return after I recommended buying it around $10,000 in February 2020. I thought it was a burgeoning store of value. But since then, it has behaved like just another inflated tech speculation.

In the long term, I expect it'll become a lot more than that. But for now, it continues to behave like a speculative stock.

Of course, the biggest crypto story of the year was the collapse of the now-bankrupt crypto exchange FTX and the downfall of its co-founder and former CEO, Sam Bankman-Fried.

Again, I didn't see this one coming. That's mostly because I'd never even heard of FTX or Bankman-Fried until the company started blowing up in early November.

Now, it's almost impossible to avoid the story of how he allegedly misappropriated customer deposits and was subsequently charged with fraud and conspiracy.

Bonds are another great example. Even though I was very bearish on bonds, I never would've said the 10-year U.S. Treasury note would have its worst six-month performance since 1788.

The 10-year Treasury's yield bottomed out below 40 basis points (0.4%) during the COVID-19 pandemic in 2020. It started 2022 around 1.6%.

Now, it's more than double that amount. It's at an almost respectable yield of around 3.7%. That's a near-10-fold increase in yield on the global benchmark interest rate.

I bet most folks would've never expected Apple (AAPL), Amazon (AMZN), Alphabet (GOOGL), Microsoft (MSFT), Meta Platforms (META), and Tesla (TSLA) to each lose more than $750 billion in market cap. That works out to a combined loss of more than $5 trillion from their all-time highs.

But as Bespoke Investment Group reported Tuesday... that's exactly what happened.

Amazon recently became the first company to lose $1 trillion in market cap. A few years ago, no company on the planet even had a trillion-dollar market cap. Now, one is looking at a trillion-dollar loss of market cap.

We could fill many Digests with such examples. It's why I've consistently repeated my investment mantra, "Prepare, don't predict."

It's one thing to understand that the future is unknowable and that most forecasts and predictions are doomed. But maybe...

It's even more important to know real knowledge from fake knowledge...

This idea is best illustrated by an old joke about Max Planck, the German theoretical physicist who won the Nobel Prize in 1918. He is most famous for giving birth to quantum physics (whatever that is)...

After Planck won his Nobel Prize, he toured Germany in a chauffeured car. And he gave the same lecture on the new science of quantum mechanics. Planck's chauffeur would sit in the back as he lectured. After hearing the lecture many times, the chauffeur had it memorized.

One day, the chauffeur said...

Would you mind, Professor Planck, because it's so boring to stay in our routine. [What if] I gave the lecture in Munich and you just sat in front wearing my chauffeur's hat?

Planck agreed. After they pulled into Munich, the chauffeur took the podium and gave the lecture without a hitch.

In the question-and-answer session that followed the lecture, the first question was asked. And the chauffeur said...

Well, I'm surprised that in an advanced city like Munich I get such an elementary question. I'm going to ask my chauffeur to reply.

Planck had real knowledge of quantum physics. He created the whole field and understood it better than anyone in the world at that time. He could answer any question about it.

The chauffeur didn't know anything about physics. He was faking it.

The chauffeur could've been reciting Shakespeare's soliloquies and he would've demonstrated the same type of knowledge – the fake kind.

The cleverest thing he did was redirect the question to the real physics expert in the room without revealing himself as a fake. That took real talent.

Too many investors nowadays don't understand that they were faking it in the bull market...

It's just too hard for a human being to buy stocks in a raging bull market, see them soar in value, and not conclude that they possess real financial knowledge.

It's also too hard for all too many human beings in capitalist societies to avoid the fatal mistake of believing in "the specious association of money and intelligence," as John Kenneth Galbraith put it in his classic work A Short History of Financial Euphoria. In the book, Galbraith also noted "the extreme brevity of the financial memory."

Today, despite the bear market rout, the market chauffeurs' memories of making big, fast money are still fresh.

They were smart enough to make a fortune the first time. So today, they think that despite losing most (or all) of their gains, they can make back all their money again any minute.

After all, they had sophisticated investment theses just like real professional investors...

They created a "short squeeze" in heavily shorted stocks, like GameStop (GME) and AMC Entertainment (AMC). They bought, and they sold. They discussed their ideas in public on social media platforms, just like many wealthy, successful investors do.

But when the market questioned them the way the audience member questioned the chauffeur, they didn't have the investor equivalent of Max Planck sitting in the back of the room to bail them out.

They just lost money.

The chauffeur investors' favorite stocks have been crushed...

From their all-time highs, Tesla is down 66%, Peloton Interactive (PTON) has dropped 94%, GameStop is off 76%, and AMC Entertainment has fallen 92%.

Narrative and enthusiasm lead to big losses. They are no substitutes for understanding or recognizing and controlling risk. That's the kind of real knowledge that true investors must possess to avoid catastrophe and earn adequate returns.

In the current episode of the Stansberry Investor Hour podcast, my old friend Rick Rule, the founder of Rule Investment Media, noted the bull market tendency to rely on chauffeur-type knowledge – storytelling and price action.

But now, Rick said, investors "need to do the arithmetic." He's the Max Planck of natural resource investing, so he ought to know...

Doing the arithmetic on thousands of companies, putting real money to work, losing some of it, learning from your mistakes, finding some success...

The folks who do that type of work are the Max Plancks of investing. And we should pay attention to what they're doing with their own money and their clients' money right now.

Folks who do the arithmetic for a living are selling – and chauffeurs are buying the dip...

As the Wall Street Journal article reported recently...

U.S. equity mutual and exchange-traded funds, which are popular among individual investors, have attracted more than $100 billion in net inflows this year, one of the highest amounts on record in [fund-flow tracker] EPFR data going back to 2000.

Hedge funds, meanwhile, have been paring how much risk they are taking in stocks or making outright bets that major U.S. indexes will tumble. Mutual funds have increased their cash positions to about 2.5% of their portfolios this fall, up from around 1.5% at the end of last year and the highest level since early 2020, according to Goldman Sachs.

That makes me pause.

For years, institutional investors have been the driving force in the stock market. But the meme-stock revolution of the past couple years changed that, at least somewhat. So maybe the professionals are on the wrong side of the bet this time.

Of course, even though they created big short squeezes in meme stocks, the market chauffeurs ultimately held on for huge losses. And they were on the wrong side of the crypto trade as well. The industry has melted down, lighting a couple trillion dollars on fire.

So maybe it's a bad idea to suggest retail investors are back as a force in the markets. Maybe they're the same force they've been for years now – a source of liquidity for people who know 10 times more about how markets really work.

It'll take some more pain for these market chauffeurs to start acquiring real knowledge. Real knowledge takes hard work and doesn't come easily. And real knowledge about the stock market is usually accompanied by a substantial amount of pain in the form of losses.

The chauffeurs have my sympathies. They're living in the worst time in history for admitting the area outside their circle of competence is infinitely large...

Admitting ignorance is difficult to pull off in modern times...

In primitive times, you didn't last long if you didn't know how to find shelter, get food, and make a fire. Knowing meant surviving, and not knowing meant dying.

But for most people today, survival isn't a problem – even if their day-to-day lives are difficult.

The problem we face in the modern world is too much information...

When we turn on our TVs, phones, and computers, it's like walking up to a water fountain for a drink and instead of a trickle, we get an Amazon River of information. And it never stops flowing... 24 hours a day, 7 days a week, 365 days a year.

In today's world, it's hard to say, "I don't know." The more folks refuse to say it, the more powerful the incentive is to fit in and pretend you know things you don't know.

That's because the deluge of knowledge incentivizes chauffeur-like behavior...

Whether at home, at work, or anywhere else, the constant bombardment of information creates more pressure to act like we know it all...

We feel like we need to have something viewed as "knowledge" to say about war... elections... Wall Street... immigration... taxes... fossil fuels... climate... viruses... vaccines... various interpretations of the Constitution... and what's happening in China, Russia, and some tiny country in Africa, Asia, or Central America.

When so much information is thrust at us, the constant message is "you should know... you should know... you should know." You feel guilty for not knowing something about every new topic that pops up in the headlines. It feels stupid and wrong to admit you don't know.

But it's so right...

In the modern world where the illusion of knowledge is everywhere, describing a clear boundary between knowledge and ignorance is valuable. It calls to mind Warren Buffett's famous "circle of competence" advice from his 1996 Berkshire Hathaway (BRK-B) shareholder letter...

What an investor needs is the ability to correctly evaluate selected businesses. Note that word "selected": You don't have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.

The circle is as much about what's outside it as what's inside. It's about what you don't know as much as what you're good at and do know.

It's another version of "via negativa," an idea familiar to regular Digest readers that says the learning of life is about what to avoid – or what's outside your circle. According to via negativa, that's the most important knowledge you can gain.

Believe it or not, it was a mercifully good year to learn painful lessons...

The stock market didn't suffer a swift, steep crash. Rather, it fell in an orderly manner, punctuated by occasional rallies (like the one that started about a month ago).

Each leg down was a learning experience. Each rally gave you a chance to exit your mistakes and raise cash... which would've put you in much better shape to weather the next leg down.

According to Greg Jensen, co-chief information officer of hedge fund Bridgewater Associates, we should expect more of the same...

Last Friday, Jensen told Bloomberg that the good news about the current episode is that leverage in the financial system isn't as bad as it was during the 2008 crisis. So according to Jensen, we're unlikely to see a horrendous crash this time.

But he added...

Instead, you have this long grind that's probably a couple years.

A couple more years of market action like what happened in 2022 will likely compel at least some market chauffeurs to hit the books and learn to do some arithmetic. And it'll probably wash the rest of them out of the market for an entire generation.

Get ahead of them.

Stop doing whatever made you money in the bull market and start doing more arithmetic.

And if you know anybody still wearing a chauffeur's cap, tell them to hang it up and start learning to be like Max Planck.

New 52-week highs (as of 12/21/22): Cintas (CTAS).

We have a few housekeeping notes before we get to today's mailbag...

Our offices are closed tomorrow and Monday in observance of the Christmas holiday. We'll publish our Masters Series over the weekend. And then, we'll return to our normal weekly fare on Tuesday. And when we do, we have lined up a special year-end series featuring some of our most popular essays and ideas of 2022. So look for that next week.

Now, in today's mailbag, the conversation continues amongst subscribers. Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"Finally, after losing so much from always buying too high, I began to buy just slightly on the low side w/half what I intended to put into stock. Put in good until canceled... My returns are much better now. And I thought I made that up... I'm glad that somebody else agrees with that idea [like Jim L. in yesterday's mailbag]. Thank you." – Paid-up subscriber Deborah C.

"Thanks Larry N. for the kind words [in yesterday's mail] about my Moe rant. I didn't want to write a thesis so kept it short but there's an important point I didn't bring up and that is Larry and Curly, recognizing that they were incompetent imbeciles, looked to Moe for leadership and direction.

"After seeing how many Moes are repeatedly elected to public office in spite of the chaos they create I'm wondering if the voting public isn't mostly made up of Larrys and Curlys... again, a fact I attribute to our appalling education system. I have a friend who labels this the Silicon Valley Syndrome, which values market cap over actually making money." – Paid-up subscriber B.W.

Good investing,

Dan Ferris
Eagle Point, Oregon
December 22, 2022