Unlike Fools, the Wise Avoid Most Stocks Most of the Time

The average dollar invested in ARKK has lost money... U.S. Treasurys have been 'twice as good'... Enough remains to keep the party going... Unlike fools, the wise avoid most stocks most of the time... Nuancing Warren Buffett's two-rule adage... Heeding Greg Diamond's warning...

The story of Cathie Wood and ARK Invest is the gift that keeps on giving...

I've written about it several times in the past 11 months...

It started with my February 11, 2021 Digest, when I warned that ARK's disruptive-innovation-focused exchange-traded funds (ETFs) were a sign of speculative excess.

The firm's flagship ARK Innovation Fund (ARKK) – containing roughly 60% of ARK's assets under management – had risen 351% from its March 2020 bottom in the throes of the COVID-19 bear market through the day of my Digest.

It looked to me as if the ETF had no place to go but down. And we nailed it...

It peaked the next day, February 12, 2021. Since then, it has fallen 49%... And it's still falling!

The popularity of ARK is all too familiar...

Its focus on disruptive innovation... its epic post-COVID-crash run... Wood's calls for Tesla (TSLA) – ARKK's largest holding – to hit $3,000 per share...

It's what happens when speculative frenzies are about to burn themselves out... And clearly ARK's time to start burning out had come when I first warned about it last February.

But so what? you might ask...

The ARK Innovation Fund went public in October 2014. It traded for around $20 per share then, and it's around $80 today... It's a four-bagger, compared to a two-plus-bagger for the S&P 500 Index over that time.

In other words, ARKK is still a huge winner since inception.

That's how it looks in a simplified analysis... But looks can be deceiving – and they often are in the stock market.

In fact, ARKK is now officially a loser, as Simon Lack of SL Advisors pointed out in a recent blog post, titled, "ARKK Investors Have in Aggregate Lost Money."

In the post, Lack does the math to show what any experienced stock market participant already knows ‒ perhaps all too painfully... More investors join a manic bull run at the top than at any other time.

The situation with ARKK is no different. As Lack wrote...

[B]ecause inflows to ARKK followed strong performance, as is usually the case, it turns out that the cumulative P&L on ARKK is negative. [The total cumulative profit earned by ARKK investors since its inception] peaked last February at just under $12 [billion] and has been in steep decline ever since. At the beginning of this year, it crossed into negative territory. The average dollar invested in ARKK has lost money.

One more time... The average dollar invested in ARKK has lost money, despite the fund being a four-bagger since inception. That's because most of the money came in at the top.

Wood said in a January 7 video that she has more than half her 401(k) invested in ARK funds... so she's "right there with" ARK investors. Woods is trying to suggest she's losing money right alongside ARK Innovation Fund holders.

But she's not. And here's why...

Lack estimates that the ARK Innovation Fund has generated $230 million in fees since its inception and is still collecting them at a pace of $300,000 per day. But the investors that Wood says she is "right there with" didn't earn those fees... They paid them.

It's typical for a money-management operation to get paid even if its investors lose money... It seems Wood isn't ready to disruptively innovate in that particular realm.

The same thing happened to hedge-fund investors during the financial crisis...

According to Lack...

By the [time the] 2008 financial crisis [arrived], the hedge-fund industry was big enough that in one year it lost all the earlier profits ever generated for investors.

His 2011 book The Hedge Fund Mirage begins...

If all the money that's ever been invested in hedge funds had been put in Treasury bills instead, the results would have been twice as good.

If you're wondering what "twice as good" as losing every penny since inception means, I'm with you. But Lack's gist is clear enough... U.S. Treasurys outperformed the fee-heavy hedge-fund industry as a whole.

And don't look for fund-ratings systems to help investors avoid losses. Though ARKK holders are underwater as a whole, Morningstar rates the ETF with four stars and says it's the No. 1 fund over five years.

Buying what's popular is not a mistake when you're buying almost anything else besides stocks...

You purchase a Ford F-150 pickup truck or a Samsung smartphone because their popularity is a sign of their quality and consistency.

But in financial markets, following the herd looks wise only until its utter foolishness is revealed... As we've noted in previous Digests, fools do in the end what the wise do in the beginning.

Lack's work adds nuance... When the market includes so many fools, they can turn any investment into a disaster simply by liking it enough all at the same time.

And it sure seems like every fool in the world fell in love with stocks in 2021...

How much did they fall in love with stocks?

Last September, Bank of America reported $1 trillion had flowed into global equities up to that date from the beginning of 2021. That was more than the previous 20 years of flows combined... Every last fool came out of the woodwork last year and went all-in on stocks.

They saw markets marching straight up for several years and eventually got tired of watching everyone else get rich. Last year, they finally deemed the well-established trend as safe enough to pour money into – somehow believing it would continue forever. So fools did what fools do... they put more money at risk last year than in the previous 20 years combined.

But here's the thing they don't realize...

After they've bet (not invested) every spare penny they have, there's nobody left to buy. A stock price can't keep soaring higher if no one out there is willing to pay that level. Pretty soon, many more shares are offered for sale at any given moment than are bid on to buy.

For now, though, the fools still have enough to keep the party going... JPMorgan Chase (JPM) analysts said that this past Monday was the third consecutive day when retail investors bought more than $1 billion worth of stocks.

Monday's $1.07 billion total retail buying put it in the 93rd-percentile of historical data. That means fools have only been more foolish 7% of the time... At this rate, they're a shoo-in to get a chapter (or two) in Lack's next book.

This seems like a good time to discuss how to avoid being a fool...

Seasoned professional investors tend to agree that avoiding doing stupid things is more important than doing something smart...

All the dozens of successful traders and investors I've met, worked with, or interviewed on the Stansberry Investor Hour podcast agree that recognizing and managing risk is every investor's No. 1 priority.

Avoiding risk is at the core of every successful investment strategy... If it's not, the strategy will eventually take on a risk it shouldn't and lose all the profit it made – just like all the fools who bought into the housing bubble before the financial crisis and the ARK Innovation Fund at its top a little less than a year ago.

Investors are only human, and it's hard to make risk avoidance emotionally compelling... It's just not sexy to say, "OK, let's get out there and avoid losing money! Woohoo!"

But how many investors even believe it, no matter how many times they hear it?

Tell me truthfully, when Warren Buffett says there are two rules to investing and Rule No. 1 is "Don't Lose Money" and Rule No. 2 is "See Rule No. 1"... do you really believe him? He's looking to make money, not merely avoiding losing it... right?

Sort of.

The two-rule adage is one of the all-time great investment heuristics. However, breezy sayings only go so far... Profound as it is, the two-rule adage involves more than Buffett's folksy midwestern wisdom suggests.

What follows might earn me the title of Captain Obvious... but I would prefer that to Captain Obfuscator.

The two-rule adage really means something like, "You can't make money in the market without placing your capital at risk, but you need to know the difference between a risk worth taking and one not worth taking, and there are a lot more risks you shouldn't take than you should take."

That's the obvious part. Now, here's where it gets a little more complicated...

"Learning to identify the good risks is more about avoiding the bad ones than most people realize... To be successful, you have to do a lot of work that results in not taking any action, and most people find the lack of action uncomfortable. So people overtrade their accounts and lose too much money taking bad risks... rather than avoiding the bad risk by doing nothing. Also, a catastrophic loss can wipe out years of compounding and must be avoided."

Doing a lot of work that leads to taking no action is an especially big problem for most investors.

Humans want action... They want to buy and sell every day. And they want to make a lot of money and feel great about it all the time. As portfolio manager and author Howard Marks writes in his latest missive...

Too many people equate activity with adding value.

But investing doesn't work that way...

Investing is a creative endeavor. And creative endeavors often consist of doing work that doesn't generate any tangible result at all... Famed architect Frank Lloyd Wright designed more than 1,000 structures in his life, but only 400 of them were ever built.

That's a high success rate when it comes to researching stocks... You'd be lucky to find that 40% of all the stocks you look at are worth owning for the long term.... If you're truly embracing Buffett's two-rule adage, it's probably less than 4%.

The actual percentage is less important than understanding that it's desirable and healthy not to want to buy most stocks most of the time... That's particularly true for those stocks being snatched up in a speculative frenzy when fools are betting more in a year than in the last 20 years combined.

Those are the money-losing propositions that the two-rule adage counsels investors to avoid.

This might sound crazy given that Stansberry Research puts out a couple hundred stock picks in a year. But keep in mind... the market includes tens of thousands of stocks. And we're avoiding the overwhelming majority of them each year.

These days, fools can't find a risk they don't like...

In fact, the two-rule adage seems nowhere in sight. And no, the less than 4% dip in the S&P 500 over the past several days doesn't mean anything. It only means that we're just 4% from an all-time high of foolishness...

The two-rule adage is an example of one of the master principles for a successful life... via negativa, which states that the learning of life is about what to avoid. I wrote an entire Digest about it once.

On the current episode of the Stansberry Investor Hour podcast, Bloomberg senior commodity strategist Mike McGlone gives listeners some classic via negativa advice...

Don't Fight the Fed.

Mike thinks the Federal Reserve needs to clamp down inflation by raising interest rates... But he believes the market could drop in anticipation of rising rates, in which case the Fed's work would be done and it wouldn't have to take any further action.

Mike is a hardened veteran of the Chicago trading pits. At the start of our interview, he said you learn a lot by "getting your face ripped off" by markets early in your career...

I've heard similar sentiments from other guests, many of whom entered finance during the dot-com boom. Then, when it became the dot-com bust, they learned the difference between being smart and being in a frothy bull market.

Mike's cautious tone rhymed with that of Ten Stock Trader editor Greg Diamond...

I interviewed Greg last week on the podcast. And last night, he gave investors a warning very similar to McGlone's advice not to fight the Fed's desire to raise rates...

If you didn't get a chance to see it, watch the replay. It's a must-see presentation – and it's exactly the sort of thing I expect from Greg, an 18-year trading veteran who has helped his subscribers double their money on 26 separate occasions, most times fairly quickly.

Greg is great at nailing big turns in the market... He has done so three times in the last two years. And now, he's predicting another one in the next few months, based on 90 years of market data.

I follow Greg's work closely and consider his message as highly supportive of the views I've expressed about the stock market since late 2020. Greg is much better at timing than I am, so to see his view lining up with my bearishness of the last year and a half is something you shouldn't ignore.

Greg is predicting a rollercoaster of a year for stocks... And last night, in his special broadcast, he revealed how he can help you navigate this volatile year. But the offer will not last long, so I encourage you to watch his message right away.

New 52-week highs (as of 1/13/22): Bunge (BG), Berkshire Hathaway (BRK-B), Flowers Foods (FLO), General Mills (GIS), Coca-Cola (KO), SPDR S&P Regional Banking Fund (KRE), Invesco High Yield Equity Dividend Achievers Fund (PEY), PLDT (PHI), and W.R. Berkley (WRB).

In today's mailbag, feedback on yesterday's Digest, including a reading recommendation and an observation from a subscriber who's been to Kazakhstan many times... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"I used to fly into Kazakhstan with FedEx. It was primarily a technical stop for fuel and crew change. The airport had one runway with no parallel runway, requiring a 180-degree turn at the end of the runway. There were a lot of broken-down Russian aircraft left over from the Russian-Afghanistan war.

"My first impression was not good. The people were poor, and housing appeared to be marginal. Over the years, I noticed a big improvement where people became more energetic, car lots became numerous, and enterprise picked up. A carnival popped up next to the hotel. They even built a parallel taxiway so we could exit the runway without a back taxi.

"I always wondered why they scanned the bottom of our car for bombs upon entering the hotel property. Obviously, things were not as calm as they appeared. There were always a lot of oil people at the hotel. I guess it would be bad it they got blown up.

"I retired in 2012. From your brief, it appears that things have taken a turn for the worse." – Paid-up subscriber B.T.

"The Dawn of Eurasia is an interesting book about Kazakhstan and that area of the world." – Paid-up subscriber G.B.D.

Kim Iskyan comment: G.B.D., thank you for the recommendation... And B.T., thanks for your e-mail. In many ways, the city of Almaty (and Kazakhstan) was, and remains, the best house in a lousy neighborhood – the airport included. One time in 1996, I was a passenger in a commercial plane departing from a regional city called Osh, in neighboring Kyrgyzstan, as it took off from the grassy field next to the runway. Perhaps the runway was too much in shambles to support a Yak-40 aircraft (short for Yakovlev – creating an unfortunate English abbreviation) achieving takeoff safety speed – or maybe the pilot had some other good reason... But it certainly didn't inspire my confidence. But the plane arrived at our destination in one piece, and that's what mattered most, I suppose.

Good investing,

Dan Ferris Eagle Point, Oregon January 14, 2022

P.S. The markets and our Stansberry Research offices are closed Monday for Martin Luther King Jr. Day, so we won't publish that day. After the Masters Series this weekend, you should expect to receive your next Digest on Tuesday.