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“The most important rules of investing:
Rule #1: Never Lose Money;   Rule #2: Never forget Rule #1.”

Warren Buffett

– Enjoy more of our favorite quotes –


MAY 22, 2016





- Looking for a Trend
- Are We on 'The Wrong Side of the Trade?'
- Winner's Games and Loser's Games
- Why Investing Has Become a Loser's Game
- Our Plan for this Week



This week we will once again keep our two model portfolios in cash. The reason is that we are not seeing convincing evidence yet of a trend developing - either higher or lower. In mid-April, most major indices and sectors topped and headed downward. Many believe that could be the beginning of the third leg down in a bear market that began almost a year ago. It is possible that this could be 'the big one' that would carry below the prior lows at about 1800 on the S&P 500.

However, the downturn was not robust, and in the last week that decline stalled at the 50-day moving average. That action makes us wonder whether the 'downturn' is just a correction in the significant, strong-breadth rally that began in early-February.

Chart 1 below shows that there is a bearish Head-and-Shoulders pattern that may have developed in SPY. On the other hand, the 50-day SMA (blue line) is still above the 200-day SMA  (red line), which is called a 'golden cross,' and is a bullish signal for momentum-oriented investors. Investors should not make decisions based on these chart patterns as they a ripe for exploitation of an individual's confirmation bias.

CHART 1: The direction of the market is unclear with mixed signals.


In the last six months, we documented many aspects of the fundamental and technical evidence for a bear market which we believe started in mid-2015 and could run through 2016 and possibly even into 2017. Chart 2 below, which shows probability theory signals for bear markets (red) and bull markets (blue), is another addition to that evidence:

CHART 2: The Bear Market Probability Indicator shows that a bear-market signal was last given in April and August-2015.

Based on probability theory, Chart 2 (above) shows the S&P 500 ETF (SPY) in the top window, the probability measure of a bear market starting (>0.90) or concluding (<0.10) in the middle window. The bottom window shows a binary form of this indicator with red as bearish signals and blue for bullish signals. As you can see, the indicator was very accurate in predicting the top in 2000 and 2007. It also showed the long-running bottom from early 2009 through late 2011.

Also, notice that the indicator signaled a bear market in April and August 2015.  What's unusual about the 2015 signal is we have not yet seen a significant selloff. We witnessed violent turbulence starting last August (which our portfolios have largely avoided), but no significant selloff as observed in 2001-2003 and 2008-2009. We believe this is a result of the market manipulation by the Federal Reserve and central banks worldwide. However, how long can central banks keep interest rates at zero and even negative to continuously levitate equity markets at the expense of savers? Eventually, the distortions will collapse, and the toll may be devastating.

Following 90 months of ZIRP (zero interest rate policy) in the US and recently NIRP (negative interest rate policy) in Europe and Japan, if the market does collapse, central banks have no ammunition left to try to stimulate the economy or markets. If there is a crash, it could be of epic proportions and may put an end to the 20-year history of Alan Greenspan-led, Keynesian manipulation of equity and debt markets.

In the meantime, the S&P 500 has remained range-bound between 1850 and 2100 since late 2014 as shown in Chart 2 below:

CHART 3: The S&P 500 has been range-bound between 1850 and 2100 since late 2014.



We have recently heard from several of our subscribers who say that they are frustrated that IntelligentValue has spent so much time "sitting on the sidelines," i.e., out of the market much of the time since late June 2015. Some have expressed concern, especially during the bear-market rally from February to April, that staying in cash might be "the wrong side of the trade." There seemed to be anxiousness they were 'missing out on the action.'

These are the kinds of comments that come from individuals with a gambler's mentality, not investors. If you want the adrenaline rush of gambling, you should find another advisory with that sort of approach (there are a lot of them), or even better, just book a flight to Vegas. On the other hand, if your desire is to be a successful investor and not a gambler, the most important thing you can do to ensure your success is to avoid errors. To quote Warren Buffett's advice about the two most important rules in investing:  "Rule number one is don't lose money. Rule number two is never forget rule number one."

Individuals who are buying stocks based on 'instinct,' 'gut feelings,' a 'theory,' or even 'analysis' and feel they must be invested at all times are playing a losing hand in a 'loser's game.' Please don't take that as a harsh criticism only because it goes against IntelligentValue's advice. Let me explain what we mean by a 'loser's game.'


I recently came across an excellent in the Financial Analyst's Journal by Charles D. Ellis titled, "The Loser's Game." The date of the publication was 1995, but the concept of the article is still applicable today (actually, even more so).

Every month, hundreds of millions of employees across the world hand a percentage of their earnings over to professional money managers and mutual funds with the goal of building a retirement nest egg. A smaller number of individuals take it upon themselves to handle their investment activities with the aim of growing their savings into a larger sum than a simple arithmetic accumulation in a savings account. They seek to multiply their funds geometrically through the magic of compounding and most choose the stock market as the most effective means to achieve that goal.

The premise of both groups, the professionals and the individual investors alike, is that they can beat the broad market through a careful and logical selection of favorable equities. However, based on extensive statistical analysis, that premise is false! Investing has changed dramatically in the last few decades and especially since the 'golden era' of the 1950s through 1980s.

In the 1970s and 1980s, there was a massive pouring of the best and the brightest young minds into Wall Street to make their fortunes from the retirement and investing goals of the baby boom generation. Nevertheless, the majority of those ambitious young men and women did not fulfill their dreams of spectacular earnings because they became one another's competition. By the 1980s, the money-management business changed from a 'winners game' into a 'losers game.'

Taking a story from Mr. Ellis' article is perhaps the best way to explain why investing has become a 'loser's game.'

Simon Ramo identified the crucial difference between a Winner's Game and a Loser's Game in his excellent book on playing strategy, Extraordinary Tennis for the Ordinary Tennis Player. Over a period of many years, he observed that tennis was not one game but two. One game of tennis is played by professionals and a very few gifted amateurs; the other is played by all the rest of us.

Although players in both games use the same equipment, dress, rules and scoring, and conform to the same etiquette and customs, the basic natures of their two games are almost entirely different. After extensive scientific and statistical analysis, Dr. Ramo summed it up this way: Professionals win points; amateurs lose points. Professional tennis players stroke the ball with strong, well aimed shots, through long and often exciting rallies, until one player is able to drive the ball just beyond the reach of his opponent. Errors are seldom made by these splendid players.

Expert tennis is what I call a Winner's Game because the ultimate outcome is determined by the actions of the winner. Victory is due to winning more points than the opponent wins – not, as we shall see in a moment, simply to getting a higher score than the opponent, but getting that higher score by winning points.

Amateur tennis, Ramo found, is almost entirely different. Brilliant shots, long and exciting rallies, and seemingly miraculous recoveries are few and far between. On the other hand, the ball is fairly often hit into the net or out of bounds, and double faults at service are not uncommon. The amateur duffer seldom beats his opponent, but he beats himself all the time. The Victor in this game of tennis gets a higher score than the Opponent, but he gets that higher score because his opponent is losing even more points.

As a scientist and statistician, Dr. Ramo gathered data to test his hypothesis. And he did it in a very clever way. Instead of keeping conventional game scores – "Love," "Fifteen All," "Thirty-Fifteen," etc., Ramo simply counted points won versus points lost. And here is what he found:

In expert tennis, about 80 percent of the points are won; in amateur tennis, about 80 percent of the points are lost. In other words, professional tennis is a Winner's Game; the final outcome is determined by the activities of the winner – and amateur tennis is a Loser's Game; the final outcome is determined by the activities of the loser. The two games are, in their fundamental characteristic, not at all the same. They are opposites.

From this discovery of the two kinds of tennis, Dr. Ramo builds a complete strategy by which ordinary tennis players can win games, sets and matches again and again by following the simple strategem of losing less, and letting the opponent defeat himself."

Ellis goes on to say that politics is a loser's game, as the candidate will be elected who makes the least mistakes but with the best adversarial strategy to get people to vote against the opponent. Golf is a loser's game where the player making the fewest errors will beat the competition.

Several studies have shown that in professional football, the best defenses play an open, ad hoc, enterprising, risk-taking style (a winner's game). On the other hand, the best approach for the offensive half of the team is likely to be one in which the players making the fewest mistakes (loser's game) will win. Football fans will note that this is the strategy that took the Denver Broncos (with the #1 defense and a conservative offense led by aging quarterback Peyton Manning) to victory in Superbowl 50 in February 2016.



Getting back to investing and the article under discussion, Mr. Ellis points out that institutional money management used to be a 'winner's game' in the 1960s. However, it became a 'loser's game' when institutional transactions went from being 30% of the market's total to "a whopping 70 percent" of the total.

"The professional money manager is no longer competing with amateurs who are out of touch with the market; now he competes with other experts," Ellis reported.

Ellis went on to provide calculations to show that a money manager seeking to outperform the market by 20% must earn a great deal more than that, and concludes:

"In plain language, the manager who intends to deliver net returns 20 percent better than the market must earn a gross return before fees and transactions costs (liquidity tolls) that is more than 40 percent better than the market. If this sounds absurd, the same equation can be solved to show that the active manager must beat the market gross by 22 percent just to come out even with the market net.

In other words, for the institutional investor to perform as well as, but no better than, the S&P 500, he must be sufficiently astute and skillful to "out-do" the market by 22 percent. But how can institutional investors hope to outperform the market by such a magnitude when, in effect, they are the market today? Which managers are so well staffed and organized in their operations, or so prescient in their investment policies that they can honestly expect to beat the other professionals by so much on a sustained basis?"

The answer, of course, is they cannot.

For the individual investor who may be conducting his research and using the services of any number of websites that provide quantitative analysis and decision-making, the same conclusion can be reached. In a recent series of communications I have had with a colleague, I pointed out that starting in about 2006 I discovered a significant change in the portion of the market that individual investors focus on, i.e., small-cap stocks. It was at about that time that wide-scale adoption of Internet-based investing services came into vogue. As a result, it has become increasingly difficult to gain an advantage over other investors when basing decisions on company fundamentals and standard ratios such as PE, Price/Sales, Book Value, EV/Ebitda, and others.

The chart below shows the autocorrelation of prices, starting in 1960 through late 2015. In the period of 1960-through-1996, there was a relatively high degree of autocorrelation (blue). That autocorrelation means that forward returns could be predicted fairly accurately from past patterns (using both fundamental analysis and technical analysis). In other words, backtests were predictive of future returns.

CHART 4: Autocorrelation research shows that there was a high correlation between past price action and future price action prior to 1996. In 1996 through 2006 the correlations became much lower and after 2006 the correlation became much lower. Source:


However, starting in the late 1990s, this autocorrelation began to break down. You can see this by the decrease in correlation (red). By 2006, there was a second, more dramatic phase of this decline in autocorrelation and predictability of future stock prices.

What this means for investors is that company fundamentals and price action are no longer as predictive of future results. To what does this period from 1996 to 2016 have in common? The Alan Greenspan-led Keynesian manipulation of the equity market, that's what!

We believe that central banks need to get out of the market-price-manipulation business and allow for real price discovery. However, once a group of individuals obtains power within a system, they are loath to give it up. Therefore, we can probably expect this short-sighted manipulation of markets to continue indefinitely.


So what gives IntelligentValue an advantage over institutional investors and millions of intelligent, highly skilled individual investors? We believe our advantage is twofold: 1) a focus on avoiding losses, and 2) buying when conditions are ripe.

IntelligentValue has been able to provide our subscribers with two model portfolios that trade positions an average of only three times per year, has a 70% winning ratio, and an average annual return between the two portfolios of about 100%. We focus our purchases at times of very high probability of substantial future returns and avoid all other times. We don't mind sitting in cash indefinitely if there are no viable options for safe and profitable investment.

Investing may have now become a 'loser's game' for both institutional and savvy individual investor. That doesn't mean that we can't make money or be successful at investing. However, it means we must keep our attention on not making errors. There is no one causing us to have 'forced errors' and losses except ourselves.

It is for this reason that we frequently follow Warren Buffett's rules of investing and remain on the sidelines in cash until we see what Buffett calls a 'fat pitch.' That is, an investment opportunity that can't miss.


When we see a 'fat pitch' in either individual stocks or an ETF, we will make purchases for our model portfolios. However, until we see that high probability investment opportunity, it is likely we will remain in cash. If we see a 'fat pitch' during the week, paid subscribers will receive an email update and access to our model portfolio pages. If you have questions about our approach, please feel free to contact us.

Best Wishes for Another Week of Intelligent Value Investing,


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Opinions expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity. This is not an investment research report. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the subjects discussed, market environment, company or ETF SEC filings. Investors may wish to consult a qualified investment advisor. The information in this material was obtained from sources believed to be reliable, but were not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice. Shareholders, employees, and writers associated with IntelligentValue, Inc. may hold positions in the securities that are discussed. Neither, nor any of its employees or affiliates are responsible for losses you may incur.