Finance theory says: The only way to beat the market is by knowing what others don't. Few fight me on that. But in today's ?ber-connected world, how can anyone know what thousands of others, equally as plugged-, blogged-, and tuned-in, don't?
Unique market-beating information can be yours, as I detail in my new book, The Only Three Questions That Count (John Wiley & Sons). In it, I demonstrate how beating the market is possible if you stop treating investing as a craft, and start approaching it as a science.
Why shouldn't investing be a science? Investing is far more comparable to medicine, in a sense, than accounting. Accounting is a craft. So is blacksmithing. In both, practitioners study, apprentice, get their journeyman's card, and off they go to become master craftsmen. Sure, things change. New methods are introduced. Dingbat politicians write new laws. But new discoveries about fungus don't radically alter the face of accounting. If investing were a craft, some craft-like method would have demonstrated superiority, and we'd all be banging away with the same, market-beating hammer. No, investing is a non-stop, scientific discovery.
And all scientists require a scientific method — a targeted query session. But for answers providing the basis for actionable market bets, you need the right questions.
What are the right questions? First: What do you believe that's false? This question prevents mistakes made by betting on widely believed but baseless myths. And it gives you the basis for a bet. If what everyone expects to happen probably won't, you can bet against them and win.
Second: What can you fathom that others can't? This helps you see what others can't or won't, giving you yet another basis for market-beating bets. And it's easy to do. In my book I show you how.
Finally: What is your brain doing to blindside you? This counteracts your worst enemy — your modern skull containing a Stone Age brain, well-equipped to keep you warm, dry, and relatively free from saber-tooth puncture wounds, but miserable at dealing with counter-intuitive, intangible capital markets.
The questions help you see the truth about common investing concerns. For example, most people believe high P/E stocks are risky and debt is deadly for our economy. For a moment, pretend you could prove these concerns wrong. Fear of a false myth is bullish. If everyone is exercised over something you know won't have the outcome everyone expects, you can bet against them and win. The truth is, high P/Es, debt, and deficits, to name just a few concerns tackled in my book, don't work the way people think. With the questions you'll find commonly accepted wisdom about these and many other concerns to be nothing more than mythology.
To demonstrate the questions, consider our trade deficit. Most agree a trade deficit perpetuates economic weakness. You certainly don't hear anyone saying, "Trade deficits are great!" In 2006, journalists derived Schadenfreude by reporting impending economic devastation at the hands of our burgeoning trade deficit. The weakening dollar was deemed the smoking gun of the trade deficit's negative repercussions.
The trade deficit isn't likely to shrink dramatically in 2007, and a broad consensus agrees this is more bad news for the dollar. Before you don your tinfoil hat, ask question one. Is it true a trade deficit causes a weak dollar?
How would you even check?
Why not see if similarly sized deficits in other nations caused similarly weak currencies?
You may scoff, "No one else has a trade deficit that size!" Not so! The Brits are an excellent litmus test for many American economic conditions. They have a well-diversified economy and stock market mirroring the relative size and composition of America's.
The American trade deficit as a percent of GDP has been increasing irregularly since 1980 and now stands at about 4.9 percent (as of third quarter, 2006) — near record size! And the U.S. dollar was weak in 2004 and 2006. Never mind the dollar strengthened in all of 2005 — maybe that was a fluke. Check Britain and see.
American Trade Deficit As A Percent Of Gdp (view chart)
The Brits experienced a similar trajectory and their deficit is now 6.3 percent. Higher than ours! Yet, the pound sterling was very strong, not just recently, but consistently in recent decades. What gives?
Maybe the cumulative effect matters most. After all, we've had a huge deficit seemingly forever, and that's weakening the dollar. Fine. Take the cumulative U.S. trade deficit since 1980 and divide by today's GDP; do the same for the Brits, and you get 42 percent and 46 percent, respectively. Not too different.
British Trade Deficit As A Percent Of Gdp (view chart)
To argue our trade deficit weakens the dollar, you must also argue the similarly sized U.K. trade deficit is somehow good for the pound. That's a pretty silly argument. Your answer to this question is: No, the trade deficit has zero impact on the dollar. (In the book, we discuss whether a weak dollar even matters — it doesn't — and what really drives a currency's relative strength.)
Maybe the dollar gets a pass, but the trade deficit must be bad for the economy and stocks. Importing more than we export must be unsustainable. Freed from the weak-dollar myth, use question two. What you can fathom about the trade deficit?
Think about it a new way. Apple iPod components are manufactured cheaply overseas (Egads! Outsourcing!), creating a trade deficit. But Apple sells its many iPod creations at a hefty profit margin, increasing earnings-per-share. Intentionally creating a trade deficit is smart management by Apple. It increases shareholder wealth and makes the product more competitive. And Apple is not the only one doing it!
