Wednesday, October 13, 2010

Talk’s Cheap

When I was the manager of a small office of Merrill Lynch back in the early 1980s, my boss used to say, “Talk’s cheap. It takes money to buy land.” I never really understood the part about buying land, but I came to a true and deep understanding of “talk’s cheap.” As a stock broker in those days, I talked for a living. I would phone investors and offer them trading ideas. The extent to which I could talk them into buying was the extent to which I could earn a living.

It became easy to talk people into buying something. I was taught what to say. I learned the jargon. I became really good at talking people into buying. But I soon realized that cheap talk wasn’t really what counted. What counted was what my clients actually owned.

If my clients owned stocks during up-trends, I could make a really good living using my skilled cheap talk. And if they owned stocks during down-trends, no matter what I said, I couldn’t talk them into anything.

Most of us who invest get a certain satisfaction from talking about economic things. We love to read the financial press and follow the latest theories on what’s happening in the economy. We love the talk. And most of us have a viewpoint: we think we understand the economy and we might even have an opinion about what’s going on in the financial world. Most of us love to participate in the talk.

But here’s what we should be talking about: what investments do you own?

In my investing book, Beyond the Bull, I refer to the cycles in the stock market and how they relate to interest rates and the economy. But the most intriguing discovery I offer readers is how the talk changes through the cycle.

At the bottom of a stock market cycle, the talk is all gloom and doom. At the top, the talk is all optimism and enthusiasm. That’s how we identify the tops and the bottoms: we observe the talk. It’s called the Theory of Contrary Opinion ― and here’s how it works. When the talk is excessively negative, we buy. When the talk is inordinately positive, we sell. So the investments we own should be contrary to the talk about those investments.

For example, government bonds have gone up about 10% in the past three or four months. And the talk has been about the inevitable bankruptcy of the USA, about the fact that America can never repay her foreign debt, about the possibility of hyperinflation in the US, and about the US dollar being fiat money. As long as this negative talk persists, US bonds will continue in an up-trend. When the talk turns positive, as it inevitably will, bonds will be near a top.

A second example is gold: people love gold these days. An overwhelming majority of investment gurus are talking very positively about how the gold standard may soon return, how the currency wars that are developing will be positive for gold, and how all this talk of economic disaster is really positive for gold. And the more positive the talk is, the harder it is for the price of gold to go up.

The investments we own should reflect these two examples of economic cheap talk: we should own a lot of bonds and little or no gold.

To order your copy of Beyond the Bull and the Five Levels of Investor Consciousness CD, or to sign up for Ken’s free monthly webinar, visit (Bullmanship Code = SS32).

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