Looking for the Next Big Thing
By Brad Thomason, CPA
Everyone in the investing game wants to know what’s going to be gaining value in the weeks and months to come. A lot of time goes into trying to discern the answers. Yet some of the simplest clues are the ones that are the most often ignored.
We’ve been studying the pricing dynamics of asset markets for a long time, and one of the clearest themes that we’ve seen over the years is that big rises usually follow big falls. Want to know where next year’s good prospects are? Look at what’s falling this year.
Once you’ve found a decliner, take note of the fact that they aren’t all created equal: some of them have a much better mathematical case for a big move than others.
Consider price moves in the past couple of decades for stocks and oil. There are plenty of ways to invest in either one, such that a retail investor could participate in the market moves of whichever one they chose. So it’s reasonable to imagine a situation in which an investor might be considering one or the other.
The only time that the stock market has doubled in value (+/-) in the present generation has been in instances where it first lost close to half of its value. It did that twice in the first decade of the 21st century, and both times the ensuing recovery lead to what would have eventually been a 100% gain for new dollars invested near the bottom of a dip.
Oil on the other hand rose by a factor of more than 8x from the period of 1998 to 2008. That was helped along by the fact that prices went through the floor back in the late nineties, falling as low as the mid teens. This set the stage for not only a recovery, but also what ended up being a push into new price territory.
The fact that oil had a much bigger run up after its dip doesn’t come as a surprise, if you know what to look for.
Investment selection should consider lots of factors beyond just the rate of return. But rate of return certainly matters, and in practice is often given far more weight than anything else. So being able to quickly assess its potential has value.
The core analytical question that we’re getting at here couldn’t be more simple: how far can the price run without having to break into new territory? Even if a new, all-time-high isn’t in the cards, what can the price do simply by retreading ground it’s already covered?
Let’s take that question straight to the present market. Looking at the prospects for a big run from right here in stocks versus oil, what does your horse-sense tell you about which has the better chance to double in value over the next few years? My money would be on oil. Oil can double from its current price and still not be back to its high of even a year ago.
Stocks, conversely, will have to forge ahead into dramatically new territory to pull off the same percentage increase.
Now, you could get into all sorts of analysis about why prices in those markets are what they are today, what forces will bear on each in the coming months, the impact that government policy and market action will have on the trajectory, etc. And doing so isn’t wrong. But if you stick to the old adage of buy low and sell high, the choice is clear: one of our markets is low right now and the other isn’t. If you ask the simple question of which one probably wins the rate of return race, based on basic movement within the already established trading range the answer, again, is clear.
Oil isn’t alone, by the way. So if you prefer copper or gold, the fact that they have been in decline for awhile might be interesting. They have declined less, relatively speaking: they would not hit 100% simply by recovering to past highs from present levels. But they have more room to run within their range than equities. You can expand the theme as far as you like, though you likely want to continue to steer clear of feeder cattle for the time being (pun probably intended…).
Spend as much time as you like looking for your next investment. Thinking about it is certainly better than not. But just remember that at any given time, certain asset classes have an inherently better chance at a big run than others. An asset which has fallen a lot and can double in a recovery without having to establish a new trading range is starting the race with a significant mathematical advantage over the other choices out there. Absent a good reason to the contrary, hopping on board once the recovery starts might be a good bet; not to mention an easy one to find.