The Little Book of Sideways Markets: How to Make Money in Markets that Go Nowhere

By Vitaliy N. Katsenelson

"It's hard to talk clearly about investing and make sense to ordinary readers at the same time. Katsenelson gives a lucid explanation of today's markets with sound advice about how to make money while avoiding the traps that the market sets for exuberant bulls and frightened bears alike."
— Thomas G. Donlan, Barron's

"A thoroughly enjoyable read. Provides a clear framework for equity investing in today's ‘sideways' and volatile markets useful to everyone. Clear thinking and clear writing are not often paired - well done!"
— Dick Weil, CEO, Janus Capital Group

"The bible for how to invest in the most tumultuous financial market environment since the Great Depression. A true guidebook for how to build wealth prudently."
— David Rosenberg, Chief Economist & Strategist, Gluskin Sheff + Associates Inc.

"A wonderful, grounded read for new and seasoned investors alike, Katsenelson explains in plain English why volatility and sideways markets are a stock picker's best friend."
— The Motley Fool, www.Fool.com

Praise for Active Value Investing

"This book reads like a conversation with Vitaliy: deep, insightful, inquisitive, and civilized."
— Nassim Nicholas Taleb, author of The Black Swan

"Thoroughly enjoyable . . for the thoughtful and often entertaining way in which it is delivered. . . Katsenelson takes his reader step by step into the mind of the value investor by relating, in a fictional addendum to Fiddler on the Roof, the story of Tevye's purchase of Golde, the cow. He also describes his own big-time gambling evening (he was willing to lose a maximum of $40) and that of a half-drunken, rowdy fellow blackjack player to stress the importance of process. He then moves on to the fundamental principles of active value investing. What differentiates this book from so many others on value investing is that it describes, sometimes through the use of case studies, the thinking of a value investor. Not just his models or his metrics but his assessments. Katsenelson is an empiricist who weighs facts, looks for contraindications, and makes decisions. He makes value investing come alive. This may be a little book, but it's packed with insights for both novices and experienced investors. And it is a delight to read."
—Seeking Alpha

• Language: English
• Publisher: Wiley
• Release date: Nov 17, 2010
• ISBN: 9781118010372

Book preview

Introduction

My father’s younger sister left Moscow in 1979. I’m not sure whether she was the first Jewish/Russian immigrant to discover Brighton Beach, but she definitely found it before Russian became its primary language. In 1991 she invited my family to the United States. By that time my aunt had divorced and re-married. Her new husband was a rabbi who led a congregation in Cheyenne, Wyoming. With apologies to Wyoming, thankfully we did not move to Cheyenne, but settled about 100 miles south—in Denver.

After folding towels at the health club, busing tables at the Village Inn, and bagging groceries, my first real job was at an investment firm in Golden, Colorado. I was a junior at the University of Colorado. I was hired because of my computer skills. I wrote a database application that they still use today. They didn’t have anything else for me to do computer-wise, so I was promoted to head trader. (Okay, I was their only trader.) Trader was a glorified term for my actual position since all I really did was call or fax buy and sell orders. But the job gave me an opportunity to spend a lot of time in front of a Bloomberg terminal and allowed me to talk stocks with portfolio managers. It did not take me long to realize that I loved investing. I changed my major for the sixth and final time, and the rest was history . . . well, almost.

I wanted to be an analyst and they did not need one, so I pulled out the Yellow Pages and sent my résumé to every single investment firm in Denver. I don’t know what Michael Conn, Investment Management Associates, Inc. (IMA)’s president, saw in me, since I didn’t know much then—perhaps my ambition and hunger for knowledge stood out. Finding somebody willing to pay me to analyze stocks was almost unbelievable.

IMA had been around since 1979 and had a solid investment record. Since its founding, it had owned high-quality companies that consistently grew earnings and traded at reasonable valuations. On my very first day at work Michael Conn, now my partner, proudly showed me his positions in Walgreens, MBNA, and a few other stocks that he had bought more than a decade earlier. His cost basis was a fraction of their current prices, and many stocks were up 10- and 20-fold since he bought them. Buy and hold worked!

The years 1997 and 1998 were great for IMA; its stocks went up as much as the market, which was plenty—the market was up around 30 percent each year. But 1999 was a different story. The reasonable valuation requirement kept the firm away from the dot-coms and the majority of high-tech companies, as their business models made no sense. In 1999 the bubbly stocks were doubling every other month, while our stodgy, high-quality companies lagged. The Standard & Poor’s (S&P) 500 index was up over 20 percent in 1999, and our stocks were barely up. Our clients were grouchy, but our past success sustained their goodwill. The next year our patience was rewarded—our stocks went up, while the market, especially the dot-coms, and tech crashed. We felt vindicated, but vindication was short-lived.

That was the last year when the time-honored strategy of buying and holding great companies at reasonable valuations worked. In the next few years the market either declined or stagnated. We were stagnating, too. We had a few years of frustration to ride out. At first, I thought it was a 1999-like phenomenon: Our stocks were temporarily out of favor; but after all, we owned great companies, so how could we go wrong?

The Aha! moment came when a speaker at an investment conference I attended put up a Dow Jones chart in logarithmic scale (similar to the one in Chapter 1) and pointed out that every time the Dow got to a handle of 1 with zeros behind it (e.g., 100, 1000) it stagnated for more than a decade. This was early 2004, and Dow was bouncing around 10,000, so the speaker thought it was an appropriate time for the market to stagnate. He did not explain as to why this should happen—and I was not impressed with his every time we hit 1 with zeros logic. Still, he got me thinking about whether there might be a rational explanation to the pattern he