Smarter Than the Street: Invest and Make Money in Any Market

By Gary Kaminsky

CNBC Money Expert Gary Kaminsky Reveals the Wealth-Building Secrets of Wall Street Insiders

“Gary Kaminsky is one of the top money managers of the last two decades. His book is a must-read for anyone trying to make real money in the stock market!”
Nils Brous, Founding Principal, Samson Capital Advisors, LLC; Chairman, Arcoda Capital Management LP; former executive, Kohlberg, Kravis, Roberts and Company (KKR)

“Want to know how the best managers and traders on Wall Street make money? Read Gary Kaminsky’s down-to-earth, money-making guide and learn the secrets of profiting in any market.”
Melissa Lee, Host, CNBC’s "Fast Money"

“A must-read! Gary Kaminsky takes the mystery out of the market with his no-nonsense, take-no-prisoners approach.”
Jeffrey Moslow, Managing Director, Investment Banking, Goldman Sachs

The Book Wall Street Doesn't Want You to Read

How do savvy Wall Street investors achieve high returns even in the worst financial times? It’s one of the industry’s best-kept secrets—and now it’s yours for the taking.

Gary Kaminsky, cohost of CNBC’s "The Strategy Session"—and one of the best money managers in Wall Street’s recent history—is ready to share the secrets that have made his colleagues millions, even billions, of dollars. These simple but powerful techniques are not exclusive to Wall Street’s high rollers. With Kaminsky’s system, you will make money even in zero-growth markets. His proven formula shows you how to:

• Develop the same habits, reflexes, and practices of top market performers
• Create a proactive buy-and-sell strategy
• Beat the roller-coaster market trends—and focus on long-term returns
• Make smarter, more informed decisions—and more money!

Kaminsky brings more than two decades of experience to his low-risk, high-return system, demystifying Wall Street for novice and seasoned investors alike. Between 1999 and 2008, Kaminsky’s team at Neuberger Berman grew record-breaking returns far above the S&P benchmark. And they didn’t do it by magic. They did it by constructing a specificstrategy and sticking to it, regardless of the investing climate. It is a strategy that anyone can learn and apply, step-by-step, in any market.

With Kaminsky’s expert guidance, you’ll learn how to be more disciplined and vigilant with your investments, maximizing your returns in a minimum amount of time. You’ll not only make money in most markets, but you’ll lose much less money when those around you are losing their shirts. And you’ll be able to strengthen and protect your assets—particularly in the slow-growth decade ahead—with the confidence and know-how that drives Wall Street’s smartest investors to the top of their game.

Yes, you can beat the market—when you’re Smarter Than the Street.

• Language: English
• Publisher: McGraw-Hill Education
• Release date: Oct 29, 2010
• ISBN: 9780071753586

Book preview

Part One

WALL STREET EXPOSED

1

THE LOST GENERATION OF INVESTORS

The two major market meltdowns of the last decade have created a new phenomenon that I call the lost generation of investors. When I use the phrase lost generation, I mean the people who left the market between 2000 and 2009 and will not be coming back anytime soon as a result of their experiences during that very difficult period. I will use the phrase lost decade the way the Wall Street Journal does, to signify the period from 2000 to 2009, in which markets went nowhere. During the lost decade, millions of investors left the stock market and have never come back. Both of these phenomena occurred chiefly as a result of the two market disasters of the first decade of the 2000s, which some have called the zeroes.

The first market debacle—the bursting of the dot-com bubble—started in 2000 and caused the Nasdaq to crumble from a high of over 5,000 in the first quarter of 2000 to a low of about 1,200 by late 2002. Since major market crashes don’t happen very often, after this collapse, most investors thought that all was well with the markets and drove the Dow to top 14,000 in 2007 (while the Nasdaq has never come close to approaching 5,000 again).

During the lost decade, millions of investors left the stock market and have never come back.

Let’s look at the year-by-year performance of the stock market for the decade 2000–2009 (see Figure 1-1). Please note that all the stock charts in the book use month end numbers. They may not look exactly like the charts you may see on other Web sites, which are likely more volatile because they use daily closing numbers. These percentages represent annual actual returns of the S&P 500:

As we contemplate the lost generation of investors, we will widen our analysis to include larger and larger segments of time so that we can see how the overall markets performed over the long haul. However, before we widen our lens, let’s take a closer look at what the returns of the last decade tell us.

• First, we had a horrible start to the 2000s, with three down years in a row and each loss greater than that of the year before. That is uncharacteristic of the U.S. stock market. Since 1973, for example, only one out of every four years has been a down year. Of course, if we look at the entire decade, we actually had more up years than down ones, by a margin of six to four. But it is, of course, the magnitude of the gains and losses that counts.

Figure 1-1 S&P 10-year chart: going nowhere.

• The horrific 37 percent loss of 2008 virtually wiped out the combined gains of the previous four years. That was the year of the subprime mortgage mess, and it blindsided investors. The stock market had already had its worst days in 2000–2002, most investors thought, so surely it was not going to crash again. Yet the subprime mortgage mess caused a liquidity crisis that had many experts talking depression. The events of the 1930s were at our doorsteps again, many people believed, thanks to the huge housing bubble that burst in 2008. That bubble and the ensuing liquidity crisis drove the Dow Jones Industrial Average from its high of 14,164 in 2007 to 6,547 in March of 2009.

• A $10,000 investment in the S&P 500 at the beginning of the decade would have left you with just over $9,000 at the end of the decade. That makes the U.S. stock market the worst performing of all asset classes for the decade, worse than cash, bonds, the money market, or real estate. This negative return unnerved many investors, leaving psychological scars that we will explore in depth later in this chapter.

We also know that investors bailed out of the stock market in a big way in 2009. In fact, we now know that more than $53 billion was taken out of the stock market in 2009 by jittery investors who could not wait to get out, and 2010 started off the same way. In early March, $4.6 billion had been taken out of U.S. stock mutual funds in the first quarter of 2010, according to the Investment Company Institute (and that figure did not include ETFs, or exchange-traded funds). And if all of that is not enough to convince you of how unpopular the stock market has become, consider this: In the first nine weeks or so of 2010, world equity funds had absorbed a little less than $14 billion, while bond funds were more than four times as popular, taking in more than $56 billion. This is proof positive that investors are willing to settle for the anemic returns on bond funds rather than risk their hard-earned capital in the equity and mutual fund markets. This trend of leaving the market was sparked by what happened in the last three months of 2008. During that period, the Fed reported that U.S. households lost 9 percent of their wealth, the most ever recorded for a three-month period.

A Brief Glimpse of Historical Stock Market Returns

To understand the lost generation in context, we need to understand how the equity markets have performed over time and what most investors expect from their investment in the U.S. stock market. That is, what are the assumptions held by most retail investors (the 100 million individual U.S. investors with some stock market exposure), and where do these assumptions come from?

We know that there have been several watershed books that have had a major influence on the psyches of millions of investors. One such book, which many now consider a classic, is Jeremy Siegel’s Stocks for the Long Run. First published in 1994, it contains a plethora of information on the U.S. stock market dating all the way back to 1802, when it first began trading.

Siegel explains that a single dollar invested in the U.S. stock market in 1802 would have been worth $12.7 million by the end of 2006 (assuming that one reinvested all interest, dividends, and capital gains). That’s a remarkable number to ponder. Siegel tells us that the U.S. stock market has averaged a 7 percent gain each year over those more than 200 years, and 10 percent when adjusted for inflation. Siegel’s book has sold hundreds of thousands of copies over the years, and it has become a favorite tool of the great Wall Street marketing machine (in early editions, tens of thousands of copies of the book were purchased by brokerage houses). It is the poster child for buy-and-hold investing, a phenomenon that was held as gospel prior to the lost generation phenomenon described in this chapter (there will be more on buy-and-hold investing in Chapter 3).

Bear Markets of the Last Half-Century

There has been some great research done on the bear markets of the last 50 years or so. Examining the percentage and length of the declines tells us quite a bit about the financial markets. Since 1957, there have been 10 bear markets in the United States. A bear market is defined as a loss of 20 percent or more of the S&P 500. Table 1-1 gives a list of all 10, along with the years in which they began and ended.

Table 1-1 Bear Markets since 1957

Now let’s turn the tables and take a look at the bull markets of the last half-century (see Table 1-2).

Table 1-2 Bull Markets of the Last Half-Century

It is worth mentioning that there are several ways to slice up or synthesize the same information. For example, if you look at these bear and bull market tables, you will note that in some years, such as 1966, 1974, and 2002, we had both bear and bull markets either beginning or ending in the same calendar year. This reality reveals the complexity of attempting to time markets. Employing the definition of a 20 percent move as an indicator of a bull or bear market, we see bull markets that exist within larger bear markets and bear markets that exist within larger bull markets. The most noteworthy and greatest bull market in history occurred between 1982 and 2000. Yet within these incredible 18 years, which delivered a stunning return, there were several instances of both bull and bear markets (again, when using the 20 percent rule).

Back to the Lost Decade

These numbers tell me a great deal about the financial markets and how investors are likely to behave in the future. When one looks at all the numbers, the lost decade in particular is a fascinating period that reveals a great deal about the mysteries of the market. Within this 10-year period, we actually had more bull markets than bear markets, by a factor of 4 to 2. However, it is the timing and magnitude of the gains and losses that tell the real tale.

For example, after an incredible 18-year run-up, we lost almost half of the value of the S&P 500 in the period 2000–2002. Clearly, the dot-com bubble spread like cancer to the entire market. Then, later in the decade, from 2002 through 2007, the S&P 500 had a stunning 94 percent gain, which helped the market top the 14,000 level in the Dow. (The S&P 500 and the Dow generally move in the same direction. The S&P is a much better indicator, since it includes 500 stocks while the Dow has only 30, but any significant move in the S&P will always have a similar effect on the Dow Jones average as well.) However, it was the devastating loss of 38 percent in 2008 that destroyed any hopes of a positive decade. Despite the strong 28 percent gain in the final year of the decade, 2009, the S&P 500 still closed well under the level at which it opened in 1999 and 2000.

Research also shows that pension fund and other high-end money managers, who control large pools of funds, often amounting to billions of dollars, have also changed their investing habits. These managers have recently turned toward more investments in hedge funds and higher-fee investments, and, most important, have also significantly shifted their allocation from stocks to bonds.

The individual investors who were most affected by the last decade are those over 50 years of age. Even after the dot-com bubble, they felt that they still had enough time to get their money back. They did not anticipate the credit/liquidity crisis of 2008, and they watched with terror as they lost half of their investment portfolios on average (those with most of their money allocated to the stock market).

That explains the changes we have seen in investing behavior among retail investors as well. According to the Federal Reserve Board, household investments in bonds reached a record level in 2009, approaching nearly 25 percent of all personal holdings.

New research also proves that investors are leaving the market in record numbers. In 2008, the amounts of money being taken out of the stock and fund markets offset all of the inflows into those same markets during the previous four years.

This psychological scarring will play a major role in defining the decade ahead. The psychological shift will have ramifications that will dramatically affect the next generation of investors. As a result of the poor performance and return of equities in this last decade, those who had planned to retire couldn’t do so. We know this from numbers that were released in 2010.

One statistic shows that the retirement age has shot up (from 65 to 70.5) because of what has happened to people’s retirement savings in the last 26-month recession. In 2010, the average value of the average 401(k) was less than it had been in 2005. The researcher who came up with these numbers, Craig Copeland of the Employee Benefit Research Institute (EBRI), speculated that the retirement age could even increase to 75. No wonder pessimism is on the rise. According to the EBRI, just under 90 percent of the people it surveyed say that they will retire later. The EBRI also reported that the percentage of people with virtually no retirement savings grew for the third straight year. In 2010, it was reported that 43 percent of people have less than $10,000 in savings and, incredibly, 27 percent of workers now say that they have less than $1,000, up from 20 percent in 2009.

In addition, those families that had planned to send their children to first-rate universities or simply build up their education funds could not do so. That’s why, when I look at the next 10 years, I see the same roller-coaster ride as the last 10. Stocks will go up, and stocks will go down. There will be periods of exuberance (and note that I am not echoing former Fed Chairman Greenspan’s phrase, irrational exuberance), and similarly periods in which it looks as if the world is coming to an end.

Another by-product of the lost decade will be how specific acts of the Fed, the Treasury, and the U.S. government will be interpreted. For example, there will be periods much like those that followed the lows in 2009, when people were excited because the government had stepped in to make things better with the TARP and stimulus packages. Equity markets will react positively to these types of changes because they will view these actions as sparking productivity and increasing GDP growth. And this will be true not only in the United States, but on a global basis.

For example, in May of 2010, when the country of Greece faced insolvency, the European Union stepped in with a near-trillion-dollar rescue plan. There was such fear surrounding the Greece problem that the Dow soared more than 400 points after that deal was announced.

In other times, those same kinds of moves will be interpreted as harbingers of disaster. The reasoning during those periods will be that if the government had to take such drastic actions, then the financial outlook must really be bleak.

Investors need to inoculate themselves against the noise of the market and learn to stick to a specific buy and sell discipline. I will argue throughout the book that investors need to be just that, investors, and not traders (and God forbid day traders) that are reacting to every hiccup in the market.

Research That Proves the Tale of the Tape

One of the key assumptions of this book is that the next 10 years will resemble the last 10. And I am not alone in this belief. One noteworthy author and researcher, Vitaliy Katsenelson, has done some terrific research that backs up my thesis. He shows that despite the unprecedented events of these last 10 years, history favors a market that is likely to end the next decade (2010–2019) pretty much where we started this one.

Katsenelson explains that ever since the U.S. stock market started trading two centuries ago, every lengthy bull market has been immediately followed by a range-bound market that lasted about 15 years. A range-bound market is one that trades between two levels, usually characterized by a relatively narrow difference. For example, in 2011, if the Dow traded between 10,000 and 11,000 one would consider that a range-bound market. He also explains that the only exception was the Great Depression. Katsenelson also notes that the bull market of 1982–2000 was a super-sized bull market. To give you an idea of the magnitude of that market, consider this: if by some miracle (and it would take one) the Dow repeated its great percentage increase of 1982–2000 over the next 18 years, it would hit an incredible 175,000 points by 2028.

Lastly, Katsenelson urges investors to understand the difference between a range-bound market and a bear market, and the importance of investing differently in each of those types of markets.

Many people believe that the great recession of 2008 to 2009, brought on by the housing bubble and subprime mortgage meltdown, was so severe that it makes the current situation analogous to the Great Depression. Let’s take a quick look at these historical returns to gain further insight into the markets and see if this comparison holds any water.

In a 10-week period in 1929, from September 3 to November 13, Wall Street experienced the Great Crash and the market lost just under 48 percent of its value. After that, from November 14 to April 17, 1930, the market snapped back impressively with a 48 percent gain. Today, some members of the great Wall Street marketing machine are out there telling people to get back in the market with both feet so that they can enjoy the fruits of a similar bounceback and perhaps a new bull market. As is commonly declared in the world of finance, however, past performance is not indicative of future returns. The situations in 1929 and 2009 are totally different, for reasons that I have already explained, and will explain more fully throughout the book. As a result, I foresee no such snapback or new bull market occurring anytime soon. The bottom line is that the demand for stocks was far greater in 1930 than it is today.

This has a lot to do with the timing of the great bull market of 1982–2000. Referring back to Katsenelson’s research, every impressive bull market has been followed by a 15-year range-bound market. Perhaps 2000 to 2010 was the beginning of that 15-year range-bound market, which would mean that we will continue to be range-bound through 2015. Alternatively, the last 10 years could have simply been a return to normal valuations following the excesses of the 1982–2000 market. If that is the case, we may be in a range-bound market from 2010 to 2025. One can make a compelling argument for either scenario. One can also argue that we are going to see equities significantly underperform other asset classes, such as real estate or bonds. The scenario that seems most unlikely is that we’re going to have a significant expansion of price/earnings (P/E) ratios or an increase in the multiples paid for stocks, which is the major reason that stocks increase in value over time. (The multiple, which is derived by dividing a company’s market price by the company’s earnings per share, is also known as a stock’s P/E ratio, or simply P/E. Algebraically, earnings times the multiple will give you the share