How to Play a Declining Market

Mohnish Pabrai is as smart as they come.

And each year he continues to get better.

He religiously follows Charlie Munger’s rule of being a learning machine.

One needs to be a learning machine and be willing to give up some of one’s best-loved ideas when the evidence suggests they are flawed,’ Mohnish has said.

When stocks crashed in 2007–09, he did exactly that.

He sold off duds. He sold good ideas to buy even better ones.

He also tried to learn from as many mistakes as possible.

At his 2008 annual meeting, he told investors he would have been better off spending $20 on a book than $20 million on Pinnacle Airlines.

The airline filed for bankruptcy in 2012.

Delta Financial was another mistake. ‘If you depend on borrowed money, you have to worry about what world thinks of you every day,’ Mohnish also said at the meeting.

He admits that he did not consider that the credit market (market for loans) would freeze up to the extent that it did.

It effectively put Delta out of business, forcing them to close the doors in December 2007.

At that time, while rattling off these mistakes, Mohnish’s investors were down 60%. And there would be more losses to come in the months ahead.

Yet even with such terrible losses, Mohnish was able to get back on track and crush the market 11-fold from 2000–13.

Now it’s time for you to do the same…

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Falling stocks indicating a coming recession?

You’re lucky.

This isn’t a 2008 replay.

Lenders aren’t shutting their doors. The economy is not recoiling. Central bankers won’t rapidly cut interest rates. Consumers are not leveraged to the hilt. And we’re not about to enter a recession.

Asset prices are just falling.

That’s it.

Sure, there’ll be some pain. Those with too much debt and investors that bought stocks when prices were extraordinarily high won’t like what comes next.

But now is not the time for pessimism. It’s time to take stock. Look at what you’ve got right. Try to learn from mistakes. And keep moving forward.

Of course, you won’t hear this from the mainstream…

The Australian Financial Review writes:

Wall Street’s slow-motion stock rout – which is about to enter its eighth week – deepened on renewed jitters about trade, economic growth and tightening Fed policy, triggering the White House to insist there is no prospect of a recession on the horizon.

‘…Renewed pessimism on Wall Street is being reinforced by fears the Trump administration won’t find an off-ramp for its bruising trade war with China ahead of a likely meeting between the president and China’s Xi Jinping in Argentina at the end of the month.

‘…Anxiety about the outlook is being exacerbated by speculation the boost from last year’s corporate tax cuts has increasingly run its course, while interest rates are set to continue rising. 

The Federal Reserve Bank of Atlanta said on Tuesday that it has cut its model estimate for real gross domestic product growth in the current quarter to 2.5 per cent from 2.8 per cent last week, citing weaker industrial production data and a likely fall in home investment growth.

The way the mainstream paints this stock market rout, you’d think we’re entering a recession. 

During the most recent quarter, real US gross domestic product (GDP) came in at 4.2%. This means the output of goods and services — adjusted for inflation — grew by 4.2% over the quarter.

And have a look at the following chart (real US GDP). If that doesn’t say the American system works over the long run I don’t know what does.


MoneyMorning 21-11-18

Source: Federal Reserve Bank of St. Louis

[Click to open in a new window]

Why point this out?

Because along that rising line has been multiple corrections and multiple stock market crashes. And not one is yet to derail American businesses from producing more goods and services over the long haul.

Yet herein lies the problem.

Many investors don’t care about the long haul. They want immediate gratification. And that’s why they’re jumping out of the market right now.

Others are trying to time their trades.

As I mentioned yesterday, there are hundreds of thousands of investors who think they can outsmart the market with little more than intuition.

And right now their ‘spidey senses’ are screaming to get out of tech.

But back to recession talks…

Top white house economic adviser, Larry Kudlow says it’s all nonsense.

I’m reading the weirdest stuff, how a recession is around the corner – nonsense. My personal view, our administration’s view, recession is so far in the distance I can’t see it,’ Kudlow said.

And you don’t even have to take Kudlow’s word for it.

Just think about it logically.

Will a trade war, likely to blow over, kill corporate earnings?

Will government bond yields, which are a proxy for the risk free rate, even come close to 5%?

Not by 2019, that’s for sure.

Like I said, there will be some pain.

But the way pundits talk about stock market declines, you’d think we’ll see the US and many other economies shrink drastically.

That’s why, during all this pessimism, I want you to mimic Mohnish.

How to play it from here…

I’m not saying stocks won’t be lower next year.

And if they are, that benefits you a whole lot more.

Fund manager Joel Greenblatt recently (29 October) told Bloomberg, that the US is in the 22nd percentile towards expensive over the last 28 years.

That means the market (S&P 500) has been cheaper 78% of the time and more expensive 22% of the time. And I’ll bet the Aussie market sits at similar levels.

From here (29 October), you’d be looking at an average return from stocks of 4–6%.

And as stocks keep falling, this average potential return increases.

So as stocks fall, do what Mohnish did in 2008.

Be honest with yourself. Find the mistakes in your portfolio (not every paper loss is a mistake). Learn from them. And look at what you’ve done right.

This might mean you’ll end up selling good ideas to buy even better ones. Even while sustaining huge losses, Mohnish was able to crush the market in the following years.

I believe you can do the same, with the right investments of course.

Fortune awaits,

Harje Ronngard,
Editor, Money Morning

PS: If you need help finding those investments, our small-cap expert Sam Volkering might have exactly what you need. He’s been scouring the ASX multi-bagger gains, and he believes these three stocks are must buys. Over the years, Sam has been able to find stocks that have risen 457%, 1,010% and 1,349%.


Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

Money Morning Australia is published by Port Phillip Publishing, an independent financial publisher based in Melbourne, Australia. As an Australian financial services license holder we are subject to the regulations and laws of Corporations Act and Financial Services Act.


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