The Wallstrip (TM) Edge

"The Wallstrip Edge" reflects the views of its author, Howard Lindzon, and is not endorsed by CBS Corporation, CBS Interactive, or "Wallstrip," which is owned by CBS.

This publication is designed to provide competent and reliable information regarding the subject matter covered. However, it is sold with the understanding that the author and publisher are not engaged in rendering legal, financial, or other professional advice. Laws and practices often vary from state to state and if legal or other expert assistance is required, the services of a professional should be sought. The author and publisher specifically disclaim any liability that is incurred from the use or application of the contents of this book.

Charts courtesy of bigcharts.com and Eric Crittenden of Blackstar Funds.

Copyright © 2009 by Howard Lindzon

All rights reserved. Except as permitted under the U.S. Copyright Act of 1976, no part of this publication may be reproduced, distributed, or transmitted in any form or by any means, or stored in a database or retrieval system, without the prior written permission of the publisher.

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Hachette Book Group

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First eBook Edition: February 2009

ISBN: 978-0-446-54443-6

CHAPTER 1

Turn Off Your TV

Don't trust Whitey.

THE JERK

Noise is an investor's worst enemy. It leads to fear, anxiety, and countless investing mistakes. But we as investors are constantly inundated with headlines. They proclaim bad news because it sells. It also generates commissions. If you turn off the TV, control the flow of information, and stand farther back, your stock market returns will improve.

That seems very hard for most Americans because we're fascinated with the stock market. We all want to find the next Google (note: Google may still be the next Google), Dell, or Microsoft. CNBC knows you, and that's how it profits. But I say, turn the TV off. I will show you a better way, a quieter way, a more peaceful way, and, ultimately, a more profitable way to invest in the stock market.

You watch an NFL football game nowadays and both the offense and defense are built around distraction and misdirection. Technology has allowed noise into our lives for good and bad. The technology creep has mostly been great. Investing, though, has never changed. Bankers, brokers, analysts, "talking heads," tipsters, and the rest of old and new media are in the business of noise making. The good news is that you are the one in control of that information in 2009 and beyond. For all the noise and distraction, the idea is to have your investment dollars appreciate as much as possible. Consider Warren Buffett. He has not changed his style in fifty years. He has used technology to build risk-management vehicles, but basically he buys low in hopes of selling higher. In the stock market, you buy great companies and you are generally rewarded over time. You buy them at the right time and price and you do even better. You learn how to sell them properly and how to cut your losses, and you have mastered the game.

To the Optimists Go the Spoils

The years 2003 through 2007 were sweet ones for stock market trend followers. The emergence of China, India, Russia, Mexico, and Brazil, exchange traded funds (ETFs), low interest rates, and a weak U.S. dollar policy created a perfect storm for equities.

Homebuilders, Internet stocks, oil, gold, emerging markets, iPods, iMacs, BlackBerries, rubber shoes (Crocs), condoms, exotic dancers, guns, ammunition, aerospace, agriculture, solar—the list goes on and on. By the time you read this book, many, if not all, those trends will be long gone or on their way out. In late 2007 and early 2008, many of these trends did indeed end.

No matter—new trends will emerge. They always do. What you need is a simple way to track the new leaders so that when they emerge you are ready to ride them. You will find those tools and directions in this book.

Opportunity Knocks—Every Day!

The stock market offers opportunity for every economic condition, every single day. That's one of its greatest gifts to investors. We miss the opportunities because we are often paralyzed by our investment mistakes. The stock market is difficult. It isolates your weakness, exposes it, and, if you are not careful, inflicts great financial damage.

With over 12,000 actively traded stocks in the U.S. market and exchange traded funds (ETFs) exploding, opportunity should always be your focus. You may never find the "perfect" investment, but I will be beating into your heads how to prune and cut your losers. If you are not holding losers, those in distribution mode by Wall Street, you will be free to focus on opportunities. In other words, you will be way ahead of the game.

The goal throughout your investment life should be to catch winners, focus on those winners, and cut your losses. The great news is that opportunities are plentiful and are leaving the starting blocks to big returns daily. There is no advice on how to get rich quick in this book, but there is a long discussion with examples of how you can find, ride, and get off great stock trends. There is work involved to get there. Throughout this book I will constantly write about staying in the game. Once you begin to invest, the temptations and thrills can become intoxicating. It is human nature. The taste of freedom and money has created this thrill since the beginning of time.

When in Doubt Watch Seinfeld

In a classic Seinfeld episode, George Costanza tells Jerry and Elaine, "Every decision I have ever made in my entire life has been wrong. Every instinct I have in every aspect of life—it's all been wrong." After a discussion about whether chicken salad or salmon salad is the true opposite of tuna salad, Jerry advises George to do the opposite of what his instinct is telling him. Jerry says, "If every instinct you have is wrong, then the opposite would have to be right."

George concludes, "I will do the opposite." The result is a date with a beautiful woman and a job with the New York Yankees.

The Blame Game Is for Losers

We love to blame. When doing yoga, I blame my parents for bad genetics. When I get burned on a stock, I blame the company's CEO (I know that won't help). Turn on the television and you will see CNN blame the Republicans and Fox blame the Democrats. Controversy adds to the noise, but it sells. Short-sellers blame Alan Greenspan for the market going up and now those who bought homes on easy credit blame Alan Greenspan for tricking them. But it doesn't pay to blame stocks or the stock market. If you want to be a successful investor, take responsibility for your money and decisions.

Opinions Are Like Assholes: Everybody Has One

You ask for an opinion and you will get one. Actually, you will get opinions whether or not you ask for them. So just stop asking.

Price Targets Should Be Banned!

I don't trust people who issue price targets for stocks, which means I have developed a deep disdain for Wall Street research. The price of each stock you own will do the work for you, based on your own money-management strategy. Upward-trending growth stocks are hard to value. Therefore, the analysts on Wall Street issuing price targets are just guessing as well. They're a tool for analysts in order for them to feel relevant. In the end, price targets are just noise that will get in the way of you holding your winners.

If You Want to Invest, Be Prepared to Suck at Times!

We all have our own journey and stock market stories. Like many Americans I have always been fascinated by the stock market. I was just a teenager when I made my first stock purchase, a Canadian beverage company called Clearly Canadian. I was "clearly" wrong. It was a hot stock, and a stockbroker I was golfing with urged me to buy it. I did. I believe it was in the twenties. I believe I sold it at three. Buying high and selling low was not intoxicating. I was trend following—in reverse. I quickly gave up on the stock market. Betting football and drinking was a better intoxication.

My very first job was in the fall of 1987 as an order-entry clerk at a small bro-kerage house in Toronto. That's right—right before the crash of 1987. Talk about timing. I was now two for two. I vividly recall Black Monday. I had no money, so it's not that I lost any, but I remember the crazy flow of orders that day. I worked in the cage, which was off limits to brokers. Brokers put their order slips—green for buy and pink for sell—on a machine that swept the orders to our terminals for us to enter.

On that Monday the pink slips were flying in. Brokers were pounding on our locked door. It was total chaos. I remember having to input them that night and having to miss the Maple Leafs hockey game—I was pissed. Needless to say, I was let go by November and headed back to graduate school.

My first real job after graduate school was as a stockbroker, and I still knew absolutely nothing. Now I was three for three. And in spite of my horrific stock market experiences, I found myself once again coming back to the stock market. It must have been fate. In any event, I was a Canadian citizen looking for sponsorship so I could stay in the U.S. I answered an advertisement in the newspaper (how quaint). I got the job.

Looking back, I would have been more successful as a stockbroker if I had left it at that and just sold what they gave me. Instead of selling stocks to unsuspecting cold calls, I wanted to take everything in, try every investing style, and own every stock.

The first stock I ever truly got behind was Bank of Boston. The year was 1991 and the stock was basically a penny stock. Despite my dual master's degree in finance, I knew squat about the real world. No wonder one of my favorite movies is Back to School starring Rodney Dangerfield. The U.S. was in a real recession, the RTC was in full force, and bank stocks were poison. In short, it was definitely not a stock in an uptrend. That said, Bank of Boston was a home run. I was lucky—and totally hooked.

Flash forward a few years and careers. I remember the first time I read an article from Jim Cramer. It was back in 1997, and I used to read Smart Money. Jim was writing about the bull market in Intel and semiconductors. He was dead-on at the time. The market had been good for years. I was a young, eager entrepreneur and loved the stock market. The bull market in the NASDAQ and small capitalization stocks made me look smart. I liked reading everything—Jim's editorials the most.

When Jim started TheStreet.com, my hedge fund was up and running. It was the summer of 1998. We were a start-up, didn't have much money to manage—mostly friends and family—but we cared deeply. So did Cramer. I was an early subscriber and loyal. It was not so much that I was getting ideas from Jim and the Web site, but I was truly inspired by the overall passion of his writing. It was his entrepreneurial spirit toward the new medium: the Internet and its impact on the financial world.

As my friend Fred Wilson, an Internet venture capitalist and investor in TheStreet.com and Wallstrip, once said to me: "Cramer was the original blog-ger." He was so intense. Jim would bang out twenty posts a day from his "trading desk" on Wall Street. It was a play-by-play, the ESPN of stocks. The early days of the financial Web were shaped by Jim Cramer and TheStreet.com, and to the early pioneers went the spoils. Jim Cramer and TheStreet.com got their share.

Today, Jim is a television celebrity. His sixty-minute daily CNBC show, combined with his prolific writing and CNBC hosting appearances, are now impossible to track. Unfortunately, I think his message has been lost in the noise. The sheer number of his articles, posts, and ideas has made it impossible to keep up. There are many Web sites dedicated to just the tracking of Jim's picks and pans. Go figure. Watching TheStreet.com succeed against what seemed like an impossible business niche against the New York Times, the Wall Street Jour-nal, and the hundreds of business magazines was inspiring.

But, as much as I admire Jim Cramer for all he has done for pioneering financial media, CNBC and financial television have now taken it away. I don't believe it serves a purpose for the audience that watches it the most. There's just too much noise being thrown at us on a daily basis. To me, the average investor is now best served by doing less and cutting costs to the bone. Learn to control the noise so you can find trends.

Trounce the Averages

I believe everyone should own individual stocks. Take a look at the very long-term pricing chart of the Dow Industrials:

If you are comfortable matching the indexes, which are not bad returns, you should index. If you are going to own stocks, remember that the returns won't be linear. Some years will be fantastic and others downright miserable. But if you are going to invest in stocks, and plan to finish this book, you should do so with a goal to trounce the averages. Keep this in mind, though: Goldman, Merrill, Morgan Stanley, and the rest of the investment banks might be important for Corporate America, but are probably not so good for the individual investor.

Invest or Trade

Here is a rule I try to live by: Never let trades turn into investments, but be willing to let investments become trades. Everything I own is for sale at the right price. If I am trading (very rare), I have learned to be very focused on the boundaries I set for the trade. When I get lazy, I lose money.

We all exchange our services for money. Doctors with patients, lawyers with clients, and on and on. I get asked all too frequently how to make more money from trading the stock market. I tell people to build their business with their extra time, learn to knit, cat juggle, or take their family to the beach. Investing money in the stock market requires a commitment to excellence and longer-term thinking.

Ask yourself the same question as well: Why not get more customers, learn to market your business, and invest in yourself? You will get much better returns for your efforts than you will trading stocks.

I hear too many people refer to their stock accounts as "gambling money." Your gambling money should be for Vegas, where there is not a positive expectancy. Unlike Vegas, you can actually make money in the stock market, so never compare the two.

Shut Off CNBC!

Back to CNBC. You should really consider turning off CNBC for these three reasons: It has little financial value, it creates anxiety, and it is a one-way communicator. You need to get very quiet to hear what is most important and meaning-ful.

I understand that television is part of our culture and has persisted and thrived particularly in the financial sector. TV is everywhere. But just because it is always on doesn't mean it is important—and just because someone is talking to you on the tube doesn't mean they have something valuable to say.

Let me put this another way. The major events of our time that you just can't miss and that you won't forget mark individual time frames during which trends in the market begin, end, accelerate, or decelerate. For example, the stock market had been going down hard for two years before September 11.

The tragedy marked the beginning and end of many trends while accelerating and decelerating many others. But serious trend following is not about, How might I make money on the day after 9/11? Consider travel-related companies and stocks: Heading into 9/11, they were very weak. For weeks after, they were decimated. The terrorist attacks of 9/11 accelerated the market bloodshed. But it was only six months to a year later that the market bounced back and they passed their pre-9/11 prices and accelerated to the upside.

This defied all logic—at least in the eyes of the financial media. Hilton Hotels, which they couldn't give away just after 9/11, was sold in 2007 in one of the largest private equity deals of all time. As it turned out, hotel stocks were among the best investments post-9/11, and you didn't have to be an expert to understand that the movement of the stock's price was signaling something important. In hindsight, price dictated the strong trend. The hotel strength came from many factors, the biggest being a curious world and a weak U.S. dollar. Most humorous to me is how the "rich and smart" bankers are, it seems, really closet trend-followers. They have all the tools and capital to do fundamental analysis, so was Hilton not a better buy in 2002?

In the last few years, there have been only a few major news events that have really mattered to the financial markets, events that have risen above the noise of the daily news. The South Asian tsunami, September 11, Hurricane Katrina, the Chinese economic boom, the outsourcing of jobs to India, and the United States' war in Iraq and "credit crunch" all come to mind. Big money has been made off these trends. But to see them for the investment opportunities they truly present, you can't be bogged down in the daily headlines. While Britney tries to clean herself up, while Paris Hilton did time (Martha Stewart too) and aspiring politicians sound-bite each other to death, trend followers—not headline watchers—have made gigantic money. For example, the closed-end Malaysian (EWM) fund has been on a tear since the tsunami, China's boom has led to a major trend run in commodities, India's workforce has increased productivity and leverage for thousands of American and foreign companies big and small, and the war in Iraq has meant a boom for aerospace and defense stocks.

A premise of trend following is that money flows and continues to flow for long periods of time before it ends, until reason is finally out the window. In my opinion and from my experience, the market is irrational 99 percent of the time on its way to rationality. It gets there when it finally decides to get there, and that happens very quickly. If you do not manage the noise, you risk being scared into doing something stupid, so the less noise the better. Don't let the so called TV experts confuse you.

Why Most Active Money Managers Can't Beat the S&P

The payoff structure for common stocks is highly skewed to a small minority. Take a look at the chart below, which graphs the distribution of stock winners:

The chart is really quite amazing, but not that surprising if you have ever started a company. For every Microsoft there are hundreds of software companies that go bankrupt, or at best are dead money. There were fifty-plus car manufacturers in the United States in the 1950s. Ford, GM, and Chrysler were the only survivors for decades. Seventy-four percent of all stocks actually underperform the S&P during their lifetime. My friend Eric Crittenden at Blackstar has done the back testing to see that the only way to outperform the S&P consistently is to disproportionately own the other 26 percent. What do these 26 percent of stocks have in common? They spend most of their time at or near all-time highs.

Check your mutual fund holdings and see if your retirement-account mutual fund managers have been buying Intel, Dell, Microsoft, and other leaders of the past. It guarantees underperformance. Then again, if your mutual fund manager is constantly outperforming the indexes, he or she is likely trend following in a good market and/or making huge bets in a small group of stocks and betting correctly. That outperformance rarely lasts. You can't be lazy with allocating money to active portfolio managers.

Analysts Are No Better—Major Media and Magazines Too

It's not just the TV that you need to shut off—it's the constant flow of research that crosses your desk. If you have a brokerage account and an e-mail account, you know what I mean. You are getting hammered with online and institutional research. For example, do you really need a thick research report about the state of the housing industry to tell you what you already know? Can you not drive around town four times a year to get a read on the local real estate market? That is a rhetorical question, by the way. Is the number of homes for sale increasing or decreasing? Are the malls busier or slower than last year? Is a certain restaurant or retail chain popping up all over town, and, more importantly, is it crowded?

In early 2008, JPMorgan released its 312-page state-of-the-Internet report. They declared that Internet stocks would out-perform the general market in 2008. By the end of January, the S&P had endured its worst January in history. Google was down 30 percent. My point: These reports will not make you a better investor, so relax. The only takeaway from that 312-page report is that analysts are making good use of their interns. No one is more bullish than I on the Internet, but c'mon—312 pages of research that was proved worthless in two weeks? I can't imagine reading a 312-page report telling me what I already know—that the Internet is likely a 100-year bull market. I don't care about 2008 because, as I mentioned already, returns are not linear.

In January 2008, Time magazine chose Vladimir Putin for the cover of their very thinned down issue (advertisers are moving away from print to online) as Man of the Year after Russia has already been a stock market darling for ten years. One thing is true from the bull market of 2003–2007: Russia was one of the biggest benefactors. The Time cover story was, in effect, old news. If you had been following price and all-time highs, the Russian exchanges, with their heavy weighting of natural resource stocks, had been trending in all-time-high country for four years. Russia had actually been in a straight uptrend since 1998 and hit all-time highs as a country back in 2003. Jumping on the bandwagon after ten years of big gains from magazine hype is not exactly the best effort at trend following.

Magazines are anxiety producing in other ways. Once you've fired up a subscription, the issues keeps coming whether you like it or not, and they just pile up. You feel that you have to read them, as if you may be missing something. If magazines and newspapers are piling up in your home or office, if TV shows are going unwatched because you are backed up on TiVo, now's the time to take control! Cancel your subscriptions. Turn off the TV and skip the TiVo. Free yourself of the noise and anxiety. Investing can be complicated, but I choose to keep it simple. You should too.

Financial Web versus Television

Who should you trust among the many financial commentators and experts that are feeding you conflicting and confusing information? You can't interact with the host or with the owners. Remember, it's a one-way medium.

On the Web, though, you can interact with the authors and find links that allow you to quickly find sources of information; there is a path to follow. If experts on the Internet are not linking, that's a clue that they prefer to follow the one-way-communication model of TV. But if they are giving you the sources from which they are forming their opinions, you can go follow that chain of links, ideas, and opinions in order to develop confidence in their opinions or discount them. People who ask for your trust should disclose, disclose, disclose. You will get much more of that from blogs and the Web. I guarantee that your investing results will improve without news and business television as part of your diet.

The Market Is a Giant Mood Ring

Trend followers are not emotional; they just follow price. Stock prices are driven by moods, not just fundamentals. Americans are generally optimistic, and that is reflected in the long-term charts of the Dow Industrials and the S&P, but we do get overexcited and underexcited at times.

The market was super-excited in 1999 and 2000. We all had a new toy then: the Internet. Companies were building a global information railroad to connect people. The First Transcontinental Railroad, 1,777 miles of track from Omaha to Sacramento, took seven years to construct after a decades-long movement to get it built. Building the infrastructure that supports the Internet was explosive in comparison. The euphoric feeling showed up in the form of stocks such as Cisco, Lucent, Nortel, Qwest, and WorldCom—in other words, all the people who were laying the "tracks." If you were part of the Internet investing "irrational exuberance" during the late 1990s, the paper gains were gigantic. Unfortunately, euphoria breeds complacency, and investors without an exit and money-management plans paid the price when the dot-coms crashed.

I believe it is better to be optimistic than pessimistic, but markets turn, trends end, and moods change. When they do, the exit door closes fast. A lot of stock market gains get erased when the mood changes and/or trends end due to market- or company-specific changes. Investing is a business, not a game. For trend followers, if you follow certain money-management rules, the inevitable periods of losses follow big gains. With proper money management, you will be way ahead over the long run (be sure to read Chapter 5).