Reader Mailbag: Why Such A Focus?

Reader TH asks a very relevant question with regards to the focus of my attention over the past year or so.

Paraphrased, TH wanted to know why I spend so much time deliberating over the potential forces of inflation and deflation rather than focusing my attention of some of the more prospective new technologies and investment opportunities of the future. He contends that there are opportunities to make money in any market environment and wonders if my time would be better spent searching for those, as opposed to trying to "predict the future actions of madmen."

TH raises some very good points here. Indeed, there are many new technologies that I am very positive on. Nanotech would probably be at the forefront of this. There are unlimited applications for a technology that literally allows one to rearrange the building blocks of life (molecules) to conform to one's needs. This is not a new concept. But the underlying technologies have become much cheaper than the two previous speculative booms that the sector enjoyed (and then suffered through) in 2000 and 2004. Very much like the concept of the computer was posed decades before it became a useful tool, in time nanotech will gradually begin to make waves on our lives and economy. The companies that are able to be at the forefront of this will likely become some of the better investments of the next few decades.

Additionally, I still believe there are advancements to come in communications and networking. The recent introduction of "smart phones" is probably the most notable manifestation of this. Network speeds and accessibility are enjoying exponential growth. With it, they are redefining what people are able to do "away from the office." Often seen as a gimmick for text messaging friends and other social networking time-wasters, the open source nature of these things are enabling people to do away with numerous other burdensome tools and making us more productive in the process.

Another area that I see new and exciting growth opportunities are in so-called "new media." I am already invested heavily in this industry - via this blog. I don't think anyone can honestly say what the next medium will be for the transmission of news media, entertainment, or advertising. But it is apparent that it will be far more customizable and "on demand" than previous versions. There will be little bubbles along the way - for the life of me, I can't figure out what draws people to Twitter. And yes, I'm aware of the irony that blogging is itself a potential bubble.

So back to the original question from my reader TH. Why don't I spend more time talking about this kind of stuff?

The short answer is because even though I want to be invested in these technologies, I firmly believe I can do so at a fraction of the price in 2-5 years down the road. And this belief is best conveyed with an understanding of our current deflationary situation. If it were inflation that I saw in the near or intermediate future, I wouldn't care much for valuations or balance sheets. I would be buying assets on margin in expectation of their imminent explosive growth.

As I began my research into financial markets, the first area of interest for me was in understanding the history of markets. I suppose it would have been easier if I became enamored with the impressive growth of homebuilding stocks, but that seemed all too short term and frivolous to me. I was after the big picture. The more I began to research this, the more it became clear to me that successful investing rarely had much to do with picking stocks. Rather, it had more to do with making the right decisions in asset allocation once every 10-20 years. That's all that seemed to matter.

Think about it this way. Among those who were entering midlife in the late 60's/early 70's, how many managed to fully benefit by buying real estate and commodities with borrowed money at a low fixed rate of interest? And later on in the 70's how many had the acumen to sell those assets and buy stocks? And in 1999, at the height of the tech bubble, who in their right mind would sell everything and buy government bonds - and hold them for a decade?

The answer to all those questions is "not many." However, anyone who did make even one of those decisions was likely made very wealthy for the remainder of their lives. Any further decisions would have been irrelevant to their overall financial standing. For anyone else, the likely outcome was breaking even at best, bankruptcy at worst. Even those that managed to pick the best stocks through the 70's lost out to inflation. Those that held real estate into the early 80's were eventually forced to refinance debt at interest rates of 20%.

It is my contention that the environment for owning companies is poor, as it has been for 10 years. I could attempt to pick the best among the industries that I mentioned above. If I happen to be wrong - or early - I lose. Take Juniper Networks (JNPR) as an example. I like this company. They provide networking solutions for many of the new technologies I talked about above. They don't have as much risk as the underlying technologies because they simply service the needs of other companies. But they are trading at 22x their forward projected earnings and pay no dividend. Twenty two times! Of course those projected earnings could be affected by exogenous risk factors that have nothing to do with the company itself. How can I buy this with a 10 year horizon if I think there is a realistic possibility of it dropping 60%? I encounter the same conundrum in nearly every business that I feel has good growth prospects.

So we come back to the question at hand. Inflation or deflation. If it's inflation, I hold my nose and buy 'em. If it's deflation, I remain patient and wait for that 60% correction or more - yes even from these levels. It is a binary outcome. Hence, the focus of my blog and my attention is in determining this outcome.

Managing this will prove to be the single most important determinant of the future financial health of myself and my readers.




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