It seems that common sense is not so common anymore.
A glance at recent headlines makes it clear that none of our elected officials are using it. The talking heads who run breathlessly from financial "crisis" to looming "catastrophe," or perform as market cheerleaders no matter what is happening in the real world seem to be lacking a healthy dose of it. Investors and traders chasing triple-digit multiples or trying their hands at day-trading seem to have temporarily misplaced it as well. In spite of the widespread lack of it, common sense remains one of the most valuable and underused tools in an investor's toolbox.
Consider pig farmer Mr. Womack, who was originally introduced in the late 1970s by John Train in Forbes. The farmer would drive into town during panics and buy a bunch of dividend paying-stocks that had fallen into single digits and then go back to his farm. A few years later when the markets were climbing and the media was universally positive on stocks and the economy he would drive back to town and sell them. On balance, the man never lost money in the stock market. I often use that as a test. What would Womack do? One suspects that today he is at the farm, doing farming stuff, having driven into town earlier this year and sold all the stocks he bought in 2009 at a huge profit. Perhaps I should make up some WWWD bracelets and tee shirts for investors.
There are some tools that long-term investors can use a common sense check. They are not perfect, nor are they timing devices, but they can give you a quick reality check before taking a flyer on a few hundred shares of Netflix (NFLX) because everyone else is doing it or check out that new swing-trading system your brother-in-law was raving about when he borrowed a few hundred bucks.
In hedge fund manager Mark Spitznagel's new book The Dao of Capital (a must read) he introduces us to one such measure. He names it the Misean Stationary Index after the Austrian Economist who foretold the crash and the depression. It is a simple measure of corporate asset values compared to the current market value of the assets. He finds that investors who buy stocks when the measure is low and sell and keep money in short-term fixed income investments when it's high can gain an advantage of 2% per year using the indices. When the markets are in the highest percent of historic returns, the anticipated return of the market is very low and all of the largest market drawdowns in history occurred when the index was in the upper 50% of historic readings. When it is in the lowest range of historic levels, the anticipated return is very high and investors should be buying aggressively.
That sounds like a decent common sense check to me. It is not a precise measurement that will give you pin point accuracy of turning points but it does help you to be fearful when others are greedy and greedy when others are fearful. The MS Index has you start buying stocks in the mid-1970s and keeps you enthusiastically in the market all the way thought the mid-1990s when you would become more cautious. You would jump back in around 2002 and be nervous in about 2005 or so. You would have been bullish again in 2009 and more skeptical towards the end of 2011. Again, it is not a short-term timing mechanism, but it can be a reality check that helps you use common sense in your investing activities.
The best part is that the information is readily available. All Spitznagel has done is rebrand the Tobin Q ratio. It takes James Tobin's ratio between the market value and replacement value of the same physical assets and applies it to the stock market using information from Federal Reserve reports. Glancing at this chart form time to time can keep your impulses in check and avoid following the herd down the road to euphoric disaster or miss a major buying opportunity when everyone else is panicking. The Misean Stationary Index sounds more important and sophisticated so I will stick with the new name, but whatever you call the ratio, it can help you apply common sense to your stock market activities.
What would Womack do? He would avoid the silliness of predicting how the market will react to near-term events and react after they actually occur. The MS Index may help you do the same and prosper as he did in his investing activities.