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Transcription of interview with Ken Fisher on March 19, 2012.
Douglas Goldstein, CFPÆ, Financial Planner & Investment Advisor
Ken Fisher is the founder, chairman and CEO of Fisher Investments Company, which manages
about $41 billion.
He has been known for over 27 years as Forbesí portfolio strategy columnist and is the fourth-longest
running columnist in Forbesí history.
He is also a New York Times bestselling author and wrote the book, Markets Can Never Forget
(But People Do).
Douglas Goldstein, financial planner & investment advisor, interviewed Fisher on Arutz Sheva
Radio.
Douglas Goldstein: Can you tell us a little bit about the link between the stock market
price/earnings ratios and stock prices?
Ken Fisher: Much of what we commonly believe about things is because of the way our brains
work rather than the things themselves, and people have difficulty with that.
Our brains were set up to process information a long time ago, but they were not really
set up to deal with the kinds of modern phenomena that we also encounter today, and we process
that information through those old processors.
Things like price/earnings ratios are ones were we routinely presume because our brain
naturally assumes that high P/Es are riskier than low P/Es, and this becomes part of a
common culture that is widely accepted.
People agree on it, but the fact remains at almost any time I put any information in a
framework that is a framework of height, people will always see a heights framework as risky
because we are descended from people where heights were inherently risky if you fell.
You likely got killed or maimed, and if you are maimed, itís almost as bad as getting
killed so heights were risky.
For example, if you pick a high P/E and flip it into any key that would be earnings divided
by price and think of that as an interest rate as compared to other interest rates,
the heights framework goes away and the compared of cost of money becomes more important.
You become more rational and analytical, and you get closer to a reality that make sense
in an economic way, but if you just think in terms of P/E, people auto default that
high P/E is risky and low P/E is safe.
Meir Statman has done a lot of work on this that was published long ago.
Any way you measure it, looking at one, three, or five years, doesnít tell you anything
at all about risky returns.
Douglas Goldstein: If youíre buying something and paying 30, 40, or 50 times earnings, it
is very expensive.
Youíre saying that thatís just how we are programmed to think and itís not really the
reality of how the market works?
Ken Fisher: High P/E stocks over one, three, and five-year periods donít have a markedly
higher or lower return than low P/E stocks except in the periods where high P/E stocks
do better and periods where high P/E stocks do worse.
But if you take out just a very few, which you could think of as outliers and outliers
are always things that have a status of additional ones to throw out, itís likely not to be
very meaningful and doesnít look at the bulk of the returns.
So you donít see any effect that actually leads you anywhere on a predictive sense that
anybody would ever want to bet on, and yet thatís what our brains want to do.
The same is true if you think of, for example, the total market.
People generally believe that things like markets are less risky when the marketís
P/E is low.
They are more risky when the marketís P/E is high and you can just measure looking at
one, three, and five-year returns, how many times the market depends at this P/E level,
that P/E level, and the other P/E level.
High P/E tells you nothing about whether it will in the next year go up or down or by
how much, because for example you can give me a high P/E market that has done terribly
and I can show you a complete example of how an exactly identical high P/E time period
over the next 12 months did wonderfully.
Itís actually very 50/50, and the same as true with low P/E. Low P/Es sometimes do wonderfully,
sometimes they do terribly, and if you look again at one, three and five years, itís
very 50-50, but yet thatís now what our brains want to believe.
One of the key things of behavior is that we tend to see information that confirms our
prior biases and we tend to be blind to the information that contradicts some of these.
My newest book which came out last year, called Markets Can Never Forget (But People Do),
is just chock-full of examples of the things where our memories just donít work for us
in showing us what it is that weíve often seen many times before.
But because itís inconsistent with our prior bias, we donít accept it until we donít
see it, so weíre blind to it.
One of the points thatís amazing about our brains and our memory is that our memories
about some things are very good.
Weíre very good at recognizing facial patterns, for example, and holding them for a very long
time period and being able to recognize somebody that we havenít seen for 20 years as their
face changes and ages.
Weíre really good at doing that, but thatís a really old thing that weíve done for a
really long time with people.
A lot of us are in the framework that once we have ever dealt with our own, what we tend
to do is believe that all of our friends believe it.
We tend to think itís true, which reinforces our tendency to believe it.
Yet in fact, the message that Iím saying is check it out for yourself to see if itís
really true because most of what you believe isnít really true.
People find this troublesome, and they also find it to work and yet the whole world of
markets takes advantage.
Douglas Goldstein: One of the very common numbers that comes out and affects the markets
all the time is consumer confidence.
How does that affect stock returns?
Ken Fisher: Consumer confidence is something that is largely and overly simple since it
moves with the market with a very slight time lag.
If you know what the stock market has done in terms of the global stock market, you know
pretty much where the consumer confidence numbers are going to come out.
When the market goes up, rising and performing well, strong consumer confidence tends to
rise.
When the market tends to be falling, consumer confidence is often updated and revised a
little bit after theyíre initially released, but the revised numbers largely have a slightly
lag effect to the stock market.
The stock market is telling you the same thing- that consumers will be able to see how theyíre
feeling.
The point is so simple that most people donít want to believe it.
For example, in the media it regularly says that you should be more optimistic because
consumer confidence is up and thatís the sign that things will be better ahead.
On the one hand, the stock market is in of itself the leading indicator, and it always
has been both on the upside and on the downside but an improvement in consumer confidence
is really a statement that the stock market has already been up.
Itís not because consumer confidence is up, so you should be bullish, or that because
consumer confidence is down, you should be bearish.
We see lots of these things, but weíre just unwilling to accept them because we donít
want to accept them.
The most egregious that I know of are all of the features that surround deficits and
debt.
We have heavy biases with the Western world and much of the rest of the world.
Everything that has to do with debt is that debt is bad and more debt is worse, but there
are lots of examples that contradict it.
But people donít want to look at those examples of where somebody had debt and they got into
trouble, and therefore this reinforces their view that this is bad.
The willingness of people that contemplate that their bias might be wrong is very low,
very small.
Thereís this tremendous desire to say which behavior was called accumulating pride, which
is, ìWhat if Iím smart?
So you want to see me doing it again?î and that tendency really doesnít want to challenge
its own belief system because when you challenge your own belief system about basic things,
itís scary and as if youíre ego-driven.
Douglas Goldstein: If you were to give advice to regular investors, what would be the number
one thing that people should be doing when theyíre beginning to work on their own finances?
Ken Fisher: I presume that if youíve been right, youíre probably lucky, and if youíve
been wrong that you should be focusing on learning something that changes some belief
set that you have.
Otherwise, maybe youíre overconfident if youíre not ready to do that, and if youíre
overconfident, maybe you shouldnít be making your own decisions.
Thereís a tremendous tendency among humans of all types to be overconfident, to presume
that they can make decisions that arenít the basis as they donít really know anything.
Finance basically says, to make a long story very short, that you need to know something
other people donít know or when you make decisions youíll either be right because
youíre lucky or more often be wrong and be worse if you made no decisions at all.
I decide Iím going to buy stock X because I really like the new product that theyíre
coming out with, which is a really easy thing for somebody to see that you might do that,
and it goes up so you think you were smart.
If it goes down, you think, ìI didnít really decide to buy that stock; the broker sold
it to me.î The fact is, what a financier would say is that if you didnít know something
that other people didnít broadly know, you shouldnít be making the decision, and if
youíre going to be an investor, you should largely just be passive.
The part that says I want to give up my overconfidence is a very hard thing for most people.
The fundamental basis of investing should include an extra dose of pre-plan humility
that is actually very hard for many people to engage in.
Most people fall to this notion that behaviorists call ìaccumulating prideî and ìshining
regret,î which associates success with scale repeatability and associates failure with
victimization or bad luck.
Our ancestors accumulated pride and shining regret in almost everything they did, which
motivated them to keep trying, and we are the descendants of people who are very heavy
priers because if you think of doing something as audacious as taking a stick with a stone
point on it and running up next to some large animal and thinking youíre going to stab
it and take it home and defeat it, that takes a fair amount of confidence and a fair amount
of willingness to take a risk that you donít get trampled in the process and killed yourself.
We are the descendants of people who are very successful at engaging in these activities,
where they were on the one hand overconfident, but they were good at what they did, compared
to others who are not their descendants because they didnít pass on their genes.
The fact is that that overconfidence plays really well in a lot of environments.
So, in a distant time in a tribal format, one time I had to go into the north, to the
east, to the south, to the west, and the guy that comes back at the end of the day with
a couple of gazelles over his skin is a big hero around the camp fire that night.
The guy that comes back with nothing for the day comes back with a lot of excuses as to
why it wasnít his fault.
The winds are blowing the wrong way, there were big noises in the area that scared all
the gazelles off, the neighboring tribe were making a lot of noise, but nobody really appreciates
all the excuses.
They leave and go back out to hunt the next day.
The guy with both gazelles has turned into a real hero around the campfire and people
are talking about how maybe the chief is going to have the guy marry one of his daughters.
The next day, the guy who was unlucky the prior day may actually just stumble on a gazelle
that had mangled its leg and canít get away, and even if heís a terrible hunter, he brings
back meat because he got lucky that day, and thatís still good for the tribe.
The one that came back with the two gazelles accumulates pride as around the campfire they
associate his success with scale repeatability, and the one who comes back with nothing associates
his failure with victimization or bad luck that allows them to continue trying the next
day, which for the tribe is a good thing.
We as people have been hardwired for millennia on accumulating pride and shining regret,
and in that environment where we came from it is actually a beneficial feature to our
society.
In the environment where weíre engaged in security transactions and capital market,
it actually builds this overconfidence that causes us to do things that we really arenít
able to do and the market takes advantage of us, which is central to some of the basic
tenets of behaviorism.
Douglas Goldstein, CFPÆ, is the director of Profile Investment Services and the host
of the Goldstein on Gelt radio show (Monday nights at 7:00 PM on www.israelnationalradio.com.
He is a licensed financial professional both in the U.S. and Israel.
Securities offered through Portfolio Resources Group, Inc., Member FINRA, SIPC, MSRB, NFA,
SIFMA.
Accounts carried by National Financial Services LLC.
Member NYSE/SIPC, a Fidelity Investments company.
His book Building Wealth in Israel is available in bookstores, on the web, or can be ordered
at: www.profile-financial.com (02) 624-2788 or (03) 524-0942.
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