I enjoyed reading Vitaliy N. Katsenelson's The Little Book of Sideways Markets, now added to our list of recommended books. You will, too. Most individual investors will profit greatly, and even experienced investors will pick up some valuable pointers.
The Thesis
The basic thesis for the book is that investors should expect a long period of time with the market going sideways. Katsenelson's argument is that the recent rally in stocks has seen most companies borrow against future earnings. He sees mean reversion behavior in profits. He made a similar prediction a few years ago, earning widespread acclaim. He is now repeating it. He also sees various global economic headwinds which he describes in some detail, identifying several species of "grey swans."
The author has support from some influential voices. John Mauldin contributes the Foreward. While he did not know it at the time of writing, the major thesis also has the endorsement of Doug Kass. Kass has made the unusual prediction of a flat market for 2011. He emphasizes mean reversion in earnings, which he thinks will lead to a compression in P/E multiples. For those who have a serious interest in making money, you should consider the entire Kass interview cited below. (HT - Mike C.) For those who want to focus on the question of P/E multiples, scroll ahead to the eight minute mark.
Here is where the fun starts!
Regular readers know that I completely disagree with this thesis. My analysis of data shows that when market participants have an obsessive concern about a recession, the P/E multiples reflect this. There is plenty of evidence that most people think we are still in a recession, so there is intense skepticism about earnings growth. Even a modest level of economic growth will restore some confidence. I already see this in many indicators that I follow each week. I predict an expansion in the P/E multiple, and each point is about 7-8% of growth.
My conclusion is that the economy can grow modestly, earnings growth can slow, and yet ---- some confidence can be restored, increasing the multiple. Unlike other contestants in this discussion, I actually have some data on my side. Time will tell who is correct.
This raises a good question. If I disagree with the major thesis, why do I like the book?
First, we all should read a very wide range of sources. I spend much of my time each day reading viewpoints at wide variance from my own.
Second, and more important, Vitaliy's book will empower you as an investor.
Let us consider this proposition in further depth.
Investing Lessons
The book provides quite a number of investing lessons. The basic price to cash flow analysis is described in a charming fashion -- easy to understand. Sophisticated investors can just enjoy this as a lesson for the newbies.
In the middle chapters we can see the real analysis. Here are the key precepts:
- Look for real value on a price-to-cash flow/ return on equity basis
- This is not "buy-and-hold."
- Sell when a stock reaches your fair value target. Emphasizing, don't reach for a "top valuation."
These are all very good points. My summary does not do justice to the persuasively written text in the book.
Why You Should Read the Book
This is a book that teaches you about finding good stocks. It does so in a well-written and colorful fashion. You will enjoy reading the discussion and the examples, and nearly everyone will learn. You really need to dip in and read to enjoy the colorful and persuasive descriptions.
This is an investment lesson that any intelligent reader can understand.
Attention: Self Perceived Experts
If you think you know what is going to happen -- bullish or bearish -- Vitaliy has a chapter just for you!
You need a reality check! Chapter 13 will deliver! The real question is how to test yourself with alternative outcomes.
Conclusion
I would be lying if I said that I learned something about investing from this book. Realistically, it describes what I do every day -- finding value with key metrics, avoiding buy and hold, selling when there is no longer any edge.
Even for me the provocative discussions helped to focus on the key questions.
In Chapter 17 the author expains why his approach would still be strong even if markets (to his surprise) make a big rally. I think this is the key point.
You will enjoy and profit from this book regardless of your opinion about the market.
This book describes what many of us do in picking stocks, and it does it very, very well. Even if you do not embrace the sideways market thesis, I strongly recommend the book. Most readers will learn a great deal, and the lesson will be an easy one.
