"I know that for myself it makes no difference whether I do or forbear those actions which are reckoned excellent. I cannot consent to pay for a privilege where I have intrinsic right. Few and mean as my gifts may be, I actually am, and do not need for my own assurance or the assurance of my fellows any secondary testimony." 

-Ralph Waldo Emerson

            The essay entitled "Self-Reliance" was written in 1841 by Ralph Waldo Emerson, the transcendentalist thinker.  In the essay, Emerson gives examples of the follies of human kind, the purities of youth, and the corruption of the mind that comes with "growing up."  Over time, Emerson has been placed into a pantheon of original thinkers in American lore; up there with the Franklins, Jeffersons, and Kings.   English literature embraces his writings, courses are taught to explore his thoughts, and books are written to give modern perspective to his originality. 

             Unsurprisingly, there is one place Emerson hasn't been adopted; the world of finance.  See, Wall Street is a fickle place, a place where you can't really expect what the flavor of the day will be.  One day the Milken Machine is leveraging America to the hilt, and another day your little mortgage loan (and your neighbor's) are causing billions of dollars of shareholder money to vanish into thin air.    Ben Franklin once famously wrote that the only certain things in life are death and taxes.  The only certain thing on Wall Street is that what one does, another will copy; and usually amplify.  You want to buy ESOP?  Hell, I'm buying TXU!  You're slicing up mortgage bonds into CDO tranches?  How about we slice ‘em again and call it a CDO squared?  You're lending to people with bad credit scores?  I'm lending to people with no documented income! 

Wall Street Worries

            I think the Merrill Lynch "bull" is, in its glorious irony, a great symbol for Wall Street; because when the Wall Street machine gets cooking, it's like a pack of bulls running full steam ahead.  It can be amusing, even profitable for awhile.  One day everybody is drinking champagne, placing their futures in the hands of Cisco and Sun Micro as they go up and up and up and then…POOF, just like that the bubble bursts.  Streeters lose their jobs, 401(k)'s and brokerage accounts are ruined, and everybody supposedly learns their lesson.

            The only problem is that the ensuing recession causes another bubble to swell.  Slowly but surely, interest rates begin to come down, the wounds begin to heal, and everyone begins to get a case of financial Alzheimer's.   "Gee, our house has been going up in price for like, 3 years!  Mortgage rates are really low! Couldn’t we just trade it in for a bigger one and maybe make some money?"  Once this type of thinking begins to feed on itself, everyone becomes involved.  The bull starts to charge, and no one, come hell or high water, is going to stop it.  By the time the whirlwind is over, we end up with ridiculous things like "no-doc" loans, “AAA” CDO's that all of a sudden are worth $.50 on the dollar, and four major bank CEO's ousted in a period of months.

Our Friend Ralph

What can stock investors learn from this?  Moreover, how can investors profit from this?  How about listening to our friend Emerson? 

 
            Emerson teaches us that the only path to wisdom and success is self-reliance.  For investors, that means learning to rely on your own judgment.  Why is Charlie Munger so adamant in pushing for investors to develop multiple mental models?  Because with broad knowledge comes critical thinking ability.  Once an investor can learn to filter out noise and look at a set of data and say "Wall Street is wrong, and here's why," that's the day he (or she) begins to make money.  

 
           Getting too caught up in the thoughts of others is a quick way to lose money. Heck, even smart, successful investors make big mistakes.  A recent study by Tweedy, Browne showed that even the most successful investors are wrong on a significant percentage of their investments.  What if you purchase that investment you decide is so wonderful because Guru X owns it, and it turns out to be one of his worst investments?  Does anybody think Buffett would be the investor he is today if he merely parroted Ben Graham's every move?  I know Buffett doesn't think so.  He embraced the concept of Emersonian Independence and struck out on his own for unparalleled success.  This concept is very difficult to put into practice- it is natural to be influenced by other people you know are intelligent.  In fact, it is bright to have an open mind when smart people speak.  However, if you want to be successful, you must learn to take what they say and filter it through your mental models and decide if you agree.

 
        Blind faith in anything or anyone can lead to trouble.   The smart investor knows that when the bull begins to charge, ya gotta get out of the way.  The follies of Wall Street can create loads of investment opportunities for self-reliant individuals willing to dig into the details and make an informed decision.  During the tech stock bubble that ended in 2000, had you stuck to your guns and bought cheap, simple stocks you would have made loads of money over the next 7 years.

 Use your Brain

            Every investor out there would probably surprise themselves if they began relying on their own thinking ability a little more.  Take an example: Let's say you are taking a close look at Company XYZ whose stock has been pummeled, thrown in the trash, and slapped with a sell rating by every analyst out there.   Wall Street has told you “we don’t like it.”   Sounds like a clunker, eh?  I'll bet the first reaction of 90% of investors is to give up, put it away, and keep looking.  But what if, this time, you open the most recent 10-k and look for yourself?  You start going through it and see that you like their business model- it's full of recurring revenues.  The balance sheet has been improving every year, and management has been candid in admitting their mistakes.  Wow, you think to yourself, this company isn't half bad!  You check Yahoo! Finance and see that they are trading for a mere 5x earnings. 

Do you see where this thought process is going?  Now, you may end up saying you know what, I agree with Mr. Ackman, this company is stuck and it’s going to zero.  The difference is, you've given yourself a chance to rely on your own brain to decide whether that's the case or not.  Once in awhile, you are going to do the work and totally disagree with some very smart people.  Since you thought for yourself and came to your own conclusions, you’ll be able to sleep at night.   You’ve got what hedge fund manager Michael Steinhardt calls a “variant perception.” When things go awry, you'll stick with your gut and remember what Emerson said:

 
"Nothing is at last sacred but the integrity of your own mind."

The author can be contacted at jeff.annello@gmail.com