Every investor is speculating at some level. That’s Philip Carret’s argument in The Art of Speculation and he’s right. Rarely does an investor know everything about an investment (when they do it’s usually too late). There is always an unknown element just out of grasp.

Accepting that is the broadest lesson from the book. Carret dedicates the rest of it to help investors deal with the unknown in the hopes of coming out ahead.

And in that, there are some good lessons worth learning. Let’s get started.

  • “The road to success in speculation is the study of values. The successful speculator must purchase or hold securities which are selling for less than their real value, avoid or sell securities which are selling for more than their real value… There are styles in securities as there are in clothes. A security may be undervalued, but if it is also out of style it is of little interest to the speculator. He is, therefore, compelled to study the psychology of the stock market as well as the elements of real value.”

In the short term, the market is a giant popularity contest, where the crowd throws money at the cool, hip, trendy thing today. So stocks, sectors, industries, countries, and strategies go in and out of favor.

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But it never lasts.

So it’s not enough to know that something may be undervalued or overvalued. You also need to know whether the crowd believes a thing to be undervalued or overvalued.

That’s the hard part. To paraphrase Howard Marks, undervalued is not the same as going up tomorrow.

  • “For the purposes of the stock speculator who is seeking some guide to tell him when to buy and when to sell it is somewhat unfortunate that the turn in stocks…precedes the turn in business thus does not forecast the course of stock prices except in the apparently paradoxical fashion that great prosperity affords an advantageous time for selling stocks, extreme business depression an opportunity for purchase.”

For all the time we spend studying the past looking for a clue as to what might happen next, it’s important to remember that the stock market looks forward. Turns in the stock market typically precede the business cycle. Not the other way around.

The best we can hope for is to recognize when things look frothy or depressed and take advantage of the opportunity expecting that it will always be earlier or later than the exact turn.

  • “It is usually a much simpler matter to forecast a bull market than to call the turn at its end.”

This is true just based on the last ten years (and the ten decades before that). How many times has a big name on Wall Street called the next bear market? It’s happened multiple times every single year since 2008.

I have no idea when but eventually, someone will be right. The bear market will come.

But until then, it’s easy to be pessimistic. It’s hard to be pessimistic and right.

  • “The average trader is naturally a chronic bull. It is human nature to prefer optimism to pessimism. Moreover, fortunes are usually made by expansion of values, not by their destruction. The man in the street associates the acquisition of wealth with rising markets; failures, ruin, depression, panics with falling markets.”

Carret kicked off his discussion on the difficulties of short selling with this. It takes a special kind of mentality to short anything. The short-term randomness of markets makes it far too risky for my taste.

Beyond that, markets are naturally biased to the upside. But that is not a reason to overlook downside risks. Investing is all about risk management. To keep the gains you have to manage for possible losses.

  • “To be successful, then, the speculator must know a great deal more than merely enough of general conditions to determine the trend of the general markets. He must be a student of values in individual securities. To appraise values in individual securities he must know something about a great many different businesses… Above all he must know something of accounting… The question of ascertaining trend of the market is important to the speculator, but it should not rank any higher in importance than the question of intelligent selection of his vehicles.”

I see it said sometimes that investing today is harder than it was in the past. Maybe. This would suggest it was never easy.

Knowing where you are in the market cycle, knowing what stocks might benefit the most based on that, knowing which ones offer value, and understanding the language of business (accounting), tell the tale of the time and commitment needed to invest in the ’20s and today.

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