'Being street smart'

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When Jim Rogers was in his early 30s, he was invited to dine in a fancy Manhattan restaurant with a bunch of successful investment managers.

Since those were the early years of Quantum Fund, a hedge fund co-founded and co-managed by him and George Soros, it was a big deal to hobnob with these fellow wizards.

In the throes of male bonding, the host asked each guest to recommend a stock.

The names of various growth stocks were confidently spewed till Rogers named Lockheed Corporation.

(The company later merged with Martin Marietta to become Lockheed Martin).

The polite ones raised their eyebrows at this plebe. One pompous hot shot smirked and stage-whispered (loud enough for Rogers to hear) “Who buys stocks like this?”.

Rogers was understandably embarrassed. It was not just any hot shot, it was Bruce Waterfall who passed that comment; he ran a hedge fund - one of the few at that time. Moreover, it was his first dinner with this group of elite investors who got together once a month. And his pick was scorned.

Not for long though.

Lockheed appreciated 4,000% from 1973 to 1983.

Here's how he managed to hitch his wagon to that star.

Way back in October 1973, the Yom Kippur War took place when a coalition of Arab states led by Egypt and Syria launched a surprise attack on Israel. Yom Kippur is the holiest day in Judaism and is a national holiday. Naturally, Israel was caught on the back foot.

In fact, the war was a shock for the technologically superior Israeli forces. The Soviet-supplied missiles used against them took a heavy toll, particularly the SA-6.

The latter was a self-propelled, low-to-medium altitude, surface-to-air missile, known as SAM. According to experts, it would fly out parallel to the desert floor then very accurately pitch up at the target without leaving a smoke trail.

It is widely acknowledged that the Israelis suffered heavy losses of aircraft during this war, though the exact number lost to specific SAMs is not clearly documented.

Rogers’ style was not to get preoccupied with what a particular company is going earn the next few quarters. He would set his sights on how broad social, economic, and political factors would alter the path of an industry.

So when it became news that Israel was on the defensive and that some of its military technology was antiquated, a thought struck him.

Israel’s prime supplier of weapons was the U.S. Did that mean that American technology was antiquated as well? If that be the case, would the Pentagon not spend millions to ensure that its hardware was not obsolete considering that the USSR had superior technology?.

This thesis held scant appeal to most because the Vietnam war was coming to an end, spending on defense was being curtailed and defense firms were not on solid ground.

They were considered pariahs by stock analysts. Rogers was undeterred. He began to keep a special eye on the industry.

He travelled to Washington to converse with Pentagon officials and defense contractors across America.

The U.S. Defense Science Board conducted a study of the war and concluded that in any future conflict, American planes would “have a real challenge getting though air defenses.”

The board recommended development of a new kind of bomber that would evade the SA-6, by being essentially invisible to its supporting radar.

By mid-1974, the boys at Quantum Fund began scooping up defense stocks, some of which were selling for a dollar or two.

The focus was on United Aircraft (now United Technologies Corporation), Northrop and even Lockheed despite being threatened with extinction.

Though Lockheed was bleeding profusely, the firm was cutting off a huge money-losing division and was starting to focus on new technologies.

Soros and Rogers knew that all these companies had major contracts that, when renewed, would provide fresh earnings over the years.

They also noted that the modern battlefield was fundamentally changing and the new arsenal would be sensors, laser-directed artillery shells and smart bombs (which were guided to their target by laser beams).

It would only be a matter of time before defense spending took a dramatic upswing.

They were bang on. President Ronald Reagan initiated a programme to revitalise U.S. defenses.

The spending was not to be financed with tax increases but by borrowings and running a budget deficit.

As a lesson from the Yom Kippur war, the U.S. began to develop radar stealth technology. The result was the Lockheed F-117, the world’s first stealth aircraft.

The biggest beneficiaries of this development were stock holders of defense firms.

In his book Street SmartsStreet Smarts, he notes that in 1980, after a decade in which the S&P 500 rose 47%, the Quantum portfolio was up 4,200%. He referred to that period as the “glorious and exciting years; we had gains every year.”

Besides betting on defense stocks during this period, they shorted the Nifty-Fifty when banks and mutual funds were scrambling for them, even though some stocks were trading at 100x or 200x earnings.

(The Nifty Fifty refers to the 50 popular large-cap stocks on the New York Stock Exchange in the 60s and 70s. They were regarded as solid buy-and-hold stocks and are credited with propelling the bull market of the early 1970s.)

They even shorted the pound sterling and gold. Back in the late 70s, geo-political crisis across the globe, including the Russian invasion of Afghanistan and the Iranian hostage crisis, pushed the price of gold to amazing highs. After touching $850/ounce in January 1980 it began to tumble and stayed in the $300-500 range for most of the 80s.

In fact at a party in the mid-70s, he was asked by the hostess what he did for a living. He told her that he worked on Wall Street which elicited the response “Oh, you must be suffering”. (This was a natural response since the stock market was floundering.) To which he promptly retorted “No, things are great. I’m short.”

The hostess did not get it.

If there is one trait that can be picked from the earlier examples, it is the fact that Jim Rogers enjoys swimming against the tide.

Rogers’ thought process is marked more by skepticism and contrarianism than conformity. Having said that, he pays a lot of attention to research. He has stated that he was always willing and able to work harder than others.

This characteristic is evident in his personal life too. According to the New York Times, he spent 6 years looking for the right home. In 1977, when the real estate market collapsed, he picked up a home on New York’s Riverside Drive for $107,300. In 2008, he sold it for $15.75 million.

Below are some of his principles explained in his book Street Smarts.

When his bet on Helmerich & Payne, a contract drilling company, paid off, a friend attributed his success to luck. Rogers invested when business was bad but understood that the fundamentals were right.

Get the fundamentals right and the good news keeps coming. Lucky? If you want to be lucky, do your homework.

When he was at Yale, one of his classmates said that he would study 5 hours for a particular test because he thought the test was worth that many hours of study.

I found his reasoning peculiar. My approach was to study as much as was necessary until I knew the subject, and then study some more just to be sure. There is no such thing as enough. You keep studying, or working, or researching, whatever the task happens to be.

Don’t go overboard with diversification

If I were to tell you that you could only make 25 investments in your lifetime, chances are you would be extremely careful about investing. Invest very rarely.

If you buy 10 different stocks, chances are some will be good. You are not going to go broke, but you are not going to make a lot of money, either.

The way to get rich is to find what is good, focus on it, and concentrate your resources there.

But make very sure you are right. Because it is also a fast way to go broke.

Don’t let a bull market deceive you

His mother called him saying she wanted to buy a stock and when he asked her why, she said because it tripled over the last year. His response was that you don’t buy a stock because it has tripled, you buy it before it has done so.

There is nothing quite like a bull market to make people think they are smart.

All big bull markets, secular bull markets, end in a bubble. Everyone chases the conventional wisdom, following what they read in the press, and that presents the smart investor with opportunities.

Patience pays

He called the commodities boom in the late '90s, launching the Rogers International Commodity Index in 1998 before the mania hit the streets in the 2000s.

During the peak of the housing bubble, he was once again shorting. In an interview, his response to the question on whether or not he was shorting real estate: “Yes, yes, 2006, 2007, 2008. Yes, yes. I was short Fannie Mae, I was short all of the investment banks. I was short all the banks.”

It’s not just about taking a call; one must have the patience to execute a trade or investment.

Early in his career, he shorted 6 different companies anticipating a drop. As the companies’ stock prices continued to rise, he was forced to keep covering his shorts because he did not have sufficient holdings in his brokerage account to hang on until prices began to fall. He did not have the staying power and the resources that short selling requires. He reversed his position and lost everything. Within the next two to three years, every one of those 6 companies went bankrupt. So his call proved to be right, the timing was not.

One of the more obvious mistakes I had made in shorting those six companies was assuming that everybody knew what I knew. I had come in much too early. Since then I have learned to wait, or try to, at any rate.

Most successful investors do nothing most of the time. Do not confuse movement with action. Know when to sit and wait.

That, seems to be the most difficult lesson of all period.

This article is also published on www.morningstar.in on 4th June 2015.