MI269: How to Spot Turning Points in the Market w/ Milton Berg

0:00You're listening to TIP. Why was value investing work? What logic is there for value investing? Because, for example, if a stock is cheap today, obviously a stock could be cheap. So why must we assume that sometime in the future, the stock will get back to fair value? Is this a magic formula? Why is it?

0:21On today's episode, I chat with Milton Berg, who is the CEO and chief investment strategist of MB Advisors. Milton has a fascinating career and investment style as he first started in the industry, inspired by the teachings of Benjamin Graham and David Dodd, but later shifted to technical analysis and has created a great reputation in the field for himself. He has also worked with some of the titans of the hedge fund world, including George Soros, Stanley Drunkenmiller, and Michael Steinhardt before starting his own firm. In this discussion, you'll learn more about Milton's views about markets, his belief on what drives stock prices to their intrinsic value over time, how his views about markets differ from traditional value investors such as Benjamin Graham.

1:06He covers some of the common misconceptions people have about Graham's investment strategy and his criticisms of traditional value investing. Milton also gets into how he developed a framework for spotting major market tops and bottoms and explains whether he believes markets are at a turning point today or if he believes there's more downside to come. All right, with all of that said, I really hope you enjoy today's episode with Milton Berg.

1:55Welcome to the Millennial Investing Podcast. I'm your host, Rebecca Hotsko. And on today's episode, I'm joined by Milton Berg. Welcome to the show. Hello, Rebecca. Nice meeting you. I've been really looking forward to this discussion. And I wanted to begin by talking about your background as an investor, because as I understand it, you initially focused on fundamental analysis inspired by the teachings of Graham and Dodd, but then you later shifted to technical analysis and worked with some legendary investors in the hedge fund world before starting your own research and advisory firm. So I was hoping you could share with us what motivated your transition to become a technical analyst.

2:35Just what drew you to this strategy? Great. Well, there's some misconceptions about Graham and Dodd. Maybe I can sort of discuss a little bit about Benjamin Green's investment philosophy, how it worked, whether it worked or not i originally got into this business of taking analysis look to me like you know voodoo people looking at charts and lines and crossing things one kind of crazy stuff which made no sense you're buying a company you're buying a stock of course the alleyways are important i really spent my college days and days in the early net in the field becoming a professional management grading type analyst in rigorous security analysis analyzing balance sheets very fighting good companies i went to a meeting of new york society security analysts both back to 1979.

3:14And a fellow named Ned Davis, who at that time was a chief market strategist at JC Bradford. He made his presentation. And he basically made a simple presentation about how some sentiment indicators work far better in calling market turns than fundamental valuation analysts. And that sort of struck me. I mean, how can this market gain it? There's nothing to do with a particular company. How could that have some sort of predictive ability in what the market's going to do. And that really was my first initiation to technical analysis. But then he started realizing in reading Graham and Dodd's book, he himself said that his rigorous valuation analysis does not really work.

3:50For example, as you know, Benjamin Graham in the Great Depression, his value analysis did not help him. His portfolio, he had a partnership. His partnership lost 80 % to 85 % during the Great Depression. So what he did didn't protect him from that great market decline. And then he realized that not only His approach not helped him during the Great Depression, but the Great Depression got him very scared, and he spent the rest of his career worrying about the next Great Depression. And that's why he came up with this valuation analysis. He talked about buying stocks below the net asset value. I mean, he looked at fine stocks that are so, so cheap that even if he had a Great Depression, there's a good chance to be able to get out of it somehow in the future at the price he paid for it.

4:27His system really was a system of protecting us from a kind of depression and a kind of market crash that he never expected. he never anticipated he couldn't protect himself from now however the the last great depression was in the 1920 1920 or 1930s and graham was in the business from in the 30s and the 40s and the 50s and the 60s and the 70s and his valuations didn't work because the market kept going up even the market going above his evaluation parameters so besiegrieve himself had to revise his valuation formulas multiple times he revised it in the 40s he revised in the 60s and finally in 1970 the Benjamin Graham publicly said, rigorous security analysis no longer works, is no longer necessary.

5:06And he advised other formulas for buying stocks based on P-ratios, historical price action, and so on. So although Benjamin Graham's idea of buying value was an idea that makes sense and maybe works somewhat, he himself was very confused by market action. And I can't think he himself proved that value investing is the greatest thing to be involved in, and himself and his greed changed his mind. Now, why was value investing work? What logic is it for value value investing because for example if a stock is cheap today obviously a stock could be cheap so why must we assume that sometime in the future the stock will get back to fair value is this a magic formula why is it so this is really a question that was asked to benji graham in front of congress in 1954 and this is very important to understand how value investing works there's a senator fulbright in 1954 the stock market and dow jones industrialized got back to where it was in 1929.

5:5525 years later the market back at its peak so people are wondering or Congress is wondering, hey, the market is back to its price in 29. Maybe there'll be another market crash. You know, Congress always worries about the wrong thing. So they worry there'll be another market crash 25 years later. As the market reaches a certain level, and they brought Benjamin Gray, who was considered the expert of market valuation, a professor in Columbia Business School. He's running a very large investment partnership. They called him into Congress. The date was March 11, 1955, roughly 68 years ago. And the following question was asked by Senator Fulbright to Benjamin Gray.

6:25I'll quote you. Read it in quotes. when you find a special situation and you decide just for illustration that you can barge for ten dollars and it's actually worth thirty dollars and you take your position but you cannot realize again until other people decide it's worth thirty dollars how is that process brought about is it by advertising what happens so basically graham was asked the question why does value investing work if a stock can be cheap today why can't it be cheap forever if that could be overpriced today why can't it be overpriced forever now benjamin graham's answer was following a word to quote And he says to this question, that is one of the mysteries of our business and is a mystery to me as well to everybody else.

7:03But we know from history and experience that eventually the market catches up with value. There was no great fundamental understanding of value investing. He looked at history. He said, well, if your body is stuck to cheap, I'll eventually be able to get out of it. He really was looking at value investing as in Forbes technical analysis. And since he called it a mystery, I said to myself, well, why should I get involved in the mystery of value analysis? Let me be involved in other mysteries of technical analysis. Let me broaden the mystery and history of the stock market and try to find other methods of picking stocks, another method of trying to understand whether to be in a market or not to be in a market and so forth.

7:36Now, again, I must stress that Bezzi Graham, these works I published, really, really never got it right. He was always behind the curve. He's always suggesting the market is overvalued. The market can go up and then he'd raise its parameters, but he never raised its parameters where the market actually was. So, that's what got me to look at the technical analysis. Now, the approach that I use is sort of a unique type of approach. I don't really look at squiggling lines. I don't really look at breakouts and breakdowns and moving averages. We have our own type of indicators that we use. But the background basically is I began as a real fundamentalist, a believe in fundamental analysis.

8:06Fundamental analysis makes a lot of sense. You want to buy a bond. You know, you wonder whether the company's going to go bankrupt or pay off their interest and so on. When it comes to the stock market, there's so many more factors other than valuation. That's what we got involved in, and using what we call market analysis and indicators we've corrected. it. In the case, we've discovered and so on. Yeah, that was such a great backstory. Thanks for sharing that. I want to dive into your strategy a little bit later in the discussion. I'm super curious to dig into your perspective on markets a bit because you just outlined the perspective of markets from a traditional value investor such as Benjamin Graham.

8:40But how do you view markets and particularly the randomness in markets or if they're not random at all? Yeah, well, let's look at that. Unfortunately, you know about Rick Stinkofield and Roger Edmondson, they put out a book basically called Stock, Bonds, Builds, and Inflation. And look at the history of the stock market, history of the bond market, going back to the early 1900s. And they actually made predictions based on it. They looked at the stock market into some sort of very physical system. They published this in, I think, in the 1980s. So look at the volatility in the market in the last 80 years, look at the rates of change in the market in the last 80 years, look at the standard deviation of returns over the last 80 years.

9:16And what we saw in the last 80 years is what you could expect over the future. Now, that wouldn't make sense. Doesn't really make sense because the stock market is a dynamic force. Why must we assume that the rates of return that we have over the last 80 years will continue in the future? Many things can change. Our country could change from capitalist to communist. You know, you could have a run on banks. You could have the currency devalued through inflation. Many things can happen in the future that did not happen in the past. So one of the mistakes many analysts make by looking at the stock market in the past analyzed the other things that happen in the future.

9:47And exactly what happened in 1987, a great crash, the S &P 500 declined over 20 % in one day. And somebody asked Roger Imbotson the following question. I read your book about statistical analysis of the stock market. Based on your book, it never in the history of the stock market should have declined 20 % in one day, because it never did decline 20 % in one day in the past, in the past 80 years. And he actually puts this question in his book and he says, well, let's look at the monthly returns. we didn't create an outlier in the monthly return basically he was basically fudging the stock market is not a physical system by virtue of the fact that in order to understand stock price movements the wrap up the history that suggests that is not something to be analyzed because you take a pair of dice and you want to analyze statistically what are the chances of getting the 12 one chance of getting your snake eyes and so on you don't have to look at the history of the dice you have to look numbers and use statistical analysis.

10:41But, virtually the fact that you have to look at the history of the stock market in order to understand how it will perform in the future, data shows telling you that the stock market is really not analyzable. It's really random, basically, because who says what happens in the past will happen in the future? There's nothing inherent in the system of stocks to tell you that the future will be like the past. So right away, I look at the stock market a little differently than the statisticians do when I say really can't use rigorous statistical analysis on the stock market. Once you're having a history and experience, it's no longer a system because the system is now dynamic.

11:12However, what do we look at? Well, what we do look at is rarities. We believe, like the modern portfolio theorists believe, that on a daily basis, the stock market movement is random. Random. I don't know what's happening to do tomorrow. Why don't the market do a week from now? I can't predict it. On a general basis, market movements are random. However, at turning points, the action of the market is not random now. When I say the action market in that range not only the daily movement of stock prices i mean the underlying indicators that occur at market turning points are not random they're very rare and they occur at turning points and great pro they get a great probability where the month's going to rally the month's going to decline and it's these kind of um kind of information every look i'm always realizing always recognizing but the stock market is not some sort of machine and they're only working our probabilities and some things that happen in the past what happens in the future but we do believe that although the stock market on a general basis is random, at major turning points, sometimes at minor turning points, the market gives you information that allows you to make a high probability called prediction or called projection or called trade based on the information the market is generating.

12:18So I just want to tie this together because we have quite a big community of value investors who follow strategies. Value investing is terrible. It's suicidal value investing i mean unfortunately as you know i don't mention any names but there's one great world famous value investor managed over 22 billion dollars of mutual funds because uh he was a value guy when the markets weren't cheap he wouldn't buy stocks that he wouldn't buy them cheap he's very well for a number of years unfortunately he committed suicide because the market was overvalued from basically a late 1990s until you know till now it's basically an overvalue and he wasn't invested and people were pulling money out of his funds and he went down from$22 billion to less than$2 billion, and he decided to take his life, which is very, very sad.

13:01But the point is you can't invest in the market being only a value investor. You never own an Apple. You'll never own a Microsoft. You'll never own it. Many of these great growth stocks, they were never really sitting with Benjamin Graham's value investing. So as a value, I call it suicidal because I've seen people lose their careers because it sucks to value. And I started in the business. We talked about how Lloyd might transition. I wrote an article, Barron's. This is in 1980. I tried to write a bar from Barron's. i basically was pointing out using graham and dodd's security analysis book you know the book for market analysts and i proved that the stock market is way way overvalued and we should not have any bull markets ahead the market must decline i basically do what benjamin graham was doing to better get moist on the market over value but i realized first early in my career that value if you rise strictly on value you will not be successful i really i really challenged finding someone who rise strictly on value has been successful and don't mention warren buffett Because read Warren Buffett's biography, he switched sometime in the early 80s from following rigorous statistical analysis and buying stocks that were very, very, very, very cheap based on value analysis.

14:04And he decided, from the advice of Charlie Munger, to buy stocks that are not necessarily very, very cheap, but they're good companies that are growing. And that's how Warren Buffett became the great investor. He decided to buy companies and buy stocks. I remember back in the 1980s, Warren Buffett was invested in stocks like the F Corp and Candy and Harmon because they were deep, deep undervalued stocks. But subsequent to that, he started investing in companies. He invested in Coca-Cola, one of his famous investments. Coca-Cola wasn't a deep value stock. It was basically a growth stock that was trading at their share value.

14:36So even the ideas that Benjamin Graham puts forth in his books are no longer followed by successful value investors. Successful value investors themselves have graduated from Benjamin Graham's type of investment analysis. And those who stick to Benjamin Graham's type of investment of value analysis really have not done well in the business. I can't find any. They have. And that's Sequoia Funds if you once agreed to be a follower of Benjamin Graham. So you really don't see it. There's a great market analyst who's been out of the market for about 12 years now. He's on Twitter and he has some mutual funds and they haven't done anything because he's suggesting based on Benjamín Green's analysis of the markets, we've got to go down another 60%.

15:16That might happen, maybe without 60%, but if you're going to sit waiting 12 years for that to happen, then there's no way you're going to maintain a business and get a good return. So that's why I say that the value analysis really doesn't work. It's never been proven to work. Pure value analysis. And everybody uses more than just value analysis to do their market. Even though this fellow John Templeton, when he was interviewed by Forbes 20 years ago, 30 years ago, He said if I buy two stocks that are equally undervalued, I'll buy the one that is starting to move. Now, what does that mean? That's technical analysis.

15:47Yeah? Two stocks that are equally undervalued, I'll buy the one that is starting to move. If you're a real value investor, you'll buy the one that hasn't started to move because it's a little bit cheaper. So people realize it's far more to the market than value analysis. And to be honest, Benji Graham, people don't realize this, but Benji Graham himself was under the impression that it's far more to the market than value analysis. And I'll just quote from the book again, if that's okay. He says, The influence of what we call value factors over the market price is partial and indirect. Partial because it frequently competes with purely speculative factors, which influence the price in the opposite direction, and indirect because it acts to the intermediary of people's sentiments and decisions.

16:25He says, basically, that the market doesn't move strictly on value. The market has many other factors, including sentiment, psychology, technical factors, and speculative factors. And what we try to do is not focus on value, but focus on these other factors that move stocks. It's here we can do to get sort of an edge in investing in the stock market. Let's take a quick break and hear from today's sponsors. Even Einstein had blind spots. That's why modern science is built on the idea of peer review. Investing may be more art than science, but that doesn't make peer feedback any less valuable. The tricky thing is finding qualified people who are interested and willing to help vet your investment ideas.

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19:35And for a limited time, you can use code stocks15 for a 15 % discount at checkout. All right, back to the show. I want to dive into one more Benjamin Graham quote that is often quoted. I think Buffett said it in, he was paraphrasing Benjamin Graham in 1987, in the short run, the market is a voting machine, but in the long run, it's a weighing machine. I wanted to get your interpretation of this and your perspective on what this means for market performance in the short run versus long run. Is it more based on psychology or is it fundamentals? I am so glad you asked me this question because boston got it wrong and his great teacher never said or warren buckford said he said never said it i'll read the words of benjamin graham i have it in front of me as well and this is quotes from screen analysis page 42 and page 43 the original published in the 1920s 1930s he says the following in other words the market is not a weighing machine that is he doesn't say it is not a weighing machine over the short term to the market is not a weighing machine on which the value of each issue is recorded by an exact and impersonal mechanism in accordance with specific qualities rather we say says benjamin graham the market is a voting machine where our capital individuals register choices which are the product partly of reason partly of emotion what benjamin graham was saying is the market is always and ever a voting machine in order the price of the stock to change someone has to decide to buy and some has to decide to sell so in any given transaction it's a voting machine now if it's true that over long term a stock is a weight machine well look let's look at war buffett's own stock his stock is around what for 50 years already and in the latest report he discussed how his stock is fluctuating up 20 percent down 20 percent up 20 percent down 40 percent in the last year although the value hasn't changed isn't war buffett stock a long-term stock if it's true that over the long term the market as a weighing machine about now in the year 2022 shouldn't the warm-up stock be valued as a weighing machine shouldn't it not fluctuate of course not the market is always and ever a voting machine the market is never ever a weighing machine occasionally the weight of the weighting machine and the voting machine coincide but as you really said if you buy stock is cheap eventually your stock will get back to its value but that's not because the market because of a weighing machine that's because of typical fluctuation of a stock takes it back to true value we don't know why that happens but it happens through voting it doesn't happen through weighing so Warren Buffett's quote is incorrect people I've heard this quote it was repeated many many times and it's not the way markets work markets are totally always and ever voting machines based on psychology, based on sentiment, based on speculation, never ever based on the true fundamental of a company.

22:31There's no mechanism that allows the true fundamentals of a company to show up on a stock price. The only mechanism is through the voting of buying and selling. Glad to hear that question. I hope I get too passionate about this. I'm glad to hear your answer on that. I have never heard that corrected before. So I'm glad that you were here today on this show to give us the meaning behind that quote because I have heard that so often. And so in a sense then, if someone's, I guess, philosophy as an investor is that they pick stocks because they believe they are undervalued. I just want to clear this up for listeners.

23:06You're saying with your views of the market that the only way that it reaches its intrinsic value is because of randomness, this voting in the market. It's not because some catalyst will make it go to its intrinsic value? Well, there is a catalyst if there'll be a takeover. But even a takeover, how many takeovers have you had above intrinsic value? How many companies did takeovers and they paid too much for a stock, right? So even a takeover is nothing to do with value. It's a sentiment to the company that's buying the stock. The market, there's no methodology at all for a market, a stock, a stock that trades in a market to trade its value.

23:41the only mechanism is people buying and people selling which in effect is only voting so yes i disagree i won't say it's random but when measuring says historically is found he said it's a mystery but historically you're buying cheap stock it's going to get back to value well stark when you buy your stock because the five day volume is the greatest in 14 years and the stock's down 60 % of its high historically most of those stocks also go back and gain 40 30 40 percent so are you going to say that now the market is a technical machine now the many stock is going to the market but But ultimately, it all has to do with voting and voting is psychology, voting is sentiment.

24:16Of course, people vote because of fundamentals. But if there's an economic crash or a recession, and people have to, they need money to pay for their mortgage. They need money to get the flotunant table. They'll sell their stocks to get the money. But that is also a voting decision. It might be based on some fundamentals. But why sell their stock? Maybe they should sell the gold they haven't saved. Maybe they should sell the house and then they're paying a mortgage on it. It's all a decision based on personal factors, nothing to do with the intrinsic value of a company. I'm adamant about this and that people say, and I say, people who follow true value of investment have never been very successful.

24:49Never been very successful. Benjamin Rear does not follow true value investing. I mean, the kind that Benjamin Rear spoke about. Of course, he's very good. He's a very good market timer. Excuse me, Warren Buffett. Excellent market timer. When stocks are expensive, he builds up his cash and he buys when stocks are, when market comes down. he claims he's buying because stocks are cheap. That could be true. But there are many other factors that take place at a market low other than stocks being cheap. So it might be a coincidence that when he buys his stocks, they're cheap. But that is not necessarily the factor that gets the stocks to move up.

25:19As you know, it's very often stocks can be cheap and get the cheaper Berkshire Hathaway is a great example. Not from the fact that Warren Buffett used Berkshire Hathaway as a means of buying other stocks that are coming with only bankrupt. Even his interviewer read about his position in Washington Post or one of the other, I'm not sure exactly which newspaper he bought But he says it's only by chance, by the luck of God, that he's able to come out of it. Okay, one of his competitors went bankrupt. He didn't know when he bought that cheap stock that he would go bankrupt. But he's far more involved with strictly value.

25:44And again, there's no mechanism. No mechanism of value to be reflected in a stock. There is a mechanism for sentiment to be reflected in the stock. Even if you're going to say a stock is cheap based on dividends, the only mechanism for the stock to remain at this level is because people want those dividends. Now that could change. They may decide they don't need the high income, they need a lower income. everything is in flux. Everything is based on psychology. Everything is based on decision. Everything is based on buying and selling, which is all a voting machine and is never, never, ever a winning machine.

26:14I want to dive into your investment strategy though now, because your strategy is centered around identifying market tops and bottoms, a skill that you've honed over the three decades of market analysis. So could you talk a little bit about your framework, including how you developed it and the methods you use to identify significant turning points in the market? Well, first I have to point out that what I do, we never deal in uncertainties. We admit we're only dealing in probabilities. Maybe some people have to think they're dealing in certain things, but we tell our clients and we understand that whatever we do, you're dealing in probabilities.

26:51I mean, you know, in the market today, will there be a recession? Let's assume if people pound the table that there'll be a recession, are they willing to bet their life on it? Do they have 100 % certainty? Of course not. every decision that people make in a stock market is a decision based on probabilities. So the first thing we recognize is that many indicators that we use don't have a 100 % track record. They may only have a 70 % track record or an 8 % track record. But you really can't expect more than that because even if they add a 100 % track record, if I buy indicator that she goes 14 times in the last 100 years, and each time the market held its low by never never declined more than two percent and had a bull market follow right happened 14 times in a row that doesn't tell me it's gonna happen next time because as i say in theory there's an infinite number of days for the stock market the stock market could continue forever i'm only in a short period of 100 years of history maybe those 14 years were the outlier 14 signals were an outlier and everything else will be the proper signal i'm trying to point out is a very important for people watching the show to know that we only dealing probabilities is no such thing we feel is no such thing as dealing uncertainty and every great investor has made many mistakes he didn't really make a mistake he made the right decision it's just that the decision was based on a probability and the probability is always gold his favor there are mistakes people make when they don't follow the proper judgment and uh or don't follow the proper discipline that's a mistake the stock was against you and your market projection goes against you that doesn't mean you made a mistake that just means that if the probability was 80 percent that hit the 20 probability where it's not going to work out that's the first thing you want to say number two what i want to say is we did already discuss that we believe that a daily basis and a weekly basis and a monthly basis stock market flow creation is generally at random it can't be predicted but we do believe is that at 30 points there are factors that show up in the stock market that no longer random and give you a high probability trait and i compare this somewhat to in the modern day if someone has it wants to analyze his heart, but the doctor wants to analyze the health of someone's heart.