Therefore, when you consider straying away from a compounding type of investment, make sure you understand risk and that you get value and a margin-of safety price concession. Maybe John Burr Williams, a pioneer in the concepts of modern portfolio theory, said it best, “The value of any stock, bond or business is determined by the cash inflows and outflows, discounted at an appropriate interest rate, which can be expected to occur during the remaining life of the asset.” Oh, and by the way, if you doubt the magic of compounding, consider this little ditty from Andrew Tobias:
“There was the king who held a chess tournament among the peasants and asked the winner what he wanted as his prize. The peasant, in apparent humility, asked only that a kernel of wheat be placed for him on the first square of his chessboard, two kernels on the second, four on the third and so forth. The king fell for it and had to import grain from Argentina for the next 700 years. Eighteen and a half million trillion kernels, or enough, if each kernel is a quarter-inch long (which may not be; I’ve never seen wheat in its pre-English-muffin form), to stretch to the sun and back 391,320 times.”
That was nothing more than one kernel compounding at a 100 percent square for 64 squares. Accordingly, remember the old adage, “He who understands interest – earns it, he who does not understand interest – pays it.”
The call for this week: So far this year, the “rich man” has not needed the stock market. That may have changed last week. Last Thursday, I said, “I think the equity markets are bottoming at session 21 in the typical 17-25 day ‘selling stampede’ sequence.” In Friday’s missive, I wrote, “I think the ‘selling stampede’ pretty much ended at session 21 with yesterday’s (last Thursday) whippy action between plus and minus, which is typically how bottoms are made.” About a week ago, I noted that, if we do bottom in the 17-25 session timeframe, the S&P 500’s (SPX/1940.24) first upside target zone would be 1940-1950. Well here we are, which makes this week critical. If we can get through 1940-1950, the odds that we have made a sustainable bottom increase notably. If we don’t, it would mean another downside retest. I will say that there is a FULL change of “internal energy” available for a pretty decent move from here. Stay tuned . . .
Jeffrey D. Saut is chief investment strategist at Raymond James.