How to Survive a Recession

LESSON 23: Ignore Conventional Wisdom

Conventional wisdom rarely helps you survive and prosper during recessions. Natural conservatism and vested interests keep large groups of people from acting on their instincts until it is too late. By sticking with the herd, they believe their fortunes will be more assured, yet this is rarely the case in a recession.

Mass media has a vested interest in covering exciting stories in order to attract viewers and readers, rather than teaching real financial management. Information espoused by the media and major financial institutions often evolves into “common knowledge” through repetition and wide distribution. For example, media producers were still rattling on about the “New Economy” and the “Internet Boom” as major institutional investors were selling out and preparing to short the entire technology sector in 2000-2001. These theories were widely believed by the investing public even in the face of a major market crash setup. Only the most sophisticated investment publications had articles outlining where investors should consider placing their capital to profit from the upcoming economic turn.

Academic institutions do a poor job of teaching real world strategies to survive recessions. Even people with MBAs and degrees from prestigious universities are often unprepared to deal with the effects of a recession. Traditional Finance and MBA programs are rooted in academic theories that apply generically across all businesses and all time periods. These programs spend a large amount of time educating students on how to calculate cash flows, value potential investments, and do managerial accounting. But there is little taught about when to cut inventories, delay payments to preserve cash, or survive the cash crunch that plagues businesses during recessions.

The generic retail investment industry is perhaps the worst provider of financial advice when it comes to surviving a recession. The typical stockbroker, financial advisor, or mutual fund representative speaks about “Buy and Hold” investing and “Tax Efficiency”, but has a vested interest in simply keeping your money under management. Large brokerage and mutual fund firms want you to “buy and forget” – and be willing to watch your account drop in value during recessions – so they can continue to collect fees or commissions with minimal expenses. This is not to say that all financial advisors are poorly skilled or corrupt – in fact there are many outstanding advisors that fully embrace their fiduciary duties and render the best advice possible. Unfortunately, the best advice is usually to get out of the markets entirely, which is self-defeating to the majority of brokers working with the typical small investor’s money. Unless you are paying high fees for real advice, avoid relying too much on low-level retail brokers with less than 100% commitment to your financial success.

So how can you help your success by thinking unconventionally?

The first thing you should do is to identify the most successful business and financial managers you can and imitate them. For a business manager, focus on successful leveraged buyout, merger and acquisition, and turnaround specialists. For investment managers, focus on leaders that have a history of successfully investing at major turning points in markets, and selecting those assets that dramatically over- or under-perform the major markets. Greate role models include Warren Buffett (Berkshire Hathaway), John Paul Getty (Getty Oil), George Soros (Quantum Funds), Michael Dell (Dell Computers), Meg Whitman (Ebay), and many others. These incredible business people are all number- and customer-driven. They care about what is actually happening, rather than what should happen. They focus on major market forces and economies of scale. They recognize that fulfilling customer needs better than anybody else is the best way to success, even when the customer is not yet aware of what they might want. They have creative strategic minds and faith in their intuition and craft. Imitating their success means getting into the numbers, using the real world knowledge tools outlined here, and understanding what is really going on, instead of what unreliable third parties say "ought to" occur.

Highly successful market leaders have two things in common: 1) they violate conventional wisdom, and 2) they act on their convictions with impeccable timing.

Violating conventional wisdom means identifying what the masses think, then acting in the opposition direction of the masses before major shifts in the market actually occur.

For example, When every retail investor in the universe was piling money into Internet stocks in 1998 and 1999, the most astute hedge fund managers were waiting for an opportunity to short the market. This does not mean they acted immediately, but they prepared a plan and executed it when they saw demand begin to falter after a massive setup. Many of them made millions in the process.

George Soros is another example. In 1992 the United Kingdom was suffering recession yet keeping interest rates high to maintain the Pound Sterling within the European Union’s required value band. George Soros ran the numbers and saw that the UK would fail if attacked with sufficient strength. He waited until the UK’s accounts were drawn down enough to be a serious risk, borrowed 15 billion pounds, and sold them in the open market, essentially creating a giant short sale. This alerted other currency traders, who also saw the Pound’s weakness and started selling massive amounts of Pounds on the world market. After trying to fight the tide, the UK’s central bank realized it would be futile and decided to give up the fight or go broke. The Pound depreciated by 15%. Soros made 2 billion pounds in quick profits for his investors and hundreds of millions for himself by violating the common belief that a country like the UK could withstand market forces.

Violating conventional wisdom and creating success boils down to identifying what is going on, planning the correct action, recognizing the right moment, and executing with proper timing.