Say Hello to the Bad Guy!
On Friday, both the S&P 500 and Dow Jones Industrial Average ended at a fresh all-time record high. The Dow is now within striking distance of the psychological 17,000 mark, while the S&P 500 is threatening to climb over the 2,000 barrier.
By all accounts, the markets have had an almost unstoppable ascent since March 2009, fueled by a steady decline in the unemployment rate from 10% to 6.3%, a stabilization in new home sales as well as rising home prices, and record-low lending rates that have allowed businesses to expand at a fraction of previous borrowing costs, and consumers to refinance their debts at more favorable rates.
While we'd like to assume that the market could continue higher forever, history has taught us that this simply isn't the case. Cyclical rises and downswings in the U.S. economy are a natural response to fiscal and monetary policies enacted by U.S. regulatory bodies.
This is where the bad guy comes in.
Say hello to the bad guy
If you've ever watched Al Pacino in Scarface, it's pretty hard to miss his infamous "bad guy" speech, which essentially determines that optimists need a bad guy they can point the finger at so they feel better about themselves. In the stock market, the equivalent of the bad guy is a short-seller or skeptic.
In theory, it's un-American to bet against stocks, because a bet against a company is perceived as a bet against the U.S. and capitalism in general. But if you look at the performance of all stocks over the long run, you'll see a pretty even distribution of losers as gainers, so we know that not all stocks are destined to move higher.
Amazingly, though, this need to point the finger at the bad guy doesn't even start with the individual investor -- it begins with Wall Street research firms.
According to a study by NerdWallet of all analyst ratings on the Dow's 30 components in 2012, just 38 of 883 ratings were "sells." Rating a stock as a "sell" has been taboo for decades, since large Wall Street clientele are often looking to buy not short-sell, and crowd mentality from clients as well as from one's own firm usually dictates that buy or hold ratings are the only "acceptable" stock rating. But if just as many stocks will fall over the long run as rise, isn't a rating scale that sees 25 times more buy and hold ratings than sells seem somewhat silly?
I tend to think so, which is why I'm proud to call myself a bad guy.
I'm not going to lie: I love going against the herd, because some of the best profits are made staying out of the pack. Of course, sometimes contrarians like myself get steamrolled. For example, I'm a short-seller of electric-vehicle manufacturer Tesla Motors at an average price of roughly $155. Tesla closed this week just a hair below $230 per share. As much as I believe my thesis of Tesla Motors holds true, its rapidly expanding production, rising margins, and avid fan base have proved me decisively wrong thus far.
We need the bad guy
But regardless of whether you're a fanatic optimist, an economic naysayer, or stuck somewhere in between, we all need the bad guy in our lives.
In investing, the bad guy is anyone with an opposing view of our favorite stocks that can provide insight and skepticism to the other side of our investing thesis. Why do we need this individual? Simple: We're not always right and we tend to be biased toward our own conclusions. Even if the bad guy doesn't dissuade us from purchasing or short-selling a specific stock, understanding where the other side is coming from will give you a much better perspective of the stock you're investing in or betting against. With history showing us that roughly half of all stocks will move lower over the long run, wouldn't it be nice to understand the risks involved in your investments before throwing your hard-earned money into these stocks?
Take casual-dining restaurant Panera Bread as a shining example. In The Motley Fool CAPS database, just shy of 1,500 of you expect Panera to outperform the S&P 500 moving forward, compared with just 155 who expect it to underperform, including myself. A 10-to-1 ratio in favor of buys would certainly imply plenty of upside potential, but shares have actually fallen 19% over the past year as margin pressures and rising food costs are beginning to catch up with Panera. Again, this doesn't mean Panera won't prove me wrong and head higher over the long run, but it does show the power of opposing views when deciding whether to purchase a stock or to continue to hold a stock.
The lesson here is that even if you want to point your finger at the bad guy so you feel better about yourself, keep in mind that the bad guy is doing you a favor by making you more knowledgeable about the stocks you already own or want to purchase by reminding you of the risks involved that your biases often skim over, and providing a driving force to keep you engaged with your investments.
So for now, say goodnight to the bad guy -- but make sure you thank him or her once in a while for providing some perspective on your investing strategy.
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The article Say Hello to the Bad Guy! originally appeared on Fool.com.Sean Williams is short shares of Tesla Motors, but has no material interest in any other companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.The Motley Fool owns shares of, and recommends Panera Bread and Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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