How I Learned Lehman Was Drowning Before Almost Anyone Else

Doc's note: Everyone wants to know how to call a bottom. If you've seen the stock trading floor, the TV screens are full of technical charts traders use to figure out if a stock is about to break out to the top or collapse.

In today's issue (adapted from his 2018 Stansberry Digest essay), our director of research, Matt Weinschenk explains what you should be doing to know what's going on with a company. And it's not stare at charts all day...


I (Matt Weinschenk) was one of the first people to know that Lehman Brothers would go bust...

But I didn't figure it out for myself. I was just a 25-year-old kid sitting in the right place at the right time (the 2007 Value Investing Congress in New York City, to be exact).

I was in the room when then-regarded short-seller David Einhorn walked the audience through his thesis for why the investment bank would go bust...

Einhorn didn't hook the audience with a gripping story. He just talked numbers. The shocks had already started to show in the banking system... Lehman looked like it had one of the worst loan portfolios of the banks, but it hadn't written off any losses yet.

Something didn't add up. Einhorn knew an earthquake was coming.

It was November 2007, and the financial crisis was looming over Wall Street and all of America. But the market hadn't crashed yet.

And I was about to learn the biggest lesson of my investment career...

As investment conferences go, the Value Investing Congress represented the best of the best at that time. Every speaker managed billions of dollars. Even in the crowd, you could find yourself sitting next to hedge-fund royalty.

However, what I learned had nothing to do with what the speakers said on stage, the investment ideas they presented, the charts they shared, or the balance sheets they studied.

It had a lot more to do with the mood in the room...

Between every session, folks would get on their Blackberries to check in on the stock market. Whoever got an update would yell it out in the hallway.

Several speakers made good cases to buy stocks. After all, these were value investors. And you had to have guts and buy when "there is blood in the streets." They didn't know it, but the streets were about to get a lot bloodier.

See for yourself: During the conference, we were right here in the market...

We were on the precipice of the greatest financial crisis in 60 years. Everyone was worried... But we had no idea how far the market would fall. The S&P 500 Index was about 6% off its peak. The financial sector had already fallen about 20%.

I take a data-focused approach to investing...

Rather than drawing lines on charts like some of my colleagues who specialize in technical trading, I focus on economics and fundamental data.

But at that conference, I learned that numbers will never tell you everything you need to know.

The market has a certain feel to it. You can only pick it up by talking to investors, hearing hedge-fund managers speak off-the-cuff, and listening to candid conversations that aren't supposed to leave the room.

In November 2007, an uncomfortable, grim humor filled the air.

The people in the room stood to lose billions in investor money, and many would lose their jobs. Even so, they weren't panicked. They joked and laughed. They assumed the other guys' portfolios would fall apart, but not theirs.

When a presenter pitched a long stock idea, he'd finish up with a winking disclaimer like, "That is, if you're brave enough to buy any stocks right now." Other speakers made similar jokes: "This is a buy... if there even is a financial sector tomorrow." The crowd reacted with nervous laughter.

What I realized later was that when the bottom is truly in, nobody is cracking jokes...

It's pure fear.

Had the speakers sensed that, they could have avoided some disastrous calls. I remember hearing a presentation from Tom Brown, who runs a website called Bankstocks.com and a hedge fund focused on bank stocks. He basically threw up his hands and admitted it's hard to figure it all out when everything keeps moving so fast.

I do remember one bold claim he made, though...

I think we're really close to, if not at, the bottom for the financial-services industry. There are many opportunities in the most battered sectors.

That same day, news service Reuters reported his fund was down 50% for the year... Yet, the S&P Financial Index would go on to fall another 80% from there.

Portfolio manager Richard Pzena of Pzena Investment Management gave a talk claiming that Freddie Mac was the cheapest stock he had ever seen. After that, shares of Freddie went from $35 to around $1, and nearly brought down his investment firm in the process.

Today, everybody wants to be the person who calls the top. That can be just as hard as calling the bottom... And no single chart or number-driven solution is the silver bullet.

But the reverse of what you see at the bottom – pure fear – is pure euphoria. And we're simply not seeing that euphoria yet. That means the market can still climb the "wall of worry" higher.

As the old saying goes, the most dangerous words in investing are "this time it's different"...

That's catchy. But in one sense, every time is different. We've never had fast-growing technology companies, an 11-year bull market with ultra-low interest rates, a pandemic-induced market crash – followed by a roaring recovery and unemployment below 4% – all in rapid succession. Of course it's different.

What has never changed are investors' mindsets. They are always driven by the same fear and greed...

They are likely to let their emotions lead them into doing the exact wrong thing at the exact wrong time. And eventually, they will bid the market up to unsustainable levels before the whole thing comes crashing back down like a house of cards.

As journalist Edwin Lefèvre wrote about trader Jesse Livermore in his classic 1923 biography, Reminiscences of a Stock Operator...

There is nothing new in Wall Street. There can't be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again.

That will never change. So, look at as many charts as you want... But make sure you're listening to what investors are saying, too.

Good investing,

Matt Weinschenk