Where do you get your latest stock tips from? Scouring through balance sheets, poring over profit and loss statements and scrutinising cash-flow statements? Or do you listen to the latest punt your mate Joe is boasting about at a cocktail party?

Believe it or not, the second option might be a better bet. At least in a sense.

Whatever you do, don't buy the stock Joe is punting on and then write an email to letters@dailyreckoning.com.au complaining it went down. That's not what we mean by 'get your latest stock tip'.

Instead, think of Joe as your market signal. The louder he is, the more he drinks and the newer his shoes, the wider the perception gap.

The what?

The Perception Gap

It's the difference between what people think will happen and what will happen. Or, strictly speaking, it's the difference between what can reasonably be expected and what is expected.

Consider this: If Joe is telling everyone that ASX listed stock XYZ is about to cure cancer, that doesn't mean the stock is a buy. Because if Joe knows about it, everyone else probably does too. And they will have bid up the stock's price already, probably well beyond a justifiable price. Especially if the other gullible people at the party add to the buying pressure.

What's true of an individual stock is just as true of an entire stock market and any other asset class. If the Joes of the world are spruiking the life out of a certain investment, the opportunity is probably dead already.

The most obvious example of all this is the tech bubble of 2001.

Spot the NASDAQ Bubble

Back in 1999, tech stocks were being peddled like ... well ... subprime mortgages in 2006. Companies that barely existed and had nothing to sell were listed on the stock exchange. If you had an idea, why not go public (with the company, not the idea). Like all crazes, it ended in tears. Stocks crashed.

Back to the point of today's Daily Reckoning. The perception gap was what made tech stocks such a bad bet. Even many of the stocks that survived the carnage and become profitable businesses were bad investments back then. Because they were perceived to be better than they really were. The stock prices didn't match the fundamentals.

So that's an example of a positive perception gap - where expectations are delusional to the upside. Irrationally exuberant, as some might say. A positive perception gap means things are overvalued, overestimated and perceived to be safer than they really are. But there are also negative perception gaps. Where people think things are worse than they really are. The master of discovering negative perception gaps is Daily Reckoning founder, Bill Bonner. He invests in lost causes, stands up for the down trodden and supports the underdog every time. And the fact that you're reading this today shows that it works quite well as a business model and investment strategy.

The trick is to find negative perception gaps that fit the puzzle piece that is you. For Bill, a decade ago, the obvious answer was gold. No doubt Bill likes gold. But that's not why he made it the buy side of his 'trade of the decade' so many years ago. It was because it was the asset nobody wanted to have anything to do with. It was perceived as a rubbish investment. And so Bill had the perception gap well in his favour. Even if gold had been a poor investment, people perceived it to be much worse than it was.

It turned out that gold was a good investment and Bill was right to take a shine to it personally. But the investment decision, we suspect, had more to do with the perception gap. What makes your editor think so? Well, Bill's new trade of the decade is to buy medium-sized Japanese companies. And the only reason he could possibly have to come up with such a completely ridiculous idea is that it seems ridiculous. There is a negative perception gap. People perceive the Japanese stock market and economy to be more of a basket case than it actually is.

Now, there's a reason the trade is called the trade of the decade. Gold didn't stage its dramatic surge until very late in the last decade. And so Japanese stocks must be given quite some time to prove themselves.

By the way, we've only covered half of both trades of the decades. There is a 'sell' recommendation to match each buy, too. And sure enough, there is a perception gap on the sell recommendations. This one is a positive perception gap, because over enthusiasm hints at trouble. People in 2000 thought stocks were in for a great run. And so Bill said they were a sell. It turns out that people's optimism was based on hot air, or freshly printed money if you prefer. Goldman Sachs actually referred to stock performance since 2000 as a bear market in one of its recent reports. That's not something thrown around lightly by a mainstream investment bank, even in hindsight. But Bill threw the same idea around back then, when it was a useful idea.

So Bill's ears successfully twigged to a perception gap in stocks and he was proven right. This decade around, it's government bonds and their perceived 'safe haven' status that is vastly overvalued. And so they form the sell side of Bill's trade of the decade.

Back to Joe at the cocktail party you're attending. Consider him your perception price signal. The more sure he is of something, the more overvalued the perception. The more dismissive he is of your ideas, the more enticing the opportunity.

So what are the Australian Joes telling cocktail party goers? Well, it's a buyer's market in the property world, that's for sure! And gold remains a barbarous relic because it pays no interest. In fact, it's in a bubble. Be sure to invest in the likes of wind and solar power, or iron ore the ever-growing Chinese Dragon will consume. But don't touch the fracking energy companies or radiating uranium miners.

Let us know about any perception gaps you discover listening to Joes at cocktail parties. Or the pub.

letters@dailyreckoning.com.au

There is another person you could watch closely to find perception gaps you can take advantage of. Greg Canavan's entire investment philosophy is based on a slightly more scientific version of the perception gap. And he reckons he has found a combination of investments that are either over or undervalued. And he's researched what to do about the fact that they are. Find out more here.

Until next week,

Nickolai Hubble.
The Daily Reckoning Weekend Edition