As I sit down to write in the pre-dawn here in Cafayate, Argentina, I am listening to a current favorite new track in the genre of dramatic music that is my steady preference. As you might enjoy it too, here’s a link to the song, Death Cab for Cutie’s Black Sun.
I’ll let you in on a secret of marketing financial services: fear sells.
To paraphrase my old friend and keen marketing professional Ted Kikoler, “If you offer someone a dollar to climb out of bed, they’ll think about it. But if tell them that their bed is on fire, they’ll muster out in a hurry.”
Having been involved in a number of financial-research businesses over the years, I have some relevant insights into this phenomenon that may be helpful in how you view the world and maybe invest your money.
First off, doom and gloom is infectious. Until recently, as a direct result of being exposed to the doomster community, I have been mostly bearish about the outlook for the US and global economy for the past 40 years.
Which is to say, pretty much for the entire period I’ve been an active investor.
Yet even a cursory glance at the data reveals my bearish posture as misguided. Here’s a chart showing US GDP in constant prices (i.e., adjusted for inflation) from 1975.
While this is, of course, only one of any number of data slices one could look at, I think the chart above makes the optimistic case fairly clearly.
Here’s the DJIA over that same period:
(As an aside, you can quickly create any number of useful charts on the TradingEconomics.com website… definitely worth book-marking).
While the DJIA chart reveals periods where the stock market as a whole has remained flat or even suffered precipitous declines, there’s no denying that the overarching trend has been upwards for the past four decades.
It’s also worth noting that (a) during the flat periods, you would have been earning dividends, and (b) if you had held rather than panicked out of your positions during the precipitous declines, in each instance your portfolio would have fully recovered within five years or less.
This isn’t to say the stock market can’t suffer a decades-long decline such as the one that kicked off in 1929, but that crisis took place almost 100 years ago, which suggests that sort of market action is rare. Based on the historical record, the odds are high you will be born, live, and die without experiencing the equivalent of a Great Depression.
Yet if you look at the financial headlines or the avalanche of financial-services marketing, you’d be excused for thinking THE END IS NIGH!
In fact, the situation has reached a point where certain popular measures of investor fears are now red-lining near the top of the scale. Likewise, short-selling in the United States has reached the highest level since 2007.
Everywhere you look there is talk of the imminent demise of the dollar, hyperinflation, systematic financial collapse, etc.
Well, I’m here to tell you that, within certain circles, this very same chatter has been going on since I made my first investment. Which is to say, 40 years or so ago.
Paranoia, Big Destroyer
As an investor, right now you can throw your arms in the air, commence screaming, and follow the crowd toward the exits—almost never a good idea. Or you can step back and assess the situation with a cool head.
Following the path of panic could result in your selling solid investments and dumping the money into instruments offering a negative yield (i.e., guaranteed losers).
Or worse, you could go overboard with investments in asset classes like precious metals, which are best viewed as either insurance or a speculation. Yes, these assets should absolutely be a part of your portfolio mix, but in my opinion never more than 15%.
Unless, of course, you’re a steel-hearted speculator willing and able to suffer big losses if your speculation fails. And holding a precious metals position of over 15% of your portfolio for a long period of time is a speculation that’s probably going to fail.
(That said, if you are going to speculate in metals, now is probably a pretty good time to do so.)
By contrast, the alternative approach of taking a step back and dispassionately assessing markets may give you a contrarian leg up in the zero-sum game of investing. Simply, by keeping a cool head, you should be able to pick up some serious bargains from the panic sellers.
On that topic, in the hopes it is illustrative, let me provide real-time examples of some of the more optimistic trades I’ve done lately.
I do so with the caveat that my investing style is mine, and mine alone. I don’t follow any particular guru or apply rigid filters when making a decision. Instead, I look for contrarian opportunities to buy deep value—or markets where temporary spaz attacks by Mr. Market have created a trading opportunity.
By the time you read this, I may have already hit my target and sold, or simply tucked the stock into my long-term holdings. In either case, the prices may have moved up and much of the opportunity may have passed.
Trading on the Sunny Side of the Street
Seadrill (SDRL). Seadrill is in the business of providing the proverbial picks and shovels to the oil exploration and extraction industry. Its portfolio of equipment and services is typically deployed in longer-term contracts at rates that allow it to make a decent return.
Importantly, its fleet of ships and equipment is quite new, compared to its peers. Thus, during periods like now, when pricing is under pressure, it isn’t forced to burn through cash replacing the (expensive) capital assets needed to generate cash flow.
Here’s what else you need to know about Seadrill:
1) It makes a very healthy margin.
2) It is volatile (a beta of 1.58). Therefore, when oil dips, it gets thrown out with the bathwater of the entire oil services sector. As a consequence, the company gets ridiculously cheap at times. How cheap? Seadrill is currently selling below one year’s sales… and for less than half of the company’s book value. An investment in SDRL is literally buying a dollar worth of assets for 50 cents.
3) The company currently pays a yield of about 4%. Historically, that number has been much higher (over 10%), but Seadrill has had to pare back to conserve cash against continued low oil prices. When oil prices stabilize above extraction costs—which they inevitably must—the yield should increase. But the stock will have appreciated so much by then, you’ll turn your nose down at the yield.
The key point is that unless you believe that the world is going to stop drilling for oil, this is a deeply undervalued stock you can either buy and hold or… do as I do. Which is to buy it when it gets slammed, then trade out of it on rallies of more than 10%—then put in a stink bid in an attempt to buy your shares back at low prices on the next round of weakness in oil.
In my opinion, with the stock off by more than 74% over the past year, most of the risk is out of the play, so this is a buying opportunity (and I have recently started buying again).
As the odds are good that oil prices are going to remain volatile over the next couple of years, this is one of those trades that should keep on giving.
Alibaba (BABA). For a number of reasons—some fundamental and some opportunistic in nature—I have recently begun nibbling at certain core China commerce stocks.
Stocks like Alibaba (BABA), China’s version of Amazon (AMZN). Except, unlike Amazon, which has never been profitable, Alibaba makes money… a LOT of money.
Here are Amazon’s core metrics:
And here are those of Alibaba:
Plus, thanks to the sheer size of China’s population and its fast-spreading adoption of all things Internet, Alibaba is growing like a weed, with year-over-year revenue growth of close to 50%.
I had a stink bid on Alibaba for a couple of months, which, thanks to the recent correction, recently got filled, moving BABA into my long-term holdings.
Market Vectors ChinaAMC A-Share ETF (PEK). This is an ETF made up of the 300 largest and most liquid publicly traded stocks on the Shanghai and Shenzhen Exchanges.
Investing in PEK was a pure contrarian speculation. Did you believe the blaring headlines telling you the Chinese stock market retracement was a collapse? Well, I didn’t.
While the correction was sharp (the best kind), it was certainly within a normal range for any market that had moved up too far, too fast.
The PEK ETF is heavy with the sort of stocks taking the biggest losses, specifically banks and other financial institutions, which means it felt the brunt of the recent sell-off.
I was first tipped to PEK by Jared Dillian, the former head of ETF trading for Lehman Brothers and now one of the editors at Mauldin Economics (his free e-letter, The 10th Man, is excellent and well worth signing up for).
I watched PEK casually, then started watching it closely when it fell, along with the broader Chinese markets (for which it is a good proxy), by over 30% over the course of a month. Earlier this week, when PEK dropped another 11% in a single day, I backed up the truck.
Happily (okay, luckily), the stock rebounded by 18.5% the very next day, then followed up with another 7% at the opening bell on the day after that.
So why did I make the trade? Here’s what I know about the Chinese market.
The percentage of the population with brokerage accounts is still small, though growing rapidly. In fact, the rate of new brokerage accounts opened each month in China has been the equivalent of the population of Los Angeles. More buyers means more upwards pressure. While the pace of buying may slow a bit following the correction, it’s very much a trend in motion that will stay in motion.
Oddly, to the Western perspective, the average Chinese has an unshakeable faith that their government will always be there to ensure they don’t suffer big losses. There was a lot of news about the Chinese government damaging its credibility by interfering in the markets this week—but quite the opposite is true. To the Chinese investment community, those actions restored the government’s credibility.
As a consequence, instead of running for the exits, my logic was that the market had (quickly) moved to an oversold point and, with confidence restored by the government stepping in to arrest the selling, I bought.
Any time you can lock in a 26% return in just over 24 hours, the correct thing to do is to sell, and so I did.
That said, I was tempted to hang on to the position because my entry point was so low. In addition, the Chinese are culturally fond of gambling, and the bounce will, I believe, bring a lot of money back into the market from newbie investors looking to recoup losses.
But if you have no investment discipline, you greatly increase your chance of getting disciplined (with a good spanking), so I exited.
I mention these trades only as a way of trying to make the key point of these musings.
Namely that if you are scared out of the markets by all the fearmongering, you are potentially missing out on some amazing contrarian opportunities.
But what if the market does correct?
A couple of useful adages pop to mind:
You make money investing not when you sell, but when you buy. Buy low enough and as certain as night follows day, in time your investment will pay off, regardless of the interim market action.
It’s not a loss until you sell. If you have bought at the right price and for the right reasons, then you can (and usually should) ignore market gyrations.
So, please don’t get spooked out of investing by the gloomsters who, interestingly, may not actually believe their own bear droppings, or invest in the way they say that you should. You know, to avoid being wiped out by the imminent collapse of civilization as we know it.
Per above, the bear case can make for very effective marketing.
Call it mercenary, cynical, callous, manipulative, or just good business. Regardless, just accept the fearmongering as a natural extension of the free market and scrawl the words Caveat Emptor on a sticky note and slap it on the side of your computer screen.
To be fair, the financial media are far from the only folks who play the fear card for financial gain. The time-honored maxim of the mainstream media, “If it bleeds, it leads,” has kept reporters in beer and the consumers on the edge of their seats for time immemorial.
If challenged about publishing dire headlines designed to scare half-wits off another half, the reporter would likely answer they were just “doing their job.”
Well, the same is true of the marketing folks at the successful financial advisories. They are successful, for the most part, because they are so competent at scaring you into buying their solution to whatever BIG FEAR, real or imaginary (but mostly the latter), gets the biggest response.
Yet internalizing the fear, as I did for many years, can result in abandoning conventional equities or bonds entirely, or being frightened into parking more than 15% of your money in insurance assets such as precious metals.
That means you’ll be sitting on the sidelines with your net worth eroding over time thanks to persistent (and underreported) inflation while the natural ascent of mankind marches on.
Don’t get me wrong, there have been times when insurance hedges—specifically precious metals and related stocks—can supercharge a portfolio, but you have to recognize that these things run in cycles.
When off-cycle, as the metals have been for the past five years, your precious metals holdings will be a drag on your portfolio… and maybe even a bullet through the head. At 15% of your total, even a 50% haircut is likely tolerable and can be rationalized as the cost of insurance. At 50% of your portfolio, the case with a number of investors I have come in contact with, losing half can be life changing—and not in the right way.
THE END IS NIGH!
As this posting is dangerously close to the point where anyone with a life will begin contemplating jumping ship, I would like to wrap up by quickly ticking through some of the doomsday scenarios now being touted as not only inevitable but imminent.
The Collapse of the US Dollar!
In favor of, what? Cockle shells? Gold and silver coinage? Or slips of paper backed by gold that has been revalued at $20,000 an ounce in order to cover the outstanding currency stock?
Any of those are possible and even probable (well, maybe not the cockle shells), but what makes such a tectonic monetary shift imminent?
In my view, nothing.
Sure, there could be a black-swan event, but black swans are, by definition, exceedingly rare. While you may disagree, in my opinion the last black-swan event of any real consequence (and by that I mean life altering for the majority of the population) was the Japanese attack on Pearl Harbor.
Besides, any turmoil happening around the world these days is only to the benefit of the US dollar. I can assure you that if the Greek exit were to wreak havoc on the euro, the French and Germans wouldn’t be rushing out to buy Chinese renminbi.
Also, based on direct personal experience, I can confirm there is a lot of ruin in a country… and a lot more ruin in an empire.
Here in Argentina, life continues apace despite 60 years of almost unbroken gross government mismanagement. If there is a single hare-brained, socialist, communist, fascist, or just plain moronic economic or social scheme that hasn’t been tried since Juan Perón first stepped into the Casa Rosada, it doesn’t come readily to mind.
Yet, most Argentines get along just fine. And here in the Argentine outback town of Cafayate, they get along a lot more than just fine.
The Collapse of the US Stock Market/Looming Depression!
However, the historical record clearly demonstrates that a 1929-style crash is very rare indeed. There are trillions of dollars floating around the globe looking for a return. It takes no deep analysis to figure out that the US financial markets are the most trusted on the planet.
Where is all that money going to run to if it were to cut the anchor and flee from the US?
China? The European Union? Indonesia?
So unless the whole concept of publicly traded equities is discarded in favor of some other scheme to raise capital, it’s a fairly safe bet that the US stock markets will continue to find favor both domestically and abroad.
Rising Interest Rates/Collapse of the US Bond Market!
Of course, interest rates can’t stay low indefinitely, but the current trend is more toward deflation than price inflation. As a consequence, while there has been some upward movement in yield over the last year, the fact that you can still get a fixed-rate 30-year mortgage at around 4% would suggest pressure to the upside is still pretty minimal.
Again, the theme of the US as a financial safe haven comes into play. Any serious turmoil pretty much anywhere in the world opens the spigots on foreign (and domestic) cash flowing into US government securities.
Case in point, despite the purported friction between the US and China, the Chinese government’s holdings of US Treasury bills remain almost exactly where they were a year ago.
So, sure, interest rates are going to rise at some point. And when they do, people will flee bonds in droves. However, and trust me on this one, when that begins to happen in earnest, you’ll know it and will have plenty of time to take whatever corrective action you need to protect yourself.
Reading over what I just wrote, I fear I’ll alienate some of my perma-bear friends. Or people may think that now that I’m no longer involved with Casey Research, my remarks are somehow directed at my long-standing friend and former partner Doug Casey, the patron saint of perma-bears.
I can say with complete sincerity that Doug truly believes the world as we know it is headed toward a hard landing. And he almost always caveats his dire predictions by underscoring that no one can say with certainty when the final shoe will drop—just that he believes it will drop.
Besides, I wholeheartedly agree with Doug that this era of “free” money and government mismanagement of the economy has created huge investment misallocations. There will be consequences, some of which could be quite severe.
However, reviewing the counter-arguments to the most hyped bear scenarios, and glancing at the historical record, should give one hope that:
(a) Things are unlikely to be anywhere as dire as the gloomsters say they will be. Again, keep in mind that the passion with which some of these promoters extol the bear case is directly connected to the success of their marketing. The more dire, the more successful… but also the more divorced from reality.
(b)There is a lot of ruin in an empire. The US is the world’s big enchilada and will likely remain so for the rest of our lives (if you are over 50). The size of China’s economy will almost certainly surpass that of the United States within the next decade (which is why I’m interested in Chinese consumer stocks at these levels), but that won’t make more people want to entrust their money to its government securities, currency, or financial institutions. Yes, the quality of life in the US will likely continue to trend down, but Rome wasn’t made, or destroyed, in a day.
(c) The business cycle will continue pretty much as it usually does. Sure, we’ll have inflation, deflation, a strong dollar, a weak dollar, recessions, recoveries, and so on, and so forth. But absent a real black swan, the business cycle should remain within established trend lines for the foreseeable future.
As a consequence, don’t let the fear of a market sell-off scare you away from putting your capital to work in solid businesses (directly or through publicly traded equities). And whatever you do, don’t plan your investments or your affairs around the extreme fears shouted from the rooftops by self-serving pundits.
I have learned from painful personal experience that heading into the fallout shelters before the bombs actually start falling is to unnecessarily deny yourself the best things this beautiful world has to offer. In addition, it all but ensures that you’ll misallocate your personal capital and prevent you from accumulating a solid capital base over time.
Until next time… enjoy whatever trail you are currently traveling down.