Do this one simple thing to get richer every day
How much do you really know about building wealth? This week, Mark Ford explains why we should all learn the fundamentals of finance – and shares the one simple> READ MORE
How much do you really know about building wealth? This week, Mark Ford explains why we should all learn the fundamentals of finance – and shares the one simple> READ MORE
How do you give a country a cardio stress test? This question drifted through my brain yesterday as I huffed uphill on a treadmill. I was hooked up to a bulky> READ MORE
On its current trajectory, in this century tobacco will claim 200 million Chinese lives. That’s double the death toll of both World War I and World War II> READ MORE
Most stock analysts at banks and brokerage houses really like the stocks they cover. On average, stock market analysts have five times more “buy”> READ MORE
A lot of people have money managers, private bankers or financial advisors. One of the reasons why we started Stansberry Churchouse Research is that we believe –> READ MORE
Not long ago, a special agent – working for a secretive agency that’s in the news a lot these days – asked me to take a Chinese man out to dinner, ply him> READ MORE
Right now, the VIX index is saying you have nothing to worry about when it comes to the U.S. equity market. But today I’m going to introduce you to another> READ MORE
Many people say they want to find new and unique investment ideas - those off-the-radar ways to make a lot of money. But it’s a lot more difficult than it> READ MORE
How much do you really know about building wealth? This week, Mark Ford explains why we should all learn the fundamentals of finance – and shares the one simple idea that put him on the road to financial success.
Do this one simple thing to get richer every day
By Mark Ford
My hairdresser and her boyfriend were planning to get married. As her wedding approached, she asked me for financial advice.
I asked her what she knew about money. She likes money, she told me, and found the subject “interesting.” But she didn’t know a lot about “stocks and investing and stuff like that.”
“Do you know the difference between profit and loss?” I asked her.
“When a business makes or loses money?’’ she replied.
“How about the difference between an asset and a liability?”
“How about net worth? Do you know what that means?”
She had no idea.
(Net worth is a measure of a person’s total wealth. It’s the value of all of their assets minus all of their expenses and debts.)
Why everyone should know the basics
A colleague of mine once said that the biggest problem America faces is not political corruption or corporate greed, but ignorance about money.
He may be right.
According to a poll commissioned and conducted in 2016, roughly 6 out of 10 people in the U.S. rated themselves as “financially savvy.” Yet only a third of them knew the annual percentage rate (APR) on their primary credit card.
Among young people, only 13 percent knew the maximum they could put in a 401(k), which is the main retirement savings mechanism for millions of people in the U.S.
In 2016, ABC News reported that Americans tested on 14 basic financial questions got an average score of 40 percent.
Two-thirds of those questioned believed that there is “an organisation that insures you against losing money in the stock market or as the result of investment fraud.”
And nearly half believed diversification is a “guarantee” investments will do well even if the stock market falls.
Six out of 10 people surveyed did not understand the basic concept of inflation. One said, “I know what it is but I can’t explain it.” And another added, laughing, “Inflation? It’s bad.”
Studies in other countries paint a similar picture. The Bank of Japan’s 2016 Financial Literacy Survey asked 25,000 people a series of true/false questions… and the proportion of correct responses came in at just over 55 percent.
This lack of knowledge translates into lots of personal financial misbehavior. For example:
Financial ignorance in America (and elsewhere) is widespread, and it is costly. If you could add up the lost value of all the bad wealth-related decisions made on a daily basis by Americans, the number would be astronomical.
We do know that American consumers owe US$11.5 trillion to lenders and creditors. And we know that this debt burden increases every year. We know that in 2015 alone student loan debt soared by more than 11 percent.
But it’s not just happening in the U.S. Chinese consumers are taking on record levels of debt too: Chinese household debt as a proportion of GDP has more than doubled to just over 40 percent in less than a decade.
There is a reason we are financially illiterate. Less than 5 percent of us get any sort of financial education by the time we graduate high school. College isn’t much better. You can take plenty of courses in economics or accounting, but the fundamentals of personal wealth building?
It’s simply not taught.
I suppose it’s not taught because most teachers — even those who have degrees in accounting, economics and finance — don’t know the first thing about it.
That’s certainly true of most accountants, economists and financial experts I know.
I was thinking about this as Kristin was cutting my hair.
There are really two problems operating simultaneously: Financial illiteracy (which means you don’t know the difference between an asset and a liability) and ignorance of the fundamentals of wealth building (which means you can talk a good financial game but you are secretly broke).
What could I say to Kristin? What could I teach her right then that would be useful to her and her husband for the rest of their lives?
I could have explained terms to her, but she would soon forget them. I’d rather talk about principles and then, if necessary, explain terms.
I could have done all that… if I’d had about 10 hours with her.
But I didn’t. And so I wanted to tell her something that was simpler and more fundamental than all those things. I wanted to tell her the one thing that could make the biggest difference in her and her husband’s future financial life.
The first step to financial success
I thought about it as she was trimming my sideburns, and then I had it. I told her that the most important thing she should know about money is the concept of net worth, and the first and most important rule she and her husband should follow is:
Make sure that your net worth increases — if not every day, then at least modestly every month and significantly every year.
This was a slightly refined version of a thought that hit me many years ago, one I’ve written about before. That thought was that I should “get richer every day.” It was simple and obvious, but it hit me like a bolt of intellectual lightning.
But by making that resolution — that I would do whatever it took to get a bit richer every day — my entire view of investing changed overnight.
Instead of doing what everyone else was doing, I took a different path, where the preservation of my existing net worth was the most important thing, and where to boost that net worth I’d sometimes have to create more income.
Even if your money is conservatively diversified into great stocks and safe bonds, you can still experience a drop in net worth when — as has happened several times in my wealth-building career — stocks and bond returns go down simultaneously.
I realised I needed more diversity. But not in assets that just sit there. I needed assets that would create more income. So I got into rental real estate and direct lending and direct investments in small businesses and tax liens and all these other “off-Wall Street” ways of generating extra income.
And that worked. Since I made that change, my net worth has increased — if not every day, definitely every year. I made that decision about 20 years ago. My net worth has increased almost six-fold since then. And it has never, ever gone down.
So that’s what I said to Kristin. I didn’t brag about my net worth as I just did to you. I didn’t think she needed to hear that. She might have started charging me more (which I would have admired.)
But she got the idea and liked it because, I think, it was so simple and obvious. It’s something everyone can do.
How do you give a country a cardio stress test?
This question drifted through my brain yesterday as I huffed uphill on a treadmill. I was hooked up to a bulky medical machine with a printer that spat out paper showing squiggly lines that reflected the flow of blood through my heart.
The curly lines show the chances that your heart will stop working properly… and lead to a heart attack.
So, how can you tell if an economy is about to have a heart attack?
An economic crisis – a “cardiac event” for a country – can be caused by debt, a fragile property sector or bad banks.
As an investor, you want to be comfortably distanced from these events, lest your wealth gets taken down during the crisis.
In a recent book, The Rise and Fall of Nations: Forces of Change in the Post-Crisis World, Ruchir Sharma – Head of Emerging Markets for Morgan Stanley’s asset management business – identifies 10 indicators to assess a country’s future “health” prospects.
These aren’t just to gauge asset market performance for a country. They’re more like a full-day physical exam, to warn of a full-blown economic crisis.
Sharma looks at these indicators…
Two things drive economic growth – population growth (whether it’s natural or through immigration), and higher productivity (that is, how much a person, business or country produces within a certain period).
If a country’s population isn’t growing, its economy will have difficulties growing. By this measure, Africa is in a great place, and parts of Asia are poised to benefit from growing populations. Japan, on the other hand, is the poster child of terrible demographics. And for much of the developed world – with the important exception (for now) of the U.S. – the demographic destiny isn’t a happy one.
Over the long term, Sharma says, socioeconomic inequality tends to result in political revolt. To gauge this, he looks at billionaire wealth (for example, from those lists in Forbes magazine) as a percentage of GDP; the share of billionaire wealth that’s inherited; and wealth that comes from corrupt industries.
A more common alternative way to look at this is using the Gini coefficient, which measures the level of income inequality within a country. By this measure, South Africa and Namibia are the most unequal economies in the world… and Finland and Romania are among the most equal.
As soon as the hot stock, market or country hits the cover of Time magazine, it’s already crested – and is on its way down. (Or with the oil image below, it’s on its way back up.) As my colleague Peter Churchouse puts it, “if it’s in the press, it’s in the price”.
Sharma warns to watch out for the “hot” country on the cover.
In recent years, the fear of deflation – that is, prices going down – has haunted central bank policy makers around the world (Japan, again, is a trend leader). Sharma advises keeping a close watch on asset price inflation because of the tight link between asset bubbles and recession.
If asset prices – like stocks or real estate – move up too much too fast, a bust may be on its way.
You might think that the 2008-2009 global economic crisis delivered a crowbar-to-the-head message about debt: Too much debt is bad. But since then, overall levels of debt haven’t declined. Total lending has actually risen – by 40 percent.
As of late 2014, the world economy owed itself US$199 trillion, which was US$112 trillion more than it owed in 2007. Markets where private debt rises a lot faster than the economy as a whole are particularly worth keeping a close eye on.
If the population of the capital of a country is far bigger than the second-largest city (for example, more than three times bigger), Sharma looks for a high risk of rural rebellion.
For example: Bangkok, Thailand’s capital, has 8.3 million people. The country’s second-biggest city, Samut Prakan, has just under 400,000. And… Thailand has a long and rich history of city-vs-country divisions.
The implications for Thailand of the “second city” rule.
If local capital leaves the country, it’s bad news. After all, who knows better than people at home whether their currency is in trouble, and whether they can earn a reasonable return that reflects the risk of holding the currency.
Foreign capital – “hot money” – is often pointed to as the cause of currency crises, but frequently it’s local money that is the first down the spillway.
I’ve seen this in a number of markets… most memorably in 1998, when Russian investors were selling everything that wasn’t nailed down to ditch the ruble. Meanwhile, foreigners were gleefully lining up to buy ruble-denominated sovereign bonds, drawn in by sky-high yields. Then the ruble collapsed and the Russian government defaulted on its debt. Local investors may have missed out on a bit of yield, but they had the right idea all along.
Sharma shows that economic reform – for many emerging markets, a critical building block of growth – usually happens during a leader’s first term. After that, it probably won’t happen at all. Leaders lose the impetus to change, and grow content with the status quo. That’s especially true (in more corrupt countries in particular) if the status quo entails state-sponsored stealing by the head of government to enrich himself.
An investment bubble that results in acres of empty office buildings – which don’t produce anything or help anyone – is an example of “bad” spending. But if investors, or the government, go overboard on spending on assets that will eventually boost productivity (like technology, research or manufacturing), it will be a lot better for the long-term health of the economy.
Central banks can do a lot of different things to manipulate the value of a country’s currency. Sharma says that there’s a lot of value in investors getting an on-the-ground sense of how cheap, or expensive, a currency is.
The cheapest place I’ve been to in a while? Cambodia. The most expensive? Singapore, by a long shot.
No country is going to fail on all these measures – just like no economy is going to sail through. But they are important to keep in mind as you look at market opportunities around the world. If a country fails more measures than it passes, you may want to avoid investing there.
And pay careful attention to these four: debt, asset price inflation, domestic capital flows and good spending vs bad spending.
They’ll help you avoid investing in a heart attack of a country.
On its current trajectory, in this century tobacco will claim 200 million Chinese lives.
That’s double the death toll of both World War I and World War II combined.
I discovered this fact a few weeks ago whilst doing some research. I came across a report that disturbed me. I’ve been thinking about it ever since.
It was a report by the World Health Organisation (WHO) titled “The Bill China Cannot Afford – The Health, Economic and Social Costs of China’s Tobacco Epidemic”.
When it comes to China, we’re used to big numbers. And I don’t consider myself easily shocked. But the numbers contained in this report are simply astonishing.
Just let some of those numbers sink in for a moment. I had to re-read them a couple of times at first. We’re talking tens, even hundreds of millions of lives ending prematurely and in highly unpleasant ways. It’s devastation.
When it comes to tobacco, there are no redeeming features whatsoever. None. There are no benefits of any kind attributable to an individual who smokes cigarettes.
The reason I bring this up is because one of the recommendations in The Churchouse Letter is a tobacco company. It’s returned over 85 percent. But the reality is, when a tobacco company is doing well, it usually means more people are smoking more cigarettes. And smoking equals death.
You could make similar arguments about everything from guns, to defense, to gambling, to polluting industries… the list is endless.
Where do you draw the line when it comes to ethical investing?
This is hardly a new moral dilemma. Some of the earliest ethical investing was made in the 18th century by Quakers (a religious group) who forbade its congregation from investing in anything related to the slave trade.
There are Shariah-compliant investments today which adhere to Muslim or Islamic law and have a similar ethical foundation. They prohibit investing in anything related to tobacco, gambling, or alcohol (amongst others).
In reality, this is a completely personal decision that everyone has to make for themselves. And to be honest, it’s not something I really thought long and hard about until I read that WHO report.
Take a look at the chart below which shows the iShares MSCI KLD 400 Social ETF (DSI). This tracks an index of U.S. companies that have positive environmental, social and governance characteristics (as defined by the index provider).
You won’t find any tobacco companies in here.
But over a decade, it’s slightly outperformed the S&P500.
And as we’re talking about ETFs, there’s no shortage of choice. These aren’t recommendations, but there are plenty of other ETFs with even more specific religious or moral angles out there (should these be values that you want your portfolio to reflect).
Global X S&P 500 Catholic Values ETF (CATH), which provides exposure to the companies within the S&P 500 whose business practices adhere to the Socially Responsible Investment Guidelines as outlined by the United States Conference of Catholic Bishops (USCCB) and excludes those that do not.
SPDR SSGA Gender Diversity Index ETF (SHE), for U.S. large capitalisation companies that are “gender diverse,” which are defined as companies that exhibit gender diversity in their senior leadership positions.
Barclays Return on Disability ETN (RODI), which looks at a company’s publicly observable activities relating to people with disabilities across three key areas: talent, customer and productivity.
It’s not our place to tell our subscribers what we think they should and shouldn’t invest in when it comes to ethics. Our job at The Churchouse Letter is simply to give you our best ideas and let you decide on the rest.
Most stock analysts at banks and brokerage houses really like the stocks they cover.
On average, stock market analysts have five times more “buy” recommendations than “sell” recommendations.
Does that mean you should buy their “buy” recommendations? Maybe (more on that later).
But did you know that you would have beaten the market – over the past year, at least – by buying a basket of analysts’ most-hated stocks?
We looked at the “most-hated” stocks in the entire Asia Pacific ex Japan region as of exactly a year ago. These are the stocks (with a market capitalisation of US$1 billion or more, and covered by at least eight analysts) that had the highest percentage of “sell” recommendations.
This means a group of highly educated, specially trained analysts, employed by very selective investment banks in the world’s financial centres, focused their analytical minds on these companies… and nearly all of them said that investors should sell these shares.
It takes a lot for an analyst to recommend selling a stock. Financial regulators have struggled for years to remove the connection between research (that is, stock analysts) and the business of banking (initial public offers and advisory work, for example). But the reality is that many analysts still play a role that extends well beyond simple stock analysis and stock picking.
Analysts know full well that they’ll get better access to a company’s management if they say and write nice things about the company. You don’t cosy up to a company’s management by branding their stock a “sell”.
This means that an analyst has to be especially sure of himself to call a stock a “sell”. Whether he thinks the stock is expensive, or the company is at the wrong spot in the business cycle, or management is bad, an analyst has to have a compelling reason to tell investors to sell a stock.
At a minimum, a “sell” recommendation suggests that the stock will underperform the index. Often, it means that the analyst thinks the stock will drop in value.
The table below shows the stocks with the highest percentage of “sell” recommendations in Asia Pacific ex Japan markets as of one year ago.
As shown above, 29 of the 38 analysts (78 percent) who cover Steel Authority of India (National Stock Exchange of India; ticker: SAIL) labeled the stock a “sell”.
Eight of the 9 analysts that look at Australia’s BWP Trust (Australia Stock Exchange; ticker: BWP), a REIT in Australia, called it a “sell”.
Eleven of the 16 analysts who cover Sa Sa International Holdings (Hong Kong Stock Exchange; ticker: 178) said investors should get rid of it.
Global computer maker Acer, traded in Taiwan (Taiwan Stock Exchange; ticker: 2353) was called a “sell” by 70 percent of the analysts who cover the stock.
As shown below, first of all, only one of the most-hated 10 shares declined.
Seven were up by double-digits… and one was up by triple-digits.
Overall, the average return over the past year of the ten most-hated stocks was an impressive 37.8 percent.
That’s a lot better than the 26.9 percent return posted by the MSCI Asia ex Japan index. Beating the market by nearly 11 percentage points isn’t just doing well. That’s grand-slam, hat-trick, knockout-in-the-first-round, hole-in-one investing.
What’s more, the “most-hated” stocks did even better than the “most-loved” stocks as of last year!
(These are stocks that had the highest percentage of “buy” recommendations. Those shares – including Grasim Industries (National Stock Exchange of India; ticker: GRASIM), Jiangsu Hengrui Medicine (Shanghai Stock Exchange; ticker: 600276) and Hangzhou Hikvision Digital Tech (Shenzhen Stock Exchange; ticker: 002415) – returned an average of 34.7 percent over the past year.)
In the past, we’ve written about lousy “buy” recommendations. That’s not the case for this sample, though.
Why are stock market analysts – on aggregate – so lousy at picking stocks to sell?
For a lot of analysts, picking stocks isn’t really their main job. They’re more focused on satisfying internal customers (like salespeople or the bank’s investment bankers) than external customers (like the ones who read their research and might actually consider taking their advice).
Below is a list of the current most-hated stocks in the Asia Pacific ex Japan universe. Two of the stocks in this table (Steel Authority of India Ltd and Thermax Ltd) also appeared in the same list one year ago (and are up 48.1 percent and 44.9 percent, respectively, since then).
Buying the stocks that are most hated by analysts is a silly way to speculate in stocks – and an even worse way to build a portfolio. I don’t recommend it. But it’s worth recognising that traditional investment banking research departments aren’t the best source of sell-side research, especially over the past twelve months in Asia. So when you read that an analyst says “sell,” think twice before you do.
A lot of people have money managers, private bankers or financial advisors. One of the reasons why we started Stansberry Churchouse Research is that we believe – with the right tools and insight – everyone can take care of their own finances. And part of this is helping you protect yourself from “experts” who want to separate you from your money.
If, though, you do employ someone to help you take care of your finances, you need to be sure that you’re not being ripped off. Below, Mark Ford shares an essential question that you should ask that person – if you don’t know the answer already.
By Mark Ford
Your private banker or financial advisor makes his or her money by selling you a service. If you don’t know what exactly he’s doing for you or how much he’s charging you, you are vulnerable. And yet, most investors, probably eight out of 10, don’t know these things.
If you hire a plumber to fix a leaky faucet, you know exactly what he’s doing and how much you’re paying him. But when your money manager recommends something—some sort of amazing new investment that guarantees your principle while simultaneously giving you an upside equal to the market, you probably only vaguely understand the transaction and may have no idea that he’s being paid multiple times for selling you that deal.
The financial industry is very, very good at three things:
There are plenty of regulations in place that are supposed to make such costs transparent, but most of the disclosures are in small print and peppered with legal terms.
I’m not suggesting that all fees and charges are unfair. In fact, decades of consumer advocacy have reduced the number and types of tricks brokers, financial advisors, and money managers use to fleece their clients.
But there are still things to watch out for…
Some money managers and financial advisors don’t offer much to their clients. They’ll scratch the surface but, in the end, only provide a narrow range of financial services. Make sure what they offer fits your needs and includes diverse asset allocation, stock and bond recommendations, reporting and so on.
Most of them will also charge you a fee for any financial advice. And some will collect commissions on any transactions. All of a sudden, it’ll start costing you to do anything with your managed money – including just talking about it.
Another one of the problems with money managers and financial advisors is that they have a predisposition for mutual funds. They like mutual funds because they are easy. But as you know, mutual funds are very expensive.
And that’s not all… With a money manager, you are likely paying other fees, too. My colleague Tim Mittelstaedt at the Palm Beach Research Group has a good friend with a UBS-managed account. Tim studied the fine print, and this is what he found:
The fine print showed other fees that were impossible to decipher:
So Tim’s friend is paying 2.44 percent in disclosed fees – and he may be paying even more if you consider the hidden or hard-to-decipher fees.
There is an argument to be made that fee-only financial advisors and/or money managers are better because you don’t have to pay transaction costs. This is not necessarily true. Your account could be billed for certain transaction costs separately. The money manager doesn’t receive this fee, but you pay it.
The only way to know what you are paying a financial advisor and/or money manager is to write them a letter asking them to disclose all costs clearly and fully.
If you use a money manager or financial advisor, you should expect him to be completely forthcoming and transparent about what you are paying for. If you aren’t sure, the first step is to tell him in writing, “Please send me a clear and comprehensive account of all charges, fees, commissions, and other costs I am paying for your service.”
And ask him to copy his manager on that message.
If you are ever told, “there is no commission on a purchase,” you are speaking to a liar. It may be true that no actual commissions (as defined by the industry) are being charged, but you can be sure that there are other charges, either embedded in the transaction or put through to you as “management fees”.
As with stockbrokers, there are some situations in which you may be happy to pay the fees they are charging. And there are certainly financial advisors and money managers who are smart and caring and do a good job.
But you need to know exactly what the costs are – immediately and over time.
Then, and only then, can you decide if these sorts of services are good for you.
Not long ago, a special agent – working for a secretive agency that’s in the news a lot these days – asked me to take a Chinese man out to dinner, ply him with wine, and help to “flip” him.
Unfortunately, all that I knew – and know – about espionage I learned from James Bond.
And that’s exactly what was so concerning about the situation. Let me explain…
A few years ago, the doorbell rang one morning while I was working at home, in a leafy suburb of Washington, D.C.
I answered the door, and ushered in a well-dressed man and woman who introduced themselves as agents of a well-known American federal agency that investigates (and which shall remain unnamed here).
The two good agents, through smart sleuthwork, had uncovered that a car registered in my name had recently been parked in the driveway of a house a few minutes away. Did I know why my car was there? They asked.
Well, yes, my wife and I owned the nearby house. Our tenants – more on them in a moment – weren’t taking care of the place, and the property management company wasn’t doing their job. So I drove (in the American suburbs, people only walk on treadmills, or if they want to get run over) over to see what was going on. And I parked my car in the driveway of the house I owned.
Ah, the agents said. Since a two-second web search would reveal that we’d owned the house for more than twelve years, I assumed (hoped) that this wasn’t news to them – their feigned surprise notwithstanding. They continued: Have you frequently visited your tenants? What is the nature of your relationship with them?
As I answered their questions, it emerged that our tenant, Mr Lo from China, was a “person of interest” to the agency. This meant that Mr Lo hadn’t been charged with doing anything wrong. But he was on the radar of the authorities as worthy of attention or concern.
Mr Lo worked for a Chinese science and technology newspaper, and had been introduced to us by our former tenant, who was also from China and had worked for the same publication. Mr Lo’s predecessor was a model tenant, and as long as he paid the rent on time, we were delighted to have Mr Lo take over the lease.
After a get-to-meet-you dinner at a local Chinese (of course) restaurant – featuring linguistic awkwardness and mediocre American suburbia faux-Szechuan cuisine – Mr Lo and his family moved in. For the first few months, all was good. But then our property management company, after a routine check-up visit, gave him poor marks – which had led to the two very (overly) friendly agents sitting on my sofa.
The agency – my visitors told me – was very eager to learn more about Mr Lo and his activities. I assumed this had something to do with China trying to get its hands on American science and technology – and that Mr Lo, properly motivated, would spill secrets about China stealing American intellectual property.
To help incentivise Mr Lo, the agents had uncovered his pressure point: he had a high-school aged daughter, and he wanted more than anything for her to attend university in the U.S. (not unlike millions other Chinese parents). But these two agents could easily block the approval of the requisite visa and immigration documentation for her to study at a U.S. college.
The agents suggested that due to my unique relationship with Mr Lo – a mutual interest in ensuring that Mr Lo’s toilet didn’t leak, I suppose – I was the perfect person to encourage him to talk with my new friends. Heady with the idea of getting a foreign agent to flip – I was ready to put on my tux and order martinis – I said I’d be thrilled to help. The agents left, promising to get back in touch once the groundwork was laid.
A few weeks later, the agents invited me and my wife (who I’d brought into the scheme) for a cup of coffee. Their plan: We invite Mr Lo out for a nice dinner (courtesy of the agency) and have a glass or two of wine. We guide the conversation to children and college admissions. And we plant the seed. “Oh, your daughter will be applying soon to university? Hmm, how interesting. If you ever need any help with the whole visa thing, I know just the guy to call!”
And the guy to call would be our agent friend – who would then (I suppose) present an information-for-visa proposal. Mr Lo would talk, and his daughter would go to State U.
How many normal people can say that they’ve helped flip a foreign agent? Not many. I wanted to be one of them.
My sensible wife thought otherwise. “What’s the upside?” she asked. At best, Mr Lo is drawn into the trap. I wouldn’t know what would happen – the agents would have no use for us at that point – but I’d have a good cocktail party story.
At worst, we lose a tenant. We’re put on the U.S. government’s “naughty child” list. And China – the most important country in the region of the world where we’re about to move to – blackballs me.
So I didn’t call the agents back. We never heard from them again.
Mr Lo’s house maintenance skills didn’t improve. I had a few unpleasant dreams about the house being impounded by the authorities after becoming the site of a federal investigation. In any case, we’d grown tired of the endless investment required of a middle-aged house sliding toward old age. A few months later, we sold the property. So my cocktail party story ends with a whimper.
But the episode opened my eyes to a few realities.
Right now, the VIX index is saying you have nothing to worry about when it comes to the U.S. equity market.
But today I’m going to introduce you to another ‘fear’ index. And it’s telling a completely different story…
Let me explain.
The VIX has been in the financial media a lot over the past week. The VIX (or CBOE VIX Volatility Index) is also known as the ‘fear’ index. It’s a measure of anticipated market volatility.
The index is based on option prices of individual stocks in the U.S. S&P 500 index. When investors expect more price fluctuation (that is, for prices to bounce around more), the VIX goes up.
And volatility is greatest when markets fall (as the chart below shows).
As the old saying goes: The market takes the stairs up, and the elevator down.
Quoted as a percentage, the VIX is around 10. That generally means the market expects a 10 percent range of movement in the S&P 500 index over the next 30 days.
For comparison, the VIX hit an all-time high of 89.53 on October 24, 2008, in the depths of the global economic crisis.
The VIX rises when investors are surprised and scared. Investors panic-buy options to protect against further losses. As a result, implied volatility increases.
Earlier this week, the VIX closed at 9.77, its lowest level since 1993. (Note: This comes at the same time as the S&P 500 is hitting record highs.)
The VIX has only ended the day below 10 on 11 days out of 6,893 since January of 1990.
It’s fair to say that according to the VIX index, investors are less concerned about the market falling sharply in the coming weeks and months than they have been in decades.
But a different ‘fear’ index suggests that investors are being too complacent…
A different measure of ‘fear’
You’re likely to be familiar with the concept of a “black swan” event. The term was popularized by the academic and author Nassim Nicholas Taleb to describe a major unexpected market event.
It’s often an event that is heavily rationalized afterwards with the benefit of hindsight. The 2008 sub-prime crisis, the trigger for the global economic crisis, is a good example of this.
In the context of black swans, you may hear reference to something called “tail risk”.
Tail risk simply represents the probability of a black swan event occurring – that is, like a stock market crash, or a major correction.
You see, VIX doesn’t really tell us anything about how the market views tail risk (i.e. the probability of a black swan event). It just tells us about the absolute level of expected volatility.
But there’s another indicator that can. It’s called the CBOE Skew Index, or just SKEW.
This index uses the prices of S&P 500 Index options to measure the perceived tail risk of the S&P 500 over a 30-day horizon.
It does this by looking at how much investors are willing to pay for downside protection (i.e. put options) relative to upside (i.e. call options).
The more downside protection the market wants, the higher the price of put volatility relative to call volatility, and hence the higher the level of SKEW.
In other words, this index tells us how worried the market is about a near-term black swan event.
Take a look at the chart below. It shows the historical VIX index alongside the SKEW index.
The SKEW index is a messy one (I’ve used the 3-month moving average to smooth out the chart), but the trend is clear: Whilst volatility has continued to decline, SKEW is trending up.
In fact, in March of this year, the SKEW index hit its highest ever level (for the available data going back to January 1990).
This means that despite low levels of volatility, the price of put options (i.e. downside protection) is becoming increasingly expensive relative to call options.
Far from saying everything is OK, this fear indicator is telling us the opposite… that the market is increasingly paying more for downside insurance against a black swan event. So there’s more concern about it.
Does this mean that there’s going to be a sharp market correction tomorrow? No. SKEW has been trending upwards since 2008, as you can see in the chart.
However, given that it is elevated and has just hit an all-time high, it does imply that the risk of a sharp correction is rising.
What should you do? We recommend that you:
You’ve been warned!
P.S. As I write this, our recommendation from the latest edition of The Churchouse Letter is up 6.7 percent in less than 2 weeks. But I expect it to go a lot higher. I’ll be joining a company call later this month, and if I hear what I expect to, the stock could easily jump another 10 to 20 percent in a matter of days. Click here for your no-risk trial subscription to The Churchouse Letter and get the full details.
Many people say they want to find new and unique investment ideas – those off-the-radar ways to make a lot of money. But it’s a lot more difficult than it sounds. So, few people do what they have to do to find those great ideas. And as a result, only few make a lot of money.
What makes it more difficult is that we – the human race, that is – feel most comfortable doing what everyone else is doing (this is called the bandwagon effect).
We tend to think if the majority is doing something, then it must be the right thing to do. Otherwise, everyone wouldn’t be doing it – right? We feel there’s safety in numbers.
Even investors who are resolutely determined to get off the bandwagon often just wind up on another one. Sometimes being contrarian actually becomes the consensus. And the great off-the-radar idea is actually squarely at the centre of it.
Here are a few thoughts about finding unique ideas that really no one – not anyone – else is looking at… yet.
“In other places?” you might say. “Other than where?” To which I respond: Other than where you’re looking now.
If you’re trawling the Financial Times or Bloomberg or Forbes or your favourite financial blog for investment ideas, you’re going to come up with the same ideas that everyone else has. You wouldn’t fish in the carp pond and expect to catch a tuna. So the chances are slim that you’re going to come up with something new and different by looking where everyone else is looking. And most of the time, they will turn out to be the best investment ideas for small investors (and big).
Instead… talk to someone who is involved in a completely different field. Ask your kids where they’re shopping and what they’re watching on TV.
Put down the Wall Street Journal, and pick up a copy of Science, The Atlantic, or Foreign Policy magazine. Find investment ideas other than stock. Try sources of information that have nothing directly to do with finance. And if you come across something interesting, try and create a thread between the subject matter and how you can invest in it.
Hop on a plane and go someplace new. Investing doesn’t have to be overly complicated. But new ideas need oxygen. And you’re not going to find that in the Wall Street Journal.
(I got the idea for this article from a piece by business consultancy McKinsey about originality. I’m not particularly interested in McKinsey (business consulting is full of people who are like financial advisors and personal bankers – the kind of folks who make a living by complicating things). But I wouldn’t have come up with this idea if I wasn’t wandering down a path that was different for me.)
I’m talking about investment idea for beginners. Eat ideas for breakfast. Have them for lunch. Drink them at teatime and fry them up for supper. Throw them at the wall and see what sticks. The more, the merrier.
Why? Because most ideas are bad. The best that most of us can do is come up with ideas that are old and tired, or misguided, or based on incorrect assumptions, or otherwise just plain wrong. Almost every idea I come up with is a bad one.
But a bad idea is better than no idea at all. Because out of the pile of bad ideas, a few good ones will emerge. And any idea is better than no idea.
The trick is to understand that they’re wrong before you take them to the execution stage – before you buy something based on your lousy idea. But the first step is to have an idea – any idea – first.
And also… try reading this book: A Technique for Producing Ideas. It’s less than a hundred pages long. Written in 1965, it has become a classic for people working in creative fields. But it works just as well for investment ideas.
In investing, action is often viewed as “good”. If you’re doing something – anything – it’s better than nothing. Fund managers are often frowned upon for not being close to fully invested… “I’m paying you to invest, not take a fee from holding cash!” If you’re not doing something with your money, you’re wasting time – and, as we know, time is money.
Procrastination – putting off until tomorrow what you could do today – is often painted in terms of regret. It’s the ten-bagger that got away… the real estate deal that would have made you a millionaire many times over if only… the friend of your uncle’s friend who was an early investor in something that went huge – but you didn’t bite.
What you don’t hear about – what doesn’t make for humblebragging fodder – is the amazing stock that they said you just had to buy, and the stock went… nowhere. Or the stock that hit your stop loss and died a humble tax write-off death. You don’t hear the fisherman (he of the “one that got away”) talk about all those times that he tossed his line into the water and came up with… nothing.
Sometimes, sitting still – and procrastinating – is better. There are times – like when you’re coming off a big market victory and are flush with confidence – when doing nothing in the market is the better option. Just because you have cash doesn’t mean you should use it. After all, there’s no better hedge than cash.
Procrastination by itself, of course, is no guarantee of good investment ideas. But often it’s when you’re sitting still, or doing something else, that the best ideas come into your head. And by procrastinating – not indefinitely, but enough – you’ll be more likely to come up with something.
One of the best things about looking for ideas in new places – and speaking with people who are experts at something you know nothing about – is that you can ask the most basic (“stupid” to some people) questions without shame.
If you’re interested in what a person has to say, they’ll usually be more than happy to give you basic answers to your basic questions.
Stupid questions can do a few things:
So… I’m off to come up with new ideas. They’ll mostly be bad ones. But one or two good ones might find their way here.
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