The Champion Investor: Week in Review
Remember, cash is a fact, profit is an opinion. – Al Rappaport
To stay ahead, you must have your next idea waiting in the wings. – Rosabeth Moss Kanter
Obstacles are those frightful things you see when you take your eyes off your goal. – Henry Ford
Great investors don’t get sucked into the vortex of influence. This requires the trait of not caring what others think of you, which is not natural for humans. – Michael Mauboussin
In my whole life, I have known no wise people (over a broad subject matter area) who didn’t read all the time – none, zero. – Charlie Munger
Taylor Swift and the “Fearless” Stock Market
I couldn’t up pass mentioning this side note this week…
I was reading an article written by Jason Zweig in the Wall St. Journal.
One line stood out to me. He said, “The S&P 500 hasn’t had a down year since 2008, when Taylor Swift was 18 years old.”
It hit me… It seems like ages ago when she stormed onto the music scene.
So, I did a quick search to confirm the information. It gets even better…
The title of the album she released in November 2008 was Fearless. A few months later, the market bottomed in March 2009.
Fearless went on to become the best-selling album in 2009 and the stock market has been fearless ever since!
According to Forbes, she now has a net worth of $280 million… While the S&P 500 is up over 300%, including dividends!
Not a bad run for either over the past decade. However, times of a “fearless” stock market are close to being over.
Swift may keep launching best-selling albums. But I’d say it’s time to be FEARFUL of a healthy correction and look for value in other assets and markets.
Commodities, resource stocks, and beaten down foreign markets are a good place to start.
The Path to Being a Better Investor
I was rereading a paper written by Michael Mauboussin, Reflections on the Ten Attributes of Great Investors.
It’s jam-packed with a lot of wisdom. One of the goals here at The Champion Investor, is to help you become a better investor.
A big part of doing that is by studying the great investors. There’s two ways you can learn things in life… Study the best and take action.
We do both here.
Here’s some words of wisdom worth studying…
Great fundamental investors focus on understanding the magnitude and sustainability of free cash flow. Factors that an investor must consider include where the industry is in its life cycle, a company’s competitive position within its industry, barriers to entry, the economics of the business, and management’s skill at allocating capital.
The best investors among us recognize that the world changes constantly and that all of the views that we hold are tenuous. They actively seek varied points of view and update their beliefs as new information dictates.
He also talks about herd behavior. Something I talk about a lot.
He describes a model developed by Mark Granovetter, a professor of sociology at Stanford University.
The model frames herd activity in terms of a riot. Mauboussin says,
Imagine a 100 potential rioters milling around in a public square. Each individual has a “riot threshold,” the number of rioters that person would have to see in order to join the riot. Say one person has a threshold of 0 (the instigator), one has a threshold of 1, one has a threshold of 2, and so on up to 99.
This uniform distribution of thresholds creates a domino effect and ensures that a riot will happen. The instigator breaks a window with a rock, person one joins in, and then each individual piles on once the size of the riot reaches his or her threshold.
Substitute “buy dot-com stocks” for “join the riot” and you get the idea.
The point is that very few of the individuals, save the instigator, think that rioting is a good idea. Most would probably shun rioting. But once the number of rioting reaches a threshold, they will jump in.
You can substitute “buy Bitcoin” or “buy” any other asset that is experiencing, as former Fed Chair Alan Greenspan once said, “irrational exuberance.”
Todd Combs, one of Buffett’s potential successors as Chief Investment Officer of Berkshire Hathaway, suggested reading 500 pages a day. (Don’t worry… that’s what I’m here for.)
Mauboussin mentioned that Warren Buffett allocated 80% of his day to reading.
He also added,
Good readers tend to take on material across a wide spectrum of disciplines. Don’t just read business or finance. Expand the scope into new domains or fields. Follow your curiosity. It is hard to know when an idea from an apparently disparate field may come in handy.
Finally, make a point of reading material you do not necessarily agree with. Find a thoughtful person who holds a different view than yours, and then read his or her case carefully. This contributes to being actively open-minded.
That’s good advice for anyone, not just investors.
On the rise of passive investing…
So you want to compete against less-skilled investors because they are your source of alpha.
(It’s me here to explain alpha… Alpha is excess return relative to a benchmark. For example, your returns compared to the S&P 500. The appeal of being an active (not passive) investor is that you have the potential to earn returns greater than the market.)
It is disadvantageous for you if the weak players flee the market (selling their stocks and buying index funds), or if the least capable professional investors lose assets to passive funds, because it means that only the smartest investors remain in the active game.
The truth is that weak players, whom the strong players require to generate excess returns, are fleeing at a record pace. Before figuring out how you will win the game, figure out which game to play.
More confirmation of how important it is to understand value. The key to surviving among the strong players is looking for assets and markets that have been beat down for several years.
The kind of assets that Wall St. hates.
Then, study those assets to find the business or asset that is in a healthy industry with strong fundamentals, and low expectations from Wall St.
Then, be patient.
Takeaways from Barron’s Annual Roundtable Gathering
The roundtable is full of guru investors. It’s worth reading to see the varying points of view.
You also get to see how they think about the markets and the economy. Like I explained earlier, learn from the best.
Here are some of my takeaways…
Fund manager Paul Wick said if rates go up, “the discounting mechanism (rising interest rates) is going to take a chainsaw to stocks with lofty valuations.”
“Bond King” Jeffrey Gundlach said,
We can’t find a recession anywhere. You never get a recession without the Index of Leading Economic Indicators falling below zero. The soft data, including the Purchasing Managers’ Index and measures of CEO and small-business confidence, are all at high levels. These type of sentiment indicators fall off a cliff in front of a recession.
If you’re not familiar with it, the index of leading economic indicators (LEI) is intended to predict future economic activity. The index is a tool created by the Conference Board to signal peaks and troughs in the business cycle.
Generally, three consecutive monthly LEI changes in the same direction suggest a turning point in the economy. For example, consecutive negative readings would indicate a possible recession.
The latest reading showed an increase of 0.4 percent in November, following a 1.2 percent increase in October, and a 0.1 percent increase in September.
According to the release, it suggests “that solid economic growth will continue into the first half of 2018.”
This doesn’t mean it’s a green light to go all in on stocks because it’s getting late into the game. I’d rather be ready to buy on any healthy correction.
The two-year Treasury yield is higher today than the dividend on the S&P 500. Eighteen months ago, one argument for stocks was that they yielded more than the 10-year Treasury. Well, now they yield less than the two-year Treasury.
This is an important point.
Why would someone take the risk of losing money… say anywhere from 10-20% (hard to know how far the market will correct), to earn a dividend yield that’s less than what you can get from what’s considered the safest asset in the world… US Treasuries?
It’s not like you’re locking up your money for five-to-ten years.
Right now, the 2-year is yielding 2.05%. So, you can take the 2% and the safety that comes with it, or take say a 2% dividend yield on the S&P 500, and risk losing a significant amount of capital.
Just a thought here too… (I’m using big numbers to make it easy to see) For example, if you lose 50%, you need a 100% gain to make up for that loss.
That’s a tall order under any circumstance. That’s the kind of gains I look for but as noted above from Mauboussin, it’s getting much harder as the weak players leave the game.
At least with a two-year, it’s risk-free, and it only locks up your money for a short period. You’ll have funds ready to deploy when valuations look better.
Again, it’s just something to think about.
Here’s fund manager William Priest on the type of businesses to look for… “If you don’t have a capital-light business model embedded in your business strategy, you are going to be left behind.” (He also thinks Bitcoin is “going to end in tears.”)
Fund manager Henry Ellenbogen said, “The Amazon effect is making companies in every industry think more about efficiency.”
So, with these two comments, you have a good starting point. Look for companies that don’t require a lot a capital and/or companies that are efficient.
Henry again on what is meaningful to Millennials… “Millennials have more trust in reviews and transparency of information than brands.”
I’ll add they also trust technology more than anyone else. They probably trust it more than the government.
They’re also having a big impact on the way businesses think and how they do business.
Lastly, back to the two-year Treasury again… Gundlach says,
“Are there no votes for cash? There is nothing wrong with a two-year Treasury. It is boring as can be, and yields about 25-30 basis points less than a 10-year bond. But it comes due in two years, and you could reinvest the money.
This is a lot of insight from some of the best investors in the world. It’s worth thinking about over the weekend.
It’s time to keep an eye on the LEI for any changes, watch interest rates (The 30-year bond crossing 3% convincingly is a key marker according to Gundlach), think about the risk and reward investors are taking between stocks and the two-year Treasury (Are dividend yields worth it compared to the two-year?), and look for capital light businesses and/or businesses that are efficient.
“When Stalin Faced Hitler”
History never really says goodbye. History says, ‘See you later.’ – Eduardo Galeano
I just started reading an essay in Foreign Affairs by Professor Stephen Kotkin titled, When Stalin Faced Hitler. He teaches history and international affairs at Princeton University and this essay is adapted from his most recent book, Stalin: Waiting for Hitler, 1929-1941.
It’s the second volume of a three-volume series he’s writing on Stalin.
I thought I’d share a few interesting insights from it so far.
On Stalin… He writes,
He developed a feel for the aspirations of the masses and incipient elites; he almost never visited factories or farms, or even state agencies, instead reading about the country he ruled in secret reports and newspapers. He was a cynic about everyone’s supposed base motives; he lived and breathed his own ideals…
But his power was magnified many times over by ordinary people, who projected onto him their ambitions for social justice, peace, abundance, and national greatness. Dictators who amass great power often retreat into pet pursuits, expounding interminably on their obsessions and paralyzing the state.
On Hitler… He writes,
He lost his father at age 13 and his mother at 18. (The Jewish physician who tended to his mother would recall that in 40 years of practicing medicine, he had never seen anyone as broken with grief over a mother’s death as Hitler.)
At age 20, Hitler found himself on a bread line in Vienna, his inheritance and savings nearly spent. He had twice been rejected from Vienna’s Academy of Fine Arts (“sample drawing unsatisfactory”) and was staying in a homeless shelter behind a railway station.
A vagrant on the next bed recalled that Hitler’s “clothes were being cleaned of lice, since for days he had been wandering about without a roof and in a terribly neglected condition.”