Louis-Vincent Gave Interview
One of my favourite strategists is the GaveKal team. I don't really have access to them but I always find it fascinating to read or hear whatever little tid-bits that comes out from that team. Jim Puplava of FinancialSense recently conducted a radio interview with Louis-Vincent Gave, covering his latest book: A Roadmap For Troubling Times (click here for the 37min MP3 interview; or go here and pick one of the streaming options near the bottom).
I would say GaveKal is generally tilted towards the bullish side and their forecasts are not always correct (do note that I do not have up-to-date information from them so I am just going by their sparse public opinions, which may or may not have changed over time.) Some of their bullish calls over the last year have been wrong (their bullish view of US stocks and Hong Kong stocks have been off.) Their view back in 2005 was that US housing bubble wasn't as serious (although I have no idea if they changed their views subsequent to that) but they were off. But they have been correct with many of their other calls, such as their bullish view of 'platform companies' (these are companies that focus on design and sales, and outsource manufacturing). I tend not to rely blindly on macroeconomic forecasts and instead listen to their insights to see what may be happening in the world. Whether you agree with their views or not, they are nearly always quite unique and insightful.
As a bonus, if someone is interested in their new book and wants to get a taste for their writing, you can do so by checking out one of the their prior books. It looks like one of their old books, Our Brave New World, is out of print but a free electronic version can be freely downloaded from their site.
If you have an interest in macro issues, I highly recommend that everyone listen to the full interview (it's one of those 'must-listen' interviews of the year). On top of being generally insightful, they are located in Hong Kong and provide more information about what is happening over there. We always read stories from analysts in America or Canada talking about the Asian situation, but it's always better to get the view from the ground over there. My recap of the interview on topics I find insightful follows...
Financial Revolution
Louis-Vincent Gave thinks one of the most important elements of the last 20 years is the financial revolution. This revolution has increased efficiency and led to massive increases in productivity. Things that would have been impossible (or too costly) are possible now. Individuals and small businesses have tools that were unavailable before (eg. hedging foreign currencies, ability to borrow/lease more easily, etc.) He believes that the smoothing of economic cycles (more mild busts, less layoffs during recessions) is the most important result over the recent past.
Some question this financial revolution that has taken place. The skeptics in America and Canada are concerned about the increased leverage employed by individuals. Some are also concerned with the outsourcing phenomenon. I personally am in the Louis-Vicent Gave camp in thinking that the developed economies are much better off now due to this financial revolution. Although there is bound to be some blow-ups, the economies seem to be more resilient and it seems to be much better for workers as well. As long as the consumers don't face drastic loss in jobs or curtailment of salaries, they can carry more debt. If there is anything I would like to see, it is a push towards improving government balance sheets. This won't be easy given that both sides of the political spectrum love spending money they don't have. The left loves to waste money on so-called social programs, while the right loves to spend it on so-called defense (military, police, and not to mention the bogus "war" on drugs or whatever else is a minor threat.) The George Bush administration (supposedly a fiscally-responsible government) has managed to outspend the Clinton administration (a left-leaning government). As for Canada, the federal government is running balanced books but the debt is still somewhat large. Some provincial governments are in bad shape and they need to curb spending. I don't think spending is going to decline any time soon due to the slowing economy but hopefully it'll be kept in check when the economy recovers (I'm more partial to Keynesian views of keeping spending during downturns so that's ok; I just don't think they should keep going even when the economy recovers.) The ideal situation would be if governments shrink by spinning off assets or service "businesses". The Ontario government, for example, should "spin off" its liquor stores (govt has a monopoly here), lottery business (another monopoly), public transit, and so forth. I'm not saying it has to happen tomorrow but that is the ideal path for the next 10 to 20 years. Of course, this is the idealist in me talking and who knows when that will happen...
Three Step Process to Revive the Banking System
Louis-Vincent Gave mentions a 3-step process to fix the banking crisis. First step requires the collapse in the currency (this attracts foreign capital.) The second step is to steepen the yield curve so that banks can make money (typically banks borrow short and lend long eg. borrow from FedRes and provide a 20 year loan to a homebuyer.) The third step is to recapitalize the banks by pushing them to do a rights offering or nationalize the banks in the worst case.
Louis-Vincent says that all three steps have happened quickly in the US. I am also quite impressed with all that has happened in less than an year. American and European banks have been writing off a large amount of losses (hopefully paper losses) and raised a large amount of capital. Although there is still some worry that things can get much worse, the balance sheets of most of the American banks looks decent (European banks still look a bit dodgy; Canadian banks never had much exposure; Asian banks had low exposure as well.) There is still some concern over the balance sheets of some businesses that were intimately involved with housing (particularly the mortgage lenders such as Countrywide and monoline insurers) but the system itself is more stable right now. Although we have no idea how much worse things can get, so far the banks are doing well (admittedly the shareholders have taken a huge beating but that's capitalism.)
Contrast what has happened to that of Japanese banks in the early 90's. On top of not taking big write-downs, many of them didn't really re-capitalize like the American banks have. It's too early to say the banking crisis has subsided but I have to give a lot of credit to Ben Bernanke at the Federal Reserve. Some of his actions are dodgy (bailout of Bear Stearns could have been handled better) but he put himself on the line and initiated some bold action. Some of his innovative strategies, such as providing cheap liquidity to the banks while sterilizing any inflationary effect from it, should be commended. (with the first battle largely within victory, they need to move onto the second battle against inflation.)
Potential Change in Leadership
Another point that was raised in the interview was the possibility that, like all other bear markets, leadership changes in the stock market may occur. Louis-Vincent Gave thinks leadership may shift to American and Japanese equities. Over the last 5 to 10 years, emerging markets have totally trounced the US market (Japan has been even worse.) The way things are shaping up this year, with some emerging markets such as China, India, Hong Kong, and Vietnam down 30%+ (versus around -10% for US and around +3% for Japan), this may indeed happen.
But I think there is the possibility of everything doing poorly is pretty high. US stocks as a whole are not cheap (they are not expensive either.) What is cheap are Japanese stocks, and certain beaten-down sectors in the US (such as financials, retailers, real-estate suppliers.)
Infrastructure
Another big theme that GaveKal is betting on is infrastructure spending. Their view is pinned on the fact that a switch from agarian society to a manufacturing society, with workers moving to cities, will result in increased infrastruture needs. Louis-Vicent also points out that consumption will increase with such a switch. Countries like China are also supposedly becoming less reliant on exports (I'm not entirely sure to what degree. I'm still bearish on China right now.)
I'm still not sold on the infrastructure idea in the near-term. Given all the uncertainty in many of these developing countries (high inflation, slowing economies, weak fiscal government picture, increasing cost of government debt) that are supposed to be spending money on infrastructure, I really wonder how many of these projects will come onstream. Undertaking big infrastructure projects may also increase inflation so many of these countries may not do anything for a few years, until inflation is tamed. In the long run, I can see this idea having some merit.
The Four Economic Quadrants
One of the key insights I have picked up with the GaveKal team is to use their four quadrant analysis to look at economic outcomes. Essentially, based on prices and economic activity, an economic outcome can be slotted into four cases: inflationary boom, inflationary bust, deflationary boom, and deflationary bust. The booms are good and the busts, needless to say, are to be avoided. Here is an outline of the four cases along with some examples of where he thinks some countries lie:
No one can predict the future so who knows what will happen. If you agreed with his opinions, Europe, India, and Vietnam, among others, should be avoided; while USA, Japan and China should be considered. As for me, I'm wary of nearly all emerging markets since (i) they have run up so much over the last 5 years, (ii) inflation is a huge problem, and (iii) politics is dubious. I like USA and Japan in general. However, note that details--the industry groups--matter a great deal. American technology stocks may be overvalued (I don't know) but American retailers may be undervalued (I don't know for sure but valuations look low.) Since I'm trying to be a stock picker, the notion that one whole country may be attractive or unattractive is somewhat too simplistic.
Not A Fan of SWFs
He isn't a fan of SWFs; neither am I. SWF sounds like single white female but these are actually monstrous creations from governments called Sovereign Wealth Funds. As Louis-Vincent Gave points out, governments are inefficient and it is likely that SWFs will be as well. He thinks the SWFs will lower return on capital in the future. I have never heard this view elsewhere but I think I agree with him. I'm pretty sure that politics may play a larger role than trying to maximize returns when it comes to these SWFs.
On top of SWFs depressing returns for their own holdings, it is possibly that they will have a mildly deflating pressure on other investors. For example, if they keep buying overvalued assets, other investors will not see attractive opportunities for a period. This is kind of similar to how Warren Buffett has been priced out of the takeover market for a few years now due to the boom in private equity (PE). PEs would bid at prices that are neither economic nor attractive for Buffett. It made sense for PEs because they use leverage to boost their returns whereas Buffet does not (some private equity deals were likely dumb even if they didn't use leverage).
One thing, though, is that SWFs are providing funding for troubled financial institutions. So there is some good side to all this.
On Currency Pegs
Louis-Vicent Gave mentions that nearly all currency pegs have failed. The only key one that has survived is the Hong Kong peg to the US$. He says that is because the government kept its spending under check, even during the tough times after the Asian bust in 1998. Anyone following some of my posts on inflation, or reading up on those inflation articels from The Economist, would know that the culprit behind the inflation problems in many Asian countries is their currency pegs to the US$. Asian countries had been printing money like crazy due to their currency account surplus which means capital flows into the country. Louis-Vincent mentions that this 15% to 20% money supply growth is bound to have big inflationary effects and that is what we are seeing now.
Some of those emerging markets are hesitant to remove their pegs in order to keep their currency compeitive (low). But I believe that the pegs are going the way of the dodo bird soon. Low US rates, resulting in lower US$, may be tolerable in America, but it causes disastrous inflation in some of those emerging markets. It'll be interesting to see what comes of all this.
Euro May Collapse
Louis-Vincent Gave, similar to Jim Rogers, thinks the Brusselles-based Euro regime may splinter. The countries in Europe are quite different, and run diverse fiscal regimes. The market is indicating its skepticism of the Euro. Spreads on various soverign bonds are widening.
I like the Euro idea and think that the arguments against it are flimsy in the long run. However, there are big short-term risks because Europeans can't seem to agree on some key financial policies (the fact that some big countries like Britain are still independent doesn't help). I think the Euro can work because it works in USA. For instance, USA is a very diverse country. Industries, culture, etc in Midwest is totally different from, say, east coast. The midwest is sensitive to agriculture whereas the east coast literally produces no agricultural goods. The state of Michigan, which is dependent on auto manufacturing, is literally in a depression whereas Texas, which benefits from the oil & gas boom, is doing really well. When the central bank cuts rates because (primarly) New York and West Coast banks are in trouble, it doesn't help the midwest. Of course, the biggest difference is that USA has had hundreads of years to work out these differences whereas trying to get the fiscally-weak Italy to agree with the fiscally-conscious Germany might take some time.
Recommendations
As for investments that he, and his team at GaveKal like, they include:
As for me, I'm not too sold on the infrastructure theme. I can see it playing out but would like to see some stabilization in those countries that are supposed to spend money on infrastructure. I mean, I don't even know if USA, which is supposed to increase infrastructure spending, has enough money to spend on these projects (the credit crisis and the collapse of the monolines are going to increase their costs).
I don't care much about his CDS (credit default swap) idea because I am not as bearish on the Euro and have little direct exposure. Furthermore, I have no access to CDS and don't have the expertise to dabble in derivatives.
I like his American and Japanese stock idea. The problem I see with Japan is that their companies are not efficient and shareholder-friendly--but that is changing slowly...
I would say GaveKal is generally tilted towards the bullish side and their forecasts are not always correct (do note that I do not have up-to-date information from them so I am just going by their sparse public opinions, which may or may not have changed over time.) Some of their bullish calls over the last year have been wrong (their bullish view of US stocks and Hong Kong stocks have been off.) Their view back in 2005 was that US housing bubble wasn't as serious (although I have no idea if they changed their views subsequent to that) but they were off. But they have been correct with many of their other calls, such as their bullish view of 'platform companies' (these are companies that focus on design and sales, and outsource manufacturing). I tend not to rely blindly on macroeconomic forecasts and instead listen to their insights to see what may be happening in the world. Whether you agree with their views or not, they are nearly always quite unique and insightful.
As a bonus, if someone is interested in their new book and wants to get a taste for their writing, you can do so by checking out one of the their prior books. It looks like one of their old books, Our Brave New World, is out of print but a free electronic version can be freely downloaded from their site.
If you have an interest in macro issues, I highly recommend that everyone listen to the full interview (it's one of those 'must-listen' interviews of the year). On top of being generally insightful, they are located in Hong Kong and provide more information about what is happening over there. We always read stories from analysts in America or Canada talking about the Asian situation, but it's always better to get the view from the ground over there. My recap of the interview on topics I find insightful follows...
Financial Revolution
Louis-Vincent Gave thinks one of the most important elements of the last 20 years is the financial revolution. This revolution has increased efficiency and led to massive increases in productivity. Things that would have been impossible (or too costly) are possible now. Individuals and small businesses have tools that were unavailable before (eg. hedging foreign currencies, ability to borrow/lease more easily, etc.) He believes that the smoothing of economic cycles (more mild busts, less layoffs during recessions) is the most important result over the recent past.
Some question this financial revolution that has taken place. The skeptics in America and Canada are concerned about the increased leverage employed by individuals. Some are also concerned with the outsourcing phenomenon. I personally am in the Louis-Vicent Gave camp in thinking that the developed economies are much better off now due to this financial revolution. Although there is bound to be some blow-ups, the economies seem to be more resilient and it seems to be much better for workers as well. As long as the consumers don't face drastic loss in jobs or curtailment of salaries, they can carry more debt. If there is anything I would like to see, it is a push towards improving government balance sheets. This won't be easy given that both sides of the political spectrum love spending money they don't have. The left loves to waste money on so-called social programs, while the right loves to spend it on so-called defense (military, police, and not to mention the bogus "war" on drugs or whatever else is a minor threat.) The George Bush administration (supposedly a fiscally-responsible government) has managed to outspend the Clinton administration (a left-leaning government). As for Canada, the federal government is running balanced books but the debt is still somewhat large. Some provincial governments are in bad shape and they need to curb spending. I don't think spending is going to decline any time soon due to the slowing economy but hopefully it'll be kept in check when the economy recovers (I'm more partial to Keynesian views of keeping spending during downturns so that's ok; I just don't think they should keep going even when the economy recovers.) The ideal situation would be if governments shrink by spinning off assets or service "businesses". The Ontario government, for example, should "spin off" its liquor stores (govt has a monopoly here), lottery business (another monopoly), public transit, and so forth. I'm not saying it has to happen tomorrow but that is the ideal path for the next 10 to 20 years. Of course, this is the idealist in me talking and who knows when that will happen...
Three Step Process to Revive the Banking System
Louis-Vincent Gave mentions a 3-step process to fix the banking crisis. First step requires the collapse in the currency (this attracts foreign capital.) The second step is to steepen the yield curve so that banks can make money (typically banks borrow short and lend long eg. borrow from FedRes and provide a 20 year loan to a homebuyer.) The third step is to recapitalize the banks by pushing them to do a rights offering or nationalize the banks in the worst case.
Louis-Vincent says that all three steps have happened quickly in the US. I am also quite impressed with all that has happened in less than an year. American and European banks have been writing off a large amount of losses (hopefully paper losses) and raised a large amount of capital. Although there is still some worry that things can get much worse, the balance sheets of most of the American banks looks decent (European banks still look a bit dodgy; Canadian banks never had much exposure; Asian banks had low exposure as well.) There is still some concern over the balance sheets of some businesses that were intimately involved with housing (particularly the mortgage lenders such as Countrywide and monoline insurers) but the system itself is more stable right now. Although we have no idea how much worse things can get, so far the banks are doing well (admittedly the shareholders have taken a huge beating but that's capitalism.)
Contrast what has happened to that of Japanese banks in the early 90's. On top of not taking big write-downs, many of them didn't really re-capitalize like the American banks have. It's too early to say the banking crisis has subsided but I have to give a lot of credit to Ben Bernanke at the Federal Reserve. Some of his actions are dodgy (bailout of Bear Stearns could have been handled better) but he put himself on the line and initiated some bold action. Some of his innovative strategies, such as providing cheap liquidity to the banks while sterilizing any inflationary effect from it, should be commended. (with the first battle largely within victory, they need to move onto the second battle against inflation.)
Potential Change in Leadership
Another point that was raised in the interview was the possibility that, like all other bear markets, leadership changes in the stock market may occur. Louis-Vincent Gave thinks leadership may shift to American and Japanese equities. Over the last 5 to 10 years, emerging markets have totally trounced the US market (Japan has been even worse.) The way things are shaping up this year, with some emerging markets such as China, India, Hong Kong, and Vietnam down 30%+ (versus around -10% for US and around +3% for Japan), this may indeed happen.
But I think there is the possibility of everything doing poorly is pretty high. US stocks as a whole are not cheap (they are not expensive either.) What is cheap are Japanese stocks, and certain beaten-down sectors in the US (such as financials, retailers, real-estate suppliers.)
Infrastructure
Another big theme that GaveKal is betting on is infrastructure spending. Their view is pinned on the fact that a switch from agarian society to a manufacturing society, with workers moving to cities, will result in increased infrastruture needs. Louis-Vicent also points out that consumption will increase with such a switch. Countries like China are also supposedly becoming less reliant on exports (I'm not entirely sure to what degree. I'm still bearish on China right now.)
I'm still not sold on the infrastructure idea in the near-term. Given all the uncertainty in many of these developing countries (high inflation, slowing economies, weak fiscal government picture, increasing cost of government debt) that are supposed to be spending money on infrastructure, I really wonder how many of these projects will come onstream. Undertaking big infrastructure projects may also increase inflation so many of these countries may not do anything for a few years, until inflation is tamed. In the long run, I can see this idea having some merit.
The Four Economic Quadrants
One of the key insights I have picked up with the GaveKal team is to use their four quadrant analysis to look at economic outcomes. Essentially, based on prices and economic activity, an economic outcome can be slotted into four cases: inflationary boom, inflationary bust, deflationary boom, and deflationary bust. The booms are good and the busts, needless to say, are to be avoided. Here is an outline of the four cases along with some examples of where he thinks some countries lie:
- Inflationary boom: He thinks China is presently in this state, with high inflation while growth is strong. He thinks USA will be entering a state between mild inflationary boom and mild inflationary bust.
- Inflationary bust: Vietnam is currenly facing an inflationary bust, and he thinks India may end up in this state as well.
- Deflationary boom: An example would be US in the 90's. Technology and financial innovations put a downward pressure on prices, while the economy was growing well. He speculates that Japan may enter a mild deflationary boom.
- Deflationary bust: Probably at the top of everyone's head is Japan in the 90's. Severely overvalued real-estate caused a deflationary bust that lasted for decades. Louis-Vicent is very bearish on Europe and thinks it may enter a deflationary bust.
No one can predict the future so who knows what will happen. If you agreed with his opinions, Europe, India, and Vietnam, among others, should be avoided; while USA, Japan and China should be considered. As for me, I'm wary of nearly all emerging markets since (i) they have run up so much over the last 5 years, (ii) inflation is a huge problem, and (iii) politics is dubious. I like USA and Japan in general. However, note that details--the industry groups--matter a great deal. American technology stocks may be overvalued (I don't know) but American retailers may be undervalued (I don't know for sure but valuations look low.) Since I'm trying to be a stock picker, the notion that one whole country may be attractive or unattractive is somewhat too simplistic.
Not A Fan of SWFs
He isn't a fan of SWFs; neither am I. SWF sounds like single white female but these are actually monstrous creations from governments called Sovereign Wealth Funds. As Louis-Vincent Gave points out, governments are inefficient and it is likely that SWFs will be as well. He thinks the SWFs will lower return on capital in the future. I have never heard this view elsewhere but I think I agree with him. I'm pretty sure that politics may play a larger role than trying to maximize returns when it comes to these SWFs.
On top of SWFs depressing returns for their own holdings, it is possibly that they will have a mildly deflating pressure on other investors. For example, if they keep buying overvalued assets, other investors will not see attractive opportunities for a period. This is kind of similar to how Warren Buffett has been priced out of the takeover market for a few years now due to the boom in private equity (PE). PEs would bid at prices that are neither economic nor attractive for Buffett. It made sense for PEs because they use leverage to boost their returns whereas Buffet does not (some private equity deals were likely dumb even if they didn't use leverage).
One thing, though, is that SWFs are providing funding for troubled financial institutions. So there is some good side to all this.
On Currency Pegs
Louis-Vicent Gave mentions that nearly all currency pegs have failed. The only key one that has survived is the Hong Kong peg to the US$. He says that is because the government kept its spending under check, even during the tough times after the Asian bust in 1998. Anyone following some of my posts on inflation, or reading up on those inflation articels from The Economist, would know that the culprit behind the inflation problems in many Asian countries is their currency pegs to the US$. Asian countries had been printing money like crazy due to their currency account surplus which means capital flows into the country. Louis-Vincent mentions that this 15% to 20% money supply growth is bound to have big inflationary effects and that is what we are seeing now.
Some of those emerging markets are hesitant to remove their pegs in order to keep their currency compeitive (low). But I believe that the pegs are going the way of the dodo bird soon. Low US rates, resulting in lower US$, may be tolerable in America, but it causes disastrous inflation in some of those emerging markets. It'll be interesting to see what comes of all this.
Euro May Collapse
Louis-Vincent Gave, similar to Jim Rogers, thinks the Brusselles-based Euro regime may splinter. The countries in Europe are quite different, and run diverse fiscal regimes. The market is indicating its skepticism of the Euro. Spreads on various soverign bonds are widening.
I like the Euro idea and think that the arguments against it are flimsy in the long run. However, there are big short-term risks because Europeans can't seem to agree on some key financial policies (the fact that some big countries like Britain are still independent doesn't help). I think the Euro can work because it works in USA. For instance, USA is a very diverse country. Industries, culture, etc in Midwest is totally different from, say, east coast. The midwest is sensitive to agriculture whereas the east coast literally produces no agricultural goods. The state of Michigan, which is dependent on auto manufacturing, is literally in a depression whereas Texas, which benefits from the oil & gas boom, is doing really well. When the central bank cuts rates because (primarly) New York and West Coast banks are in trouble, it doesn't help the midwest. Of course, the biggest difference is that USA has had hundreads of years to work out these differences whereas trying to get the fiscally-weak Italy to agree with the fiscally-conscious Germany might take some time.
Recommendations
As for investments that he, and his team at GaveKal like, they include:
- US large cap stocks
- Japanese stocks, such as machinery, pharmaceuticals and technology
- Companies that will benefit from Asian and Middle Eastern infrastructure spending
- CDS on Europen countries and CDS on European financial stocks (he is worried about a potential collapse of the Euro regime)
As for me, I'm not too sold on the infrastructure theme. I can see it playing out but would like to see some stabilization in those countries that are supposed to spend money on infrastructure. I mean, I don't even know if USA, which is supposed to increase infrastructure spending, has enough money to spend on these projects (the credit crisis and the collapse of the monolines are going to increase their costs).
I don't care much about his CDS (credit default swap) idea because I am not as bearish on the Euro and have little direct exposure. Furthermore, I have no access to CDS and don't have the expertise to dabble in derivatives.
I like his American and Japanese stock idea. The problem I see with Japan is that their companies are not efficient and shareholder-friendly--but that is changing slowly...
There ought to be a rule that economists (and that would include GaveKal) who completely missed the credit bubble and dismissed the adverse effects of leverage should disqualify them from making any bottom-calling or offering solution to the problem.
ReplyDeleteI had a 3-month trial subscription to GaveKal in 2006. Their breezy dismissal of the credit bubble in their real-time writing was, in some way, quite precocious and naive.
To their credit, they do ocassionally own up to their mistakes, and in one case, I remember, they published one hostile letter to them that accused their writing as engaging in a form of "intellectual masturbation". That is actually quite an apt description in of their writings. If you have read their regular missives, you can see the the self-congatulatory intellectual satisfaction, the pomposity, and the triumphalist tone of their precious little Brave New World. As a result, their writing can be quite insufferable. Marc Faber likes to make fun of them in his Doom, Gloom and Boom report.
In many ways, the credit crisis that blew up their neat little Brave New World in their faces is quite a comedown for this bunch. I wouldn't call them pompous fools because they occasionally do enage in some self-reflection.
Still, if your nature is naturally optimistic about how this credit bubble bursting will benignly resolve itself, I strongly encourage you to ask for a trial subscription, as its analysis tends to confirm your bias very nicely, and WILL provide lots of temporary comfort as we continue the de-leveraging party.
I myself tend to dismiss their thinking completely, though for entertainment purposes, I do read them to see what new intellectual cus-de-sac they have now gotton themselves into.
Btw, to successfully get them to grant a trial subscription to their very expenseive economic analysis, you have to pose yourself as some sort of institutional financial type that is engage in the noble act of shuffling money around and get a cut in the act.
Cheers!
Synchro,
ReplyDeleteContinuing from prior post...
Bill Miller outperformed the S&P 500 between 2000 and 2003 if I'm not mistaken. His record of outperformance only ended somewhere in 2004 (or 2005?) and that's mainly due to avoiding energy.
Now, I don't necessarily look at S&P 500 as my benchmark. It can drop 50% and if I lose 49% there's not comfort in that. However, someone running a very large fund (I think the largest active mutual fund by far at that time, and probably still) like Miller can be compared to the S&P 500. This is especially true given that he is limited to investing in USA only.
You are pretty set in your thinking and that's fine. But your mistake is that you may be wrong with your bearish views, just like a bull may be wrong with his/her bullish views. That's why people like Whitman, Miller, Pzena, Dreman, et al, keep buying while surrounded by storm clouds. You perceive this as reckless behaviour but they are stockpickers and evaluate the merits of each business.
You seem to be bitter, not just with Bill Miller but GaveKal as well. Admittedly GaveKal makes macro calls and they don't get everything right but I like them because they provide off-the-wall thinking. Anyone providing macro calls can be wrong here and there. I mean, Marc Faber has been wrong quite a bit over the years. Even Jim Rogers has been wrong (if I'm not mistkaen he was bullish on Vietnam (need to check that) and that has been a diaster this year.)
Synchro,
ReplyDeleteAs Sivaram also suggested may be the case I get the impression that we attach very different meaning to the word " risk". To me, risk is the possibility that an investment may permanently lose value because the business I invested in declines in value. This can happen either because of entirely unforeseeable future developments or it can happen because of something I overlooked. The first is unavoidable and I try to avoid the latter by reading as much as possible on potential investments, the good, the bad and the ugly.
I will get out of an investment, taking such losses as are necessary to close the position, when I become convinced I made a mistake and I have severely misvalued the company. The market price is irrelevant to that analysis. It is all the exit strategy I think I need.
This also means I am not interested in just seeing my biases confirmed. I like to read both bulls and bears views to test my ideas and obtain additional information. What I want to know before buying something is if I think the current price is below a more objective measure of value. If it is, that means both that risk, as I define it, should be small because value changes much more slowly then market price, and I should have a good chance of profit when the market realizes what it is overlooking, as it inevitably does.
It helps that I have a terrible record trying to pick short-term winners. Me buying something is a pretty reliable indicator that it will drop substantially in a few weeks (I will tell you if I decide to press ahead with the oil short, expect bombing of Iran and an oil superspike above $200/barrel in two weeks at most after that).
If I suck at short term picks, I figure I should look at the longer term possibilities and so far it is working well for me. I am building quite a record of stomach churning losses that reverse into significant gains. If I have to sit on a 30% loss for a year (or more), so be it.
I get the impression you think of "risk" more in terms of volatility and want to avoid going into the red even for a short period on an investment, but I could be mnistaken. Could you perhaps give an outline of your understanding of "risk".
As Sivaram pointed out many succesfull investors have sat on massive unrealized losses, sometimes for years, and eventually had their ideas vindicated. That's the kind of record I am trying to achieve. What matters is the return when you eventually sell, the rest is just noise in the data as far as I am concerned.
My remark on Bear Stearns leverage was entirely serious in it's intend. Wall Street uses lot's of leverage, all of them. That is dangerous but it is also what makes their business tick. Yet for some reason Bear Sterns got taken out and shot andf the others were not. The difference is that Bear Sterns had it's credit suddenly pulled largely on the back of a rumour campaign. It didn't help that Bear Sterns did a lot of business with hedge funds making it possible for a handfull of managers to pull out billions in a few hours, but any bank is vulnerable. (And no Sivaram, the retail public isn't any more reliable. Just ask Northern Rock. The minute rumours started flying in earnest everybody and their granny was lining up at their branches to get their deposits). Banks are built on leverage and this always makes them vulnerable to rumours. Doesn't mean rumour campaigns are a good thing. Or should I be allowed to short an oil company and then blow up all it's wells and refineries?
I have read Nassim Taleb and his views are interesting. Yet, to push his avian analogy a bit further, what is a fully informed turkey to do? Stop eating? It won't even make it to christmas and it's death will be much slower and more painfull then if is just keeps eating and gets the chop. The is even more true if only a few turkey's get the chop and the rest can become pets (ie, Bear gets shot but other investment banks go on with getting rich).
The modern economy is build on debt, for better or worse. The enormous increase in debt that has been going on at least since the first established national debts and stock exchanges in the seventeenth century (in the Netherlands as it happens) has coincided with the greatest economic progress in human history and I suspect the two are linked. Debt appears an effective way to allocate capital and to fund all sorts of advantageous projects. Sometimes things blow up and you have to call the cleanup crews. But what is the alternative? You no leverage at all? The economy would grind to a halt.
Taleb seems to have no real idea to get a invesment return. Buy treasuries he says, but what if the next black swan is a US government default? Buy deep out of the money options he says, but which ones? the whole point of his theory is that it is unpredictable when and where the black swan might pop up and if it is delayed (do black swans ride the train?) you will lose your money buying options that are never worth anything.
Taleb's theories are intellectually
very stimulating but in my opinion not very helpful in developing an investment approach.
You do not seem to like the whole idea of leverage, let alone lot's of it. Yet for reasons briefly outlined above I think we are stuck with it. As I have suggested before, I also think if we do get a full-blown deflationary depression the value, or lach thereof, of my investments is moot. As I alluded to before I expect Europe to collapse in civil war if we get a Great Depression mk II and when I am in a trench cursing the mortar crew keeping me awake with sporadic incoming I really don't see how my stocks will be of importance...
Synchro,
ReplyDeleteI forgot to aks in my long post, but could you give an outline of some of your own investing ideas for me (and Sivaram) to consider?
Regards,
Sivaram,
ReplyDeleteAm I correct if I think you are following a fairly strict balance sheet approach at the moment? If yes, then we do follow different approaches as I do not intend to be a "pure" balance sheet approach.
A healthy balance sheet is important, but it is not the only thing and can be wildly misleading if for example earnings and special risk factors are not considered. It is amazing how fast a balance sheet can deteriorate if heavy persistent losses are suffered. And on "special risks" I say "Bear Sterns", need I say more?
On the oil short, I am well aware of the risks of shorting into a bubble. There is just no telling when the madness will stop or how far it will go. That is why I consider using longdated puts. With put options the worst that can happen is that they end up worhtless, even if oil goes to $500/barrel. They should be fairly longdated, expiry no earlier then 12 months out, preferably more, to account for the possibility that the madness will persist. The Saudis have recently threatened to open THE VALVEtm but with my luck in short term picks, we might just see that $200/barrel price and that would blast me through my margins if I tried a direct short sale.
Unfortunately my current brokerage doesn't have many options for commodities trading so I will need to set up a ne account and the only one over here that seems to offer the full package requires a minimum deposit of E 4000,- so I will have to recruit that first and I don't want to sell my existing positions as I continue to have confidence in them.
There is an entirely different way of investing that I subscribe to. If you want to learn about it, I suggest you read,
ReplyDeleteMark Boucher, "The Hedge Fund Edge"
http://www.amazon.com/Hedge-Fund-Edge-Maximum-Strategies/dp/0471185388/ref=pd_bbs_sr_1?ie=UTF8&s=books&qid=1213651762&sr=8-1
Nelson Freeburg's newsletter, "Formula Research"
http://www.formularesearch.com/
Also, Mebane Faber's "World Beta" blog is excellent portal into the investment world I reside in.
http://worldbeta.blogspot.com/
I read fund manager John Hussman's weekly commentary religiously.
http://www.hussmanfunds.com/
Anything written by Bridgewater Associates founder Ray Dalio is worth reading and learning.
To understand how world, markets and economy really work, read the newsletter archive in
http://www.institutionaladvisors.com, which is founded by your compatriot Bob Hoyt, an excellent market thinker.
None of the investment professionals above advocate "day-trading," but they do emphasize the importance of timing and risk control. None of them really believe there is a holy grail that guarantees profit, but long-term trend following w/ risk control is a viable way to obtain good relative return and absolute return.
ReplyDeleteDuring the period when I read your blog as a lurker, I can't help but feel that the struggle that you guys are going through is something I have gone through already. That's why I bothered to respond and comment. Like Jim Paul and Brenden Moyniham said int their book, there are numerous ways to make monoey, but only a few ways to lose money.
There is nothing wrong with the "contrarian" value approach to investing, but it is an extremely hard way to make money if you are a do-it-yourself kind of small investor. Your odds of success is not good if you do not have the kind of institutional support that the famed value investment managers have.
While reading as much as you can about your investment is admirable, but that's mostly financial archeology.
ReplyDeleteBy the time it is so obvious that the business is "so misvalued" by you, presumbably it would be obvious to all the other investors too, who are excavating the same grounds. I am at a loss to understand what your edge is.
I think being bitter would be overstating my feelings. I've never invested a dime w/ Bill Miller. Like I said, I got out of David Dreman in March 2007, and Marty Whitman in November 2007, when I saw what an investment train wreck they are becoming.
ReplyDeleteI _am_ saddened by the buy-and-hold brainwashing that goes on in the investment pundit world, and the fleecing that actively managed mutual funds engaged in. Needless billions are wasted this way.
ContrarianDutch: "Am I correct if I think you are following a fairly strict balance sheet approach at the moment? If yes, then we do follow different approaches as I do not intend to be a "pure" balance sheet approach. "
ReplyDeleteI'm just a newbie trying to figure out what works for me. My style and strategy have changed over time. I used to be more into growth stocks a few years ago (that's why I was familiar with the high growth of MMORPGs in Asia). In fact, a few years ago my primary investment strategy was sector rotation (I was heavily influenced by Marc Faber and Jim Rogers). That worked well but I became bearish on commodities (about one or two years ago) and switch to more of a value-focused contrarian investing. I also came to the conclusion that some form of value investing is the way to be successful since that is the only strategy that works in almost any economic environment (look at Buffett in the booming 50's/60's, inflationary 70's, booming 80's/90's, and now).
Nowadays I do not look at growth at all, except if they are distressed or beaten-up stocks.
I generally place a high emphasis on the balance sheet because I tend to look at beaten-up stocks and balance sheet is very important for them. In terms of earnings, I tend to look at what I perceive as normalized earnings rather than earnings from growth. Since I tend to look at out-of-favour companies, if earnings hit their historical average, that is more than enough. For instance, although Ambac is primarily an asset play, my expectation is for long-term earnings of around $400 (early 2000 level, before mortgage boom) which gives it a P/E of 2. Although I am hopeful of growth potential in Europe, Middle East and Asia (particularly with public-private infrastructure projects), I do not invest based on that potential growth... Of course, all this is assuming that Ambac is a going concern and gets through this mess.
I do not consider myself a pure value investor. The main reason is because I am influenced by macro and other miscellaenous factors.
ContrarianDutch: "A healthy balance sheet is important, but it is not the only thing and can be wildly misleading if for example earnings and special risk factors are not considered. It is amazing how fast a balance sheet can deteriorate if heavy persistent losses are suffered. "
Agreed... it's kind of tough for a newbie like me to evaluate some of the non-balance-sheet factors but I do try to think about them as much as I can. Sometimes it's lessons that I learn as I read and study things more. I never had interest in any investment bank but I never would have expected Bear Stearns to collapse so quickly with a seemingly "decent" balance sheet.
ContrarianDutch: "On the oil short, I am well aware of the risks of shorting into a bubble. There is just no telling when the madness will stop or how far it will go. That is why I consider using longdated puts."
I am bearish on commodities and actually have a bearish bet that has not worked out at all so far. I'm short (via an inverse ETF) the Toronto Stock Exchange, which is one of the best performing indexes on the back of commodities. Needless to say, I have been wrong and it's hard to say how this will work out. Also, my bet is on commodity stocks whereas yours is the commodity itself (unless you are betting against oil&gas stocks).
I think going with puts with distant expiry may make sense but it's risky for the reason both of us agree: bubbles can literally keep going up for seemingly forever. If you do decide to go with the options, I think one big advantage for you is that put options on oil will likely be cheap right now. It's a totally contrarian move so I like the concept, but it's somewhat risky and speculative.
Synchro,
ReplyDeleteDid you just switch your investment strategy in 2007? I'm curious because you seem to have been invested in successful mutual funds prior to that. Why did you decide to invest in those in the first place?
Thanks for listing your influences. I took a cursory look and the only ones I'm (vaguely) familiar with are Bridgwater and John Hussman. I think you are more into market timing and quantitative strategies. That's not my cup of tea but thanks for elaborating on your thinking...
I only invested in mutual funds (until 2007) for my son's custodial account and my own IRA because they are too small to build a portfolio of stocks.
ReplyDelete