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Friday, March 26, 2010

China crazy!

Need further proof that people are going nuts over China? Simply adding "China" to a company's name has led to beating the market by 31% (for 18 listed companies so far in 2010). This is the finding of Professor Wei Wang of Queen's School of Business and reported by Jason Zweig in the Wall Street Journal this week.

The last time this happened was between 2004 and 2007, when adding the words "oil" or "petroleum" led to an 8% boost in stock performance.

Before that, it was the technology bubble from 1998 to 1999, when adding ".com" to a company's name led to 53% out-performance of other technology stocks.

In the late 1960's, a company's stock would soar if it added "-tronics" or "-dyne" to its name.

I'm sure if we went back to the 1800's, we'd find the same thing for "canal" and "railroad" companies.

It's a story as old as markets. People fall for the hype only to find they've invested in little more than smoke and mirrors.

I don't mean to say that no company is China is worth its salt. Nor am I saying that all oil, .com, or -tronics companies are pure puffery.

But, when simply changing the name of your company to reflect the latest craze leads to serious out-performance, you know there's a bubble afoot.


China, too, may not live up to the hype.

Is China a huge and growing market? Yes, indeed. Will China's economy have a huge and growing impact on the world economy? Unequivocally, yes.

But, that doesn't mean every investment in China will do well. In fact, it might be a good idea to pull back on the China hype and consider other less bubbly alternatives.

Perhaps a case history can be instructive, here. The last time people went country-crazy was the mid to late 1980's. Then, it was Japan, Inc. Do you remember how Japan was buying up real estate in New York, Hawaii and California, and how almost everyone was convinced the Japanese way of doing everything was better?

Fast forward to 2010, and Japan has been in a 20 year off-again, on-again recession. Their stock market peaked at almost 39,000 in late 1989 only to fall below 8,000 twice in the last 20 years (down over 80%). Even now, their market is around 11,000, down over 70% from it's peak of over 20 years ago!

Can you imagine if the Dow Jones Industrial Average were at 4,250 19 years from now!? That was the Japanese hype experience.

China's story may not look much better 10 or 20 years from now, either.

Before jumping into the hype machine, remember the lessons of history. Extreme hype is almost always a bad sign.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Friday, March 19, 2010

Don't trust your gut.

One year ago, almost everyone was panicking. Stock markets were hitting new lows--more than 50% below all-time highs of fall 2007. Bankruptcy risk seemed to be around every corner with rumors flying about which companies would die next. Additional rumors were floating that the government would be taking over large banks like Citigroup and Bank of America. The fear was palpable.

Today, the S&P 500 is up around 75% (it still needs to climb another 35% to get back to Fall 2007 highs). Emerging markets and some commodities are up even more. The banks everyone thought would be taken over, Citigroup and Bank of America, are up 289% and 436%, respectively. Everyone is starting to feel calm again.

So, what have we learned? Trusting your gut feel to guide your decision to invest or not works terribly. Investing when it feels like the sky is falling is excruciatingly difficult, but generates the highest returns. Intestinal fortitude--having the courage of your conviction--is as important as sound analysis.

Or, as Warren Buffett put it: 1) you pay a high price for a cheery consensus, and 2) if you wait for the robins, spring will be over. Waiting until things feels good is a guaranteed trip to poor or mediocre returns. If you wait until you feel good, it'll be too late.

With this in mind, where are we now? Investors piled into cash and bonds last year--precisely when they should have been buying equities. Now that the market and economy have recovered, they're finally starting to buy equities, again.

Knowing how the stock market and human psychology works, I expect the stock market to continue creeping up until everyone is on the bandwagon. Once they are, and fund flows into mutual funds are hitting new highs again, and everyone feels nice and comfortable, it will be time for another drop.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Friday, March 12, 2010

Batting average.

Investing is a humbling profession. Like predicting the weather, you're proud if you get things right a mere 50% of the time. That's tough because it means you're also wrong a large percentage of the time, and that's humbling.

This surprises many because they think long-time professionals should be able to do much better. The reality is that predicting the future, especially financial markets, is extremely difficult to do.

I was reminded of this recently looking at the investing records of the best in the business. Investing legends, like Lew Sanders, brag about being right 52-53% of the time. Super-humans, like Warren Buffett, are right 90% of the time. But that still means he flubs it 10% of the time. His 2008 investment in ConocoPhillips is a great example. Even geniuses sometimes get it wrong.

This reminds me, too, of how experts in a field can miss big changes. Tom Watson, the famous builder of IBM, thought there was a "world market for maybe five computers" in 1943. Bill Gates famously missed how the Internet would change the computer industry. If the the most brilliant, successful people in the field can miss things, then mere mortals, like me, have to predict with caution.

How should this impact investment decision making? In two ways, I think.

First, you have to adjust your predictions for the fact that you aren't going to project accurately 100% of the time. This means buying with a margin of safety (purchasing significantly below what you think an investment is worth). It means using probability theory to adjust your assessments of the future. It also means taking a pass on things you know you can't predict (Buffett strongly emphasized this in his latest annual report to shareholders).

Second, it means you need to keep track of your ability to predict. How can you adjust your predictions if you don't know how you've done?

I keep track of my predicting ability by comparing how my investment decisions stack up against market returns. If a stock I buy and sell beats the market, I count that as a "hit." Then I calculate my "batting average" as a percentage of the time I "hit" versus "swing." I use this batting average to adjust my investment position sizes.

I also keep track of by how much I "hit" and "miss." You can have an above 50% batting average and do terribly if your hits beat the market by 5% but your misses go down by 20%. Lew Sanders does well because his 52-53% hits go up much more than his 47-48% misses.

My batting average has fluctuated between 55-70% over time. Pretty good, but I plan to get better. Keeping track of my batting average and degree of out/under-performance helps me improve. This will boost my investing record.

It's humbling to be wrong 30-40% of the time, but without that self knowledge, I can never hope to improve. Plus, being right 60-70% of the time, at least in the investing profession, makes a big difference in results.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Tuesday, March 02, 2010

The return of the bond market vigilantes

James Carville, Bill Clinton's 1992 campaign strategist, is reported to have said, "I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody."

This quote highlights the power of markets, even over politicians.

The bond market can push around politicians because the decisions of millions of investors can raise or lower interest rates, raise or lower currency values, and push politicians into a corner where they have to change their tune.

Some see this as a dark and mysterious power run amok, but this simply is not true.

The bond market is the largest market in the world in dollar value. It does not consist of a few powerful individuals or organizations, but of millions of investors making independent decisions. When the bond market pushes politicians around, it's because there are so many people in agreement with each other (and disagreement with government) that prices move very far in one direction.

That's not a conspiracy; it's a groundswell.

The bond market vigilantes are not an organized group, but their individual actions can force change. And, change it in the wind.


The vigilantes have been quiet for several years. With low inflation and high growth, there have been profitable opportunities elsewhere.

But, now that governments of the world have spent trillions getting their economies going and propping up weak companies, governments are again vulnerable to the vigilantes.

Nowhere is this more clear than in Europe, recently. Investors are understandably concerned about the balance sheets and cash flows of European countries, especially Portugal, Ireland, Greece and Spain (dubbed the PIGS).

Worldwide, bond markets have been raising interest rates and lowering the currency values of the weakest players.

This is not a bad thing. In fact, it's quite the opposite.

Like the stock market bashes companies with weak business plans, the bond market bashes reckless countries. Where governments think they can print money and issue bonds without constraint, the bond market brings discipline.

The bond market vigilantes don't cause problems, they react and point them out.

Without them, things would get much worse. Get ready to hear a lot more about bond and currency markets because sovereigns need reigning in.

Be glad they are enforcing such discipline, but stay out of their way. This is no time to bet heavily on currencies or bonds. Unless, of course, you happen to be a vigilante yourself.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.