In a blog post in March of this year I discussed the limitations of sentiment as a market timing tool. I wrote that while it can be helpful to track the public’s sentiment and use it as a contrary indicator, there are three potential pitfalls associated with using sentiment to guide buying/selling decisions. Here are the pitfalls again:
The first is linked to the reality that sentiment generally follows price, which makes it a near certainty that the overall mood will be at an optimistic extreme near an important price top and a pessimistic extreme near an important price bottom. The problem is that while an important price extreme will always be associated with a sentiment extreme, a sentiment extreme doesn’t necessarily imply an important price extreme.
The second potential pitfall is that what constitutes a sentiment extreme will vary over time, meaning that there are no absolute benchmarks. Of particular relevance, what constitutes dangerous optimism in a bear market will often not be a problem in a bull market and what constitutes extreme fear/pessimism in a bull market will often not signal a good buying opportunity in a bear market.
The third relates to the fact that regardless of what sentiment surveys say, there will always be a lot of bears and a lot of bulls in any financial market. It must be this way otherwise there would be no trading and the market would cease to function. As a consequence, if a survey shows that almost all traders are bullish or that almost all traders are bearish then the survey must be dealing with only a small — and possibly not representative — segment of the overall market.
I went on to write that there was no better example of sentiment’s limitations as a market timing indicator than the US stock market’s performance over the past few years. To illustrate I included a chart from Yardeni.com showing the performance of the S&P500 Index (SPX) over the past 30 years with vertical red lines to indicate the weeks when the Investors Intelligence (II) Bull/Bear ratio was at least 3.0 (a bull/bear ratio of 3 or more suggests extreme optimism within the surveyed group). An updated version of the same chart is displayed below.
The chart shows that while vertical red lines (indicating extreme optimism) coincided with most of the important price tops (the 2000 top being a big exception), there were plenty of times when a vertical red line did not coincide with an important price top. It also shows that optimism was extreme almost continuously from Q4-2013 to mid-2015 and that following a correction the optimistic extreme had returned by late-2016.
Sentiment was at an optimistic extreme late last year, at an optimistic extreme when I presented the earlier version of the following chart in March and is still at an optimistic extreme. In effect, sentiment has been consistent with a bull market top for the bulk of the past four years, but there is still no evidence in the price action that the bull market has ended.
Regardless of what happens from here, four years is a long time for a contrarian to be wrong. See more at http://www.tsi-blog.com
Lesson? Always place data into context and do not rely on any one piece of information. Sentiment can be useful as part of an over-all picture of a market or company.
Indian Prime Minister Nahendra Modi has declared 500 and 1,000 rupee notes illegal for exchange. Since these are worth a mere $7.26 and $14.53, he has de facto ended paper currency for use in all major transactions.
Half the population do not have bank accounts, and consumer trade has come to a screeching halt. That is because the highest permitted denomination fetches only about one US dollar, and exchanging the larger notes requires long waits and government identification, which a quarter of Indians do not possess.
Beyond the self-inflicted economic crisis, Jayant Bhandari says India is becoming a police state. She is on a fast track to banana-republic status, before fragmentation into smaller political units.
The gold market in India is in chaos, as people rid themselves of the domestic fiat currency: the price per ounce has skyrocketed to above $2,000, and tax authorities are blocking the retailers. This means the black market is set to boom, as smugglers adapt to the new opportunity, but import demand from India has dropped momentarily, since the formal markets are under the gun.
Another dent in confidence of fiat currencies. What are YOUR thoughts. Lessons? I will pay $1 million dollars to ANYONE who can tell me how central planning helps people increase wealth over time vs. free exchange.
The balance between quantitative and qualitative research
“There’s so much you can tell in a 10-minute tour of a plant.
I can tell you right away whether we’re making money, if we have quality or delivery issues (so customer issues) and if there’s a morale problem. It’s easy to tell.
But you can’t tell until you go there.”
– Linda Hasenfratz, CEO Linamar Corporation, in conversation with The Women of Burgundy, September 21, 2016
One of the familiar tensions underlying the quality-value investment discipline is the balance between quantitative and qualitative research. Many investors intuitively understand the importance of assessing the quantitative aspects of a business. We analyze the numbers to understand what level of return the business is generating for its shareholders, what level of debt sits on the balance sheet, and whether the cash flows into the business are stable and recurring, for example.
While a quantitative assessment is vital to an investment decision, it is not complete without a qualitative framework to guide its meaning. For instance, it is not just the level of debt on the balance sheet that matters, but whether those debt levels are appropriate for the business. It’s not just a historical record of stable cash flows that gives us confidence, but rather an understanding of the economic moat that protects those cash flows from future competition.
It is with this background that I find Linda Hasenfratz’s quote truly compelling. As CEO of Linamar, she is responsible for running a global manufacturing business that spans 13 countries around the world. She may be able to look at the financial metrics to assess how her business is doing, but for Hasenfratz it is clear that a true, holistic understanding of the business comes from walking the halls of manufacturing plants and speaking face-to-face with her management teams around the world.
Her words were a welcome reminder about the importance of being there, on the ground, to gain a complete qualitative understanding of the operations. As I listened, I felt as if a member of our Investment Team had been dropped into her seat. Take, for instance, the excerpt below from the June 2016 issue of The View from Burgundy, “Boots on the Ground,” which brings us along on a site tour of a Chinese flavour and fragrance company’s R&D facility:
“Normally lab environments are tightly controlled, but in this case, rooms labelled ‘temperature controlled’ had open windows, letting in both the hot summer air and a fair share of local insects. What’s more, the facility was curiously devoid of employees, and the few research staff we did encounter were surly and unapproachable. It seemed odd to us that a company could have its main R&D facility in such a state of inactivity and disrepair, while reporting seemingly world-leading profitability in a highly competitive research-driven industry.
Our negative impression from the site tour provided useful information that would have been difficult, if not impossible, to acquire had we not done the on-the-ground work. It prevented us from making an investment in what had appeared on paper to be an attractive business, provided one didn’t scrutinize its operations – an example of why relying on company-produced financial statements alone is not sufficient when conducting due diligence.”
In other words, the science of investing is never complete without the art.
India Confiscates Gold, Even Jewelry, in Raids on Hidden Money
The chaos accompanying “demonetization” hasn’t eased up noticeably. It seems likely the disruption to the economy, especially in cash-centric rural India, will hit growth sharply for at least a few quarters. It’s tough to say for how long and by how much; we are in uncharted territory here and guesses have varied widely. But many analysts agree with former Prime Minister Manmohan Singh, who’s predicting the new policy will knock 2 percentage points off that world-beating GDP growth rate.
Demonetization was originally sold as a “surgical strike on black money”— the illicit piles of cash many rich Indians have accumulated out of sight of the taxman. It’s now clear the policy has been anything but surgical. Worse, uncomfortable questions are being asked about whether the complicated rules and exemptions that have accompanied demonetization have allowed black-money holders to launder most of their cash. Of late, Modi’s chosen to focus instead on demonetization as means of advancing a cashless economy.
Yet the idea of a war on unaccounted-for wealth remains central to demonetization’s popular appeal, which means Modi will have to find other ways to keep that narrative going. So the government has now begun to push income-tax officials to conduct raids on those who might be concealing assets in forms other than cash, such as gold.
There’s already enough fear of such raids becoming common again that the government felt the need to step in to quell some of the anxiety. That didn’t help much. The government “clarified,” among other things, the rules governing when tax officials could seize gold: Nothing would happen “if the holding is limited to 500 grams per married woman, 250 grams per unmarried woman and 100 grams per male.” It also said that there would be no limits on jewelry “provided it is acquired… from inheritance.” Also, the “officer conducting [the] search has discretion to not seize [an] even higher quantity of gold jewelry.”
What this means, unfortunately, is that India’s income tax officers have just won the lottery. During a raid, they can, on the spot, decide whether or not to confiscate a family’s gold holdings. And remember, India has an enormous amount of gold — 20,000 metric tons, much of it inherited. (The rules governing simple searches are different, but few know that.) Rather than cleaning up tax administration, the government has handed tax officials more power than they’ve had for decades. The rich will pay what they need to escape harassment; the rest will suffer.
Rich Escape, Poor and Middle Class Suffer
The last line in the preceding article says all you need to know about what’s happening: “The rich will pay what they need to escape harassment; the rest will suffer.”
Evidence suggests the politically connected, and their friends, knew about the ban on cash and acted in advance. Everyone else is stuck.
India’s raid on gold reinforces its ban on cash. Short term aside, these kinds of actions will increase demand for gold.
I keep wondering: what’s next? People pretend they know, I admit I do not. However, I am quite sure a currency crisis is coming. Where it strikes first is unknown, but the list of likely candidates increases every year.
My spotlight has been on Japan, China, and the EU. India caught me off guard, but it adheres to my general theory this pot will eventually boil over in a cascade from an unexpected place, outside the US.
US actions may cause a currency crisis, but I believe a crisis will hit elsewhere first. If I am correct, gold will be the safe haven, regardless of currency, but especially where the crisis hits.
https://www.thestockmarketblueprint.com/asset-based-analysis-does-it-work/ A great blog for NCAV stocks and more!
A while back you took my Investment IQ Test questionnaire. As you may recall, it was based on the character traits of the world’s most successful investors I outlined in my book, The Winning Investment Habits of Warren Buffett & George Soros.
Here, very briefly, are a few of the “highpoints” of the investment behaviors that made them so successful.
I trust you enjoy it and I appreciate your comments.
PS: If you prefer to read it in your browser just go here.
7 Investment “Tips” From the World’s Richest Investors
Warren Buffett, Carl Icahn, and George Soros are the world’s richest investors. Their investment styles are as opposite as night and day. Buffett buys companies that he considers to be good bargains; Soros is famous for his speculative forays into the currency markets, which is how he came to be known as “The Man Who Broke the Bank of England.”
But—as I have shown in The Winning Investment Habits of Warren Buffett & George Soros—they both practice the same 23 mental habits and strategies religiously. As do Sir John Templeton, Bernard Baruch, Peter Lynch, and all the other successful investors I’ve ever studied or worked. It doesn’t matter whether you buy stocks, short currencies, trade commodities, invest in real estate, or collect ancient manuscripts: adding these mental strategies to your investment armory will do wonders for your bank account.
To make it easy to get going, I’ve distilled these 23 mental habits into these seven simple (though not always easy to follow) rules:
1. If you’re not certain about what you’re intending to do, don’t do it
Great investors are always certain about what they are doing whenever they put money on the table. If they think something is interesting but they’re not sure about it, they do more research.
So next time, before you call your broker (or go online), ask yourself: “on a scale of 1 to 10, how certain am I that I will make money?” Choose your own cut off point, but if it’s less than a 7 or an 8, you definitely need to spend more mental energy before making a commitment.
Remember: the great investor’s sense of certainty comes from his own experience and research. If your sense of “certainty”doesn’t come from your own research, it’s probably a chimera.
2. Never take big risks
Warren Buffett, George Soros, Peter Lynch . . . they only invest when they are confident the risk of loss is very slight.
Okay, what about that person you heard about who made a bundle of money in copper or coffee futures or whatever by taking on enormous leverage and risk? A few simple questions:
Did he make any other big profits like that?
Did he do this last year as well, and the year before that, and the year before that?
If not, chances are that’s the only big profit he ever made.
(And what did he do with the money? If he spent his profits before he got his tax bill . . . )
The great investors make money year in year out. And they do it by avoiding risk like the plague.
3. Only ever buy bargains
This is another trait the great investors have in common: they’re like a supermarket shopper loading up on sale items at 50% off.
Of course, the stock exchange doesn’t advertise when a company’s on sale. What’s more, if everybody thinks something is a bargain, the chances are it’s not.
That’s how Benjamin Graham, author of the classic The Intelligent Investor, averaged 17% a year over several decades of investing. He scoured the stock market for what he considered to be bargains—companies selling under their break-up value—and bought nothing else.
Likewise, Warren Buffett. But his definition of a bargain is very different from Graham’s: he will only buy companies he can get at a discount to what he calls “intrinsic value”: the discounted present value of the company’s future earnings. They’re harder to identify than Graham-style bargains. But Buffett did better than Graham: 23.4% a year.
Even George Soros, when he shorted sterling in 1992, was convinced that the pound was so overvalued that there was only one way it could go: down. That’s a bargain of a different kind, but a bargain nonetheless.
4. Do your own leg work
How do they find investment bargains? Not in the daily paper: you might find some good investment ideas there, but you won’t find any true bargains.
The simple answer is: on their own. After all, almost by definition, an investment is only a bargain if hardly anybody knows about it. As soon as the big players discover it, the price goes up.
So it takes time and energy to find an investment bargain. As a result, all the great investors specialize. They have different styles, they have different methods, and they look for different things. That’s what they spend most of their time doing: searching, not buying.
So the only way you’re going to find bargains in the market is the same way: by doing your own legwork.
5. “When there’s nothing to do, do nothing”
A mistake many investors make is to think that if they’re doing nothing, they’re not investing.
Nothing could be further from the truth. Every great investor specializes in a very few kinds of investments. As a result, there will always be stretches of time when he can’t find anything he wants to buy.
For example, a friend of mine specializes in real estate. His rule is to only buy something when he can net 1% per month. He’s a Londoner so—aside from collecting the rent!—he’s been sitting on his thumbs for quite a while.
Is he tempted to do something different? Absolutely not. He’s made money for decades, sticking to his knitting, and every time he tried something different, he lost money. So he stopped.
In any case, his real estate holdings are doing very well right now, thank you very much.
6. If you don’t know when you’re going to sell, don’t buy
This is another rule all great investors follow. It’s a major cause of their success.
Think about it. You buy something because you think you are going to make a profit. You spend a lot of time so you feel sure you will. Now you own it. It drops in price.
What are you going to do?
If you haven’t thought about this in advance, there is a good chance you will panic or procrastinate while the price collapses.
Or . . . what if it goes up—doubles or triples—what then? I’ll bet you’ve taken a profit many times only to see the stock continue to soar. How can you know, in advance, when it’s likely to be the right time to take a profit? Only by considering all the possibilities.
The great investors all have; and will never make an investment without first having a detailed exit strategy. Follow their lead, and your investment returns should soar.
7. Benchmark yourself
It’s tough to beat the market. Most fund managers don’t, on average, over time.
If you’re not doing better than an index fund, then you’re not getting paid for the time and energy you’ve spent studying the markets. Much better to put your money in such a fund and spend your time looking for that handful of investments you are so positive are such great bargains that you’re all but guaranteed to beat the market.
Alternatively, consider the advice from a great trader. When asked what the average trader should do, he replied: “The average trader should find a great trader to do his trading for him, and then go do something he really loves to do.”
Exactly the same advice applies to the average investor.
Find a great investor to do your investing for you, and focus your energy on something you really love to do.
Evidence suggests the professional investors in my sample have significant stock-picking skills. Interestingly, these skilled investors share their profitable ideas with their competition. I test various private information exchange theories in the context of my data and determine that the investors in my sample share ideas to receive constructive feedback, gain access to a broader set of profitable ideas, and attract additional arbitragers to their asset market. The proprietary data I study are from a confidential website where a select group of fundamentals-based hedge fund managers privately share investment ideas. The investors I analyze are not easily defined: they exploit traditional tangible asset valuation discrepancies, such as buying high book-to-market stocks, but spend more time analyzing intrinsic value and special situation investments.
You have been working so hard to have an interview with Buffo and Greensplat Special Situations Hedge Fund and now you are in their offices. The interviewer sits down and then asks, “Can you please tell me what you think was the greatest special situations trade/investment of the past thirty years and what was the catalyst for the trade?” Hint: This made huge multiples on the original capital. Few recognized the opportunity until too late.
THE FIRST AND THIRD SHALL BE FIRST, WHILE THE SECOND SHALL BE LAST (August 1, 2016): There is a fascinating pattern to the trading during the first seven months of 2016. The strongest sectors by far have exclusively been silver and gold mining shares, in that order, followed primarily by other commodity producers and mining-related emerging-market equities. The second-biggest percentage winners have mostly been high-dividend, low-volatility assets including consumer staples, utilities, REITs, tobacco shares, telecommunications companies, and long-dated U.S. Treasuries. The third-best performers of 2016 have been mostly energy companies and a variety of emerging-market stocks and bonds.
This is puzzling is because the first and third groups are inflation-loving assets, whereas the second group performs well when deflation reigns. How can the financial markets be both inflationary and deflationary?
The deflation trade is nearly over, but it has remained in a bull market due to huge inflows from investors desperate for yield.
High-dividend and low-volatility assets including FXG and XLP (consumer staples), IYR and RWR (REITs), XLU, IDU, FXU, and VPU (utilities), along with TLT and ZROZ (long-dated U.S. Treasuries) have been among the second-best performers of 2016. They have also been among the top winners of the past five years. Many of those who have retired or who need to pay their monthly expenses have become overly dependent upon income-producing investments to generate yield. That’s fine as long as high-dividend assets are either bargains or reasonably priced, but it creates a dangerous situation when they are trading at all-time highs even compared with previous historic peaks. There have been all-time record inflows into high-dividend and low-volatility funds which have far outpaced their previous records. A person who has retired with a half million or a million dollars might perceive that he or she “needs income” in order to maintain a basic lifestyle, and most of these investors don’t realize that if everyone goes to their financial advisors and wants the same level of “safe” income then they are all going to end up owning the exact same assets. What would be reasonable for a tiny minority of investors has become an inevitable catastrophe since millions of others are acting similarly without realizing the consequences of collectively being in such an overcrowded trade.
The inflation trade has only been in a bull market since January 20, 2016, and has a long way to go to recover its losses since April 2011.
Unlike most high-dividend assets which had bottomed in the first quarter of 2009, most commodity producers and emerging markets had been in severe downtrends from April 2011 through January 20, 2016, and even after their subsequent strong rebounds remain far below their previous peaks. Earlier this year, many of these assets completed multi-decade nadirs, with some of them touching levels not seen since the 1970s. Therefore, they remain substantially below fair value. Silver and gold mining shares including GDXJ, SIL, GLDX, SILJ, and GDX have tripled on average in just over a half year, and have thereby outpaced nearly all energy producers which had initially rallied but have gone out of favor along with most emerging-market equities during the past several weeks. This has created the best bargains for those assets which are in the process of completing important higher lows including URA (uranium), GXG (Colombia), FCG (natural gas), and FENY, a more diversified and less volatile fund of energy producers.
The Daily Sentiment Index for crude oil, indicating the percentage of traders who are bullish toward any asset, plummeted to 10% at the close on Monday, August 1, 2016. This is an incredibly low level for anything which is in a primary bull market, as energy commodities have been since February 11, 2016. The shares of energy producers mostly approached or reached multi-decade bottoms on January 20, 2016. Whenever it is possible to buy at higher lows during a major uptrend, this is ideal because a sequence of several higher lows is often followed by an accelerated rally.
The high-dividend and low-volatility bull markets are very stale and incredibly popular, while few know about the uptrends for commodity producers or emerging markets.
Almost everyone knows that high-dividend shares have been the biggest winners of the past several years and are still eager to jump aboard the bandwagon, while few realize how overcrowded this bandwagon has become. Historically, the most wildly trendy and popular trades have always proven to be disappointing. Although it is rarely compared with the internet bubble of 1999-2000, the Nifty Fifty overvaluation of 1972-1973, or the blue-chip top of 1929, high-dividend and low-volatility names have become the bubble of the decade. The total assets in USMV, a frequently-touted low-volatility fund, have tripled in one year. Just as in 2000, almost no one who has invested in these securities realizes that they can lose half or more of their money. Almost no analysts, even those who know how overvalued these popular securities have become, can emotionally imagine them plummeting. They might know intellectually that it is possible, but they can’t really imagine it happening any more than anyone at the beginning of the century could envision the Nasdaq plunging by more than 75% within three years. Alas, a similar fate awaits those who are participating in high-dividend and low-volatility shares and funds.
Just because you’re in the water to get exercise doesn’t mean you can ignore the great white sharks.
When I point out the dangerous of owning high-dividend and low-volatility shares, I often hear the refrain that “I’m not in these due to their extreme popularity” or “I only own these to generate the income I need to pay my expenses.” The market won’t treat you differently just because your motivations are allegedly pure. You might be the nicest person on your block, you might generously donate to charities, and you might frequently help old ladies to cross busy streets. Even if you’re swimming in the water just to get your daily exercise, you’re not magically exempt from being eaten by hungry great white sharks that are lurking nearby. If any given trade has become desperately overcrowded, then no matter why you’re involved in it, you’re going to be as badly hurt as the ignorant buyer who is doing it to keep up with his poorly-informed friends. As Warren Buffett has stated, when we strip off the clothing and pretense, we’re all fully exposed underneath. When the U.S. housing bubble collapsed in 2006-2011, as it about to do again in 2016-2021, it won’t spare those who are nice to animals or who do good deeds. I will discuss real estate in more detail in the near future.
Myrmikan’s error in 2011 was an underappreciation of the forces the central banks brought to bear to reverse the credit collapse. Quantitative Easing was the least of the tools: it was the trillions of dollars of guarantees and the suspension of market-tomarket accounting that allowed the banks to puff the bubble even larger. And, there may remain policies that can lead into another round of even greater insanity, which would weigh on gold. Former Chairman Ben Bernanke, for example, recently traveled to Japan to educate them on “helicopter money.” According to Bloomberg, Bernanke suggested the government issue non-marketable, perpetual bonds with no maturity date and that the Bank of Japan directly buy them.
Sunridge Gold Corp. (SGC:TSX.V; SGCNF:OTCQX), which has a project in Eritrea that is getting sold to a Chinese entity. On a per share basis a shareholder will get about $0.35/share in cash or more payable in two tranches. It was trading at about $0.28/0.29 today in early February, and that offers about 30% upside. The deal has been voted on and accepted. See terms announced here:
From his introduction to Capital Returns: Investing Through the Capital Cycle: A Money Manager’s Reports 2002-15, which was released in hardcover today (Dec. 2015):
Typically, capital is attracted into high-return businesses and leaves when returns fall below the cost of capital. This process is not static, but cyclical – there is constant flux. The inflow of capital leads to new investment, which over time increases capacity in the sector and eventually pushes down returns. Conversely, when returns are low, capital exits and capacity is reduced; over time, then, profitability recovers. From the perspective of the wider economy, this cycle resembles Schumpeter’s process of “creative destruction” – as the function of the bust, which follows the boom, is to clear away the misallocation of capital that has occurred during the upswing.
The key to the “capital cycle” approach – the term Marathon uses to describe its investment analysis – is to understand how changes in the amount of capital employed within an industry are likely to impact upon future returns. Or put another way, capital cycle analysis looks at how the competitive position of a company is affected by changes in the industry’s supply side. In his book, Competitive Advantage, Professor Michael Porter of the Harvard Business School writes that the “essence of formulating competitive strategy is relating a company to its environment.” Porter famously described the “five forces” which impact on a firm’s competitive advantage: the bargaining power of suppliers and of buyers, the threat of substitution, the degree of rivalry among existing firms and the threat of new entrants. Capital cycle analysis is really about how competitive advantage changes over time, viewed from an investor’s perspective.