Yesterday, the Dow rose another 165 points – or about 1%.
No pre-Christmas panic this year.
Tomorrow, we will reach into the archives for a visit with Christmas Past.
Today, however, we give you a little Christmas Present.
A grotesque world
We have been trying to understand the Fed’s position…and its new ‘tightening’ cycle.
The Fed is trapped, we concluded.
When adverse conditions appear — a bear market or a recession — it won’t be able to stay the course.
Since adverse conditions are guaranteed, sooner or later, the Fed can never return to ‘normal’. It has created a grotesque financial world.
Now, it will have to live with it…and be destroyed by its own monster.
Faced with a new crisis, it will bring out new ‘tools,’ new tricks, new experiments. These will be merely variations on the fundamental magic — creating money out of thin air.
Exactly how, when, and to what effect will this develop?
We wish we knew! But it is bound to be exciting.
Another depression? Dow 50,000? A pack of gum for $25?
Anything is possible.
Put on your seat belts. Sock away some Krugerrands. Offer your neighbours some Christmas cookies and eggnog. What else can you do?!
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Diehards and lost causes
But here’s another Christmas present…
It’s nothing new. And we didn’t spend a lot of money on it. But it’s the thought that counts.
When you go to buy a stock, you might ask yourself: Is this stock likely to go up?
But that’s the wrong question.
You don’t know whether it will go up or not. No point pretending.
The right question: Has this stock gone down enough?
Now, we’re getting somewhere. Now, we’re harnessing our natural, very becoming modesty and putting our ignorance to work for us. We don’t know the future. But we can know the past.
And it is not for nothing that we are a friend to underdogs, diehards, and lost causes. It pays!
Thirty years ago, at an investment conference, there was a scalawag analyst from Germany. He showed a chart where a stock had gone up steadily for 10 years. He pointed to the bottom, left side, and in a thick accent explained his system:
‘Ja, you see, down heer? Vee buy.’
Then, pointing the upper right hand corner opposite…
‘Und up heer, vee sell. Zat vay vee never lose money.’
A hand went up. A listener had a question:
‘But what happens if the stock doesn’t go up?’
‘Ah, zen,’ he replied without a moment’s hesitation, ‘vee don’t buy it.’
He was right. The winning formula is ‘Buy low. Sell high.’ And there’s only one side of that formula you can completely control: buying low.
The way to make money from investments, above all else, is to buy the losers, not the winners.
Everybody stumbles. So the longer you see some hotshot walk down the street without stumbling, the greater your certainty that there’s a banana peel waiting for him.
What you want are stocks that have already stumbled. Not ones that have some kind of serious motor problem…not cripples…not brain damaged…not derelict companies or defunct technology stocks.
Of course, you want normal companies in decent health…but which have had a string of bad luck, or made some bad ‘life choices’ and are now getting themselves back together.
You want something that is cheap.
Dust on its jeans
Near the beginning of last year, we looked around for a stock market with dust on its jeans. Almost everything was absurdly smug, upright, and expensive, in our opinion.
But we found one exception: Russian stocks.
‘…cheap on all measures,’ we wrote last March, ‘…the most value you can get.’
We suggested a trade: Sell US stocks. Buy Russian stocks.
So, how would you have made out if you’d bought Russian stocks? We put the question to Bonner & Partners researcher Chad Champion.
Bill: ‘So Chad, Russia has done reasonably well. If someone had taken my suggestion and bought a Russian stock market ETF, how much would they have made?’
Chad: ‘Uh…Bill…I hate to tell you this, but they would be down 14%. That’s about 10% more than the S&P 500.’
Bill: ‘Well, never mind.’
Of course, you gotta give it time!
Generally, buying cheap is the way to go.
And ‘quant’ investor Mebane Faber, of Cambria Investment Management, proved it.
Faber did a study over, roughly, the last 100 years. He wanted to know what happened when the stock market fell on its face. Specifically, after stocks had gone down for three consecutive years… what next?
A year or two is usually all it takes to correct mispricing. So, a three-year slide is rare. But when it happens, there is almost always a powerful bull market afterward, with average gain in the fourth year of 30%.
Faber further studied industry groups, sectors, and overseas stock markets. Everywhere, he found the same phenomenon: When a market had gone down enough, it was ready for a big move to the upside.
When U.S. industry sectors, for example, had dropped 80% or more, the average return over the next three years was 170%.
Foreign stock markets: Same thing. If they went down 80% or more, they’d have an average gain of 118% three years later.
So, what is down 80%? What’s despised? Where are the losers? Gold? Commodities? Emerging markets?
Here’s one that stands out: Greece.
Talk about a loser!
Greek stocks are down 98% since 2007 in U.S. dollar terms. That is a record of investment failure and extreme loss that is hard to beat. What are the odds that Greek stocks will be substantially higher three years from now?
We don’t know. Wrong question. All we know is that you get a lot of stock for your money. That’s all we really know. And all we need to know.
The dividend yield on the Russian stock market is about 4% to 5%. And the average Russian stock is selling at about half its liquidation value, with the market down from 2008 even in ruble terms.
Russian stocks may not rise in 2016. Or 2017. But they’re bound to go up sometime.
And if they don’t…
…don’t buy them.
Merry Christmas…or happy holidays — as you prefer.
For The Daily Reckoning, Australia