What’s Working in 2011?

2011 has been a rough year for investors.  Stocks, as measured by the S&P 500, are down nearly 8% for the year and down 14% from the April highs.  And while 14% may not sound like all that much in the grand scheme of things, investors felt every point in a surge of volatility that brought back discomforting memories of the 2008 meltdown in which the major stock indices lost half their value.

Still, some market sectors fared better than others.  Let’s take a look at Figure 1.

Figure 1

Three sectors are in the black year to date—utilities ($XLU), consumer staples ($XLP), and health care ($XLV).  (Note: these figures do not include dividends.)  Consumer discretionaries ($XLY), technology ($XLK), and telecom ($IYZ) are down for the year, though less than the broader market.  After that, it gets ugly.  Energy ($XLE) industrials ($XLI) are down 10% and 14%, respectively, but the real losers for the year have been materials ($XLM) and financials ($XLF)—down 18% and 23%, respectively.

Investors who underweighted the highly-cyclical sectors and focused instead on the less-sexy, dividend-paying value plays haven’t had a bad year.

So WHAT if I bet the farm on banks and gold?

But what is remarkable about this year’s correction is that so few investors seemed to see it coming, and this included high-profile professionals.  John Paulson, the hero of 2008 who used the subprime meltdown to make the most successful trade in history, has had an abysmal year.  Due primarily to his overweighting to financials and materials—the two worst-performing sectors by a wide margin—Paulson’s flagship fund was down by as much as 40% this year. (See John Paulson’s portfolio holdings here.)  And over the past two weeks, his largest single holding—gold—has taken a tumble and may have much further to fall. (see “Is It Time to Call a Top in Gold?”)

No investor should be judged by a single nine-month period, and perhaps Paulson will ultimately prove to be “right” about financials.  Many banks appear cheap on paper, and sentiment is almost universally bearish towards them.  It’s entirely possible that he will eventually recoup the losses he took this year.

Still, Paulson’s heavy losses on his leveraged, concentrated portfolio should stand as a warning to investors.  Paulson ignored low-hanging fruit that was ripe for the picking—such as telecom and pharmaceutical shares trading at multi-decade lows based on earnings and dividends—and instead swung for the fences with a massive leveraged bet on an inflationary expansion.  Paulson risked his career and the wealth and livelihood of his clients without ever asking that all-important question: “What if I’m Wrong?”

Sir John Templeton

There is nothing wrong with betting big on a concentrated position.  Great value investors like Warren Buffett have made careers of doing so, and over-diversification is a recipe for mediocrity.   As the great Sir John Templeton said, “By definition, you can’t outperform the market if you buy the market.”

But the second half of Sir John’s quote is also quite illuminating: And chances are if you buy what everyone is buying you will do so only after it is already overpriced.”

If you’re going to take a large, concentrated position, two conditions should be met:

  1. You stand to make a bundle if you’re right.
  2. You won’t lose your shirt if you’re wrong.
Mohnish Pabrai

Value investor and financial guru Mohnish Pabrai  compares the investment decision to a coin toss in which “Heads I win; tails I don’t lose too much.”  I tip my hat to Mr. Pabrai, and I only wish I had thought of that quote first.

Unfortunately for his investors, Mr. Paulson did not apply the same logic.  He loaded up on gold after it had already been in a bull market for the better part of a decade and had become trendy.  And he bet big on financials even after watching what happened to them in 2008.  He swung for the fences…and struck out.

If you liked this article by Sizemore Insights, you’d probably enjoy The Sizemore Investment Letter, our premium members-only newsletter. Click here for more information.

The Myth of Commodities Investment

One of the oft-cited reasons for investing in commodities is that they have historical returns comparable to stocks while having a low correlation to the stock market. The problem is that this statement is patently false.

One of the oft-cited reasons for investing in commodities is that they have historical returns comparable to stocks while having a low correlation to the stock market. The problem is that this statement is patently false.

Yes, commodities used to have low correlations to stocks. But that was before the era of “financialization” and securitization.

In their 2011 paper “Index Investment and Financialization of Commodities,” Princeton University Professor Wei Xiong and Renmin University of China Professor Ke Tang prove empirically what many of us in the profession have long suspected: Commodities and commodity stocks are becoming more highly correlated to each other and to other asset classes.

Furthermore, while the prices of individual commodities have always been volatile, commodity prices as a whole have also become far more volatile in recent years.

The question begs to be asked: Why? Continue reading “The Myth of Commodities Investment”

The Running of the Bulls

The Sizemore Investment Letter, is committed to avoiding these kinds of behavioral traps by focusing on macro trends with staying power.

The following is an excerpt from the July issue of The Sizemore Investment Letter.

You will have to pardon me if I am a little sentimental this month. You see, dear reader, it is that time of year again. July 6 marks the beginning of the Feria de San Fermin. For one full week, thousands of otherwise sensible young men—and plenty of not-so young men too—will throw reason and commonsense to the wind to run with the bulls through the streets of Pamplona.

There is a widespread—and false—belief that the boys who participate in the encierro are drunk. Surely, no sober person would do something as phenomenally stupid as run in front of a 2,000-pound charging bull. Yet sober they are. The running of the bulls kicks off at 8:00 am, and at that hour the drunks are still passed out in the park from the excesses of the night before.

Why do they do it?
Continue reading “The Running of the Bulls”

The Luxury Toilet and the Rise of the Affluent Chinese Consumer

In the interconnected web of the global economy, the rise of China has been one of the biggest drivers of the decade-long bull market in energy and commodities. But China is also making its presence felt in other less obvious areas of the economy. Yes, it would appear that affluent Chinese are driving a global boom in luxury bathrooms.

Kohler, the American plumbing fixtures manufacturer, now sells the $6,400 Numi luxury toilet (see photo). Driven by the demanding tastes of China’s newly wealthy, the Numi features a heated footrest and a “sleek iTouch style remote,” according to the Financial Times, that controls an internal music system, the adjustable bidet, and the temperature of the seat. It also allows the user to play video games, read e-books, and call friends on Skype. The press release didn’t elaborate on whether or not Skype’s video conferencing features are enabled; I sincerely hope that they are not.
Continue reading “The Luxury Toilet and the Rise of the Affluent Chinese Consumer”

3 Myths That Will Pop the Gold Bubble

Gold prices topped $1,500 per ounce yesterday, just days after Standard & Poor’s roiled the equity and bond markets by lowering its outlook on the AAA credit rating of the U.S. government. After a decade in which stocks went nowhere and the U.S. dollar lost value to every world currency except the Zimbabwean dollar, many Americans are ready to give up on the entire system. Quite a few already have.

After watching gold more than quadruple in value, investors might be tempted to wash their hands of financial assets altogether, convert their savings to gold bars, and bury it in their backyards. But frankly, I cannot fathom a worse idea.

Gold today is as risky as tech stock in 1999 and Miami condos in 2005, and the arguments supporting its rise are every bit as flimsy. Let’s take a look at some of these arguments and how they stand up to a brief reality check.
Continue reading “3 Myths That Will Pop the Gold Bubble”