Elon Musk Is Now Richer Than Warren Buffett

I’ve been writing a lot about Warren Buffett these days. Perhaps I’m looking for a little sanity in a world that seems to have gone insane. The Oracle is certainly one to put things in perspective.

But adding to that long list insanity, last week Elon Musk passed Warren Buffett on the list of the world’s richest people. Musk’s company – leading electric car maker Tesla (Nasdaq: TSLA) – is up nearly 300% this year, which helped catapult Musk into the spot of the world’s seventh-richest person.

I like Elon Musk. As a fun fact, Robert Downey, Jr. modeled his Iron Man / Tony Stark character on him. I could imagine Musk building his own weaponized robot suit to fight the forces of evil.

But he shouldn’t be the world’s seventh-richest man. And Tesla shouldn’t be worth $290 billion. To put that in perspective, that’s more than six times as large as Honda Motor Company (NYSE: HMC) and more than eight times as large as General Motors (NYSE: GM).

I get it. Tesla isn’t an old economy car company. It’s a new economy tech company that happens to make cars. Or at least that’s the justification investors are using today.

But this story goes far beyond Tesla and its would-be superhero CEO. Tesla is a particularly nutty case of market insanity because it’s never turned a consistent profit in its 10 years as a public company. But there are signs everywhere that the U.S. stock market, let by tech stocks, are in a bubble.

I’m not calling the top just yet. If the recent surge of virus cases and the threat of a new round of quarantines hasn’t killed the bull market, I don’t know what will. But I think it’s important to have a game plan for when all of this ends. So, let’s go through a quick checklist.

Check Your Allocation

Unless you’re fresh out of college and just starting your career, you shouldn’t have all of your money in stocks. There’s nothing wrong with using a buy-and-hold strategy, of course. But even if you’re buying and holding, there’s room for regular rebalancing. If you’re in or near retirement, you probably shouldn’t have more than 60% in stocks, and I think you could make a case for having a lot less than that today given stock valuations.

So, check your allocation. If you’re a little too heavy in stocks, consider selling down your portfolio to a level that makes sense.

Value is Dead… at Least for Now

I’m a value investor at heart, so it pains me to say this. But value investing really is dead for now. Value investing has trailed growth investing for over a decade, and the coronavirus has actually made this trend worse. Tech growth stocks tend to be the most “virus proof,” whereas a lot of value stocks have been hit particularly hard by forced closures.

This will turn… eventually. At some point, investors will come to realize that value stocks are too cheap to ignore and tech stocks are priced for unrealistic growth. But I don’t see any catalyst in the immediate future to make that happen. So, at least for the time being, don’t try to be a hero and call the bottom in value.

Don’t be Afraid of Momentum

John Maynard Keynes famously commented that the market can stay irrational longer than you can stay solvent. We have no idea how much higher this bubble has to go before it ultimately bursts. Alan Greenspan talked about “irrational exuberance” in 1996, and the market went on to rally for nearly four more years.

It may be irrational. But it’s also perfectly fine to ride it higher so long as you have rules in place for selling.

That’s the key. Have selling rules in place and actually follow them. If you set a 10% stop loss (or whatever you use to manage risk), you have to actually honor it or it’s useless.

The 60/40 May Be Dead, but the ‘Permanent Portfolio’ Is Worth Revisiting

I wrote a few months ago that the 60/40 portfolio is dead.

“Dead” might have been a little harsh, but with bond yields as low as they are today and stocks close to hitting new all-time highs, a portfolio that is invested 60% in stocks and 40% in bonds isn’t likely to generate the kind of returns we’ve come to expect.

But what about that old relic of the 1980s, the Permanent Portfolio?

The Permanent Portfolio was a concept popularized by the late Harry Browne, a writer, investment adviser and two-time Libertarian presidential candidate. The portfolio is simple yet elegant. Because you can’t know with perfect foresight what sort of economy you’ll be living in, you have to plan for everything: inflation, deflation and everything in between.

Browne divided his Permanent Portfolio into four equal parts: stocks, long-term bonds, cash and gold, and he rebalanced it annually with the idea that there’s always a bull market in something.

Stocks tend to do best during times of stable prices and solid economic growth. Long-term bonds do best during times of falling inflation and during recessions. Gold is a natural inflation hedge and does best during times of rising prices or currency instability. And cash is the ultimate crisis hedge, giving you that all-important dry powder when you need it.

The Proper Permanent Portfolio Allocation

The Permanent Portfolio is simple. You can put it together with just four ETFs: The Vanguard Total Stock Market Index Fund ETF (VTI), the iShares 20+ Treasury Bond ETF (TLT), the SPDR Gold Shares (GLD) and the SPDR Bloomberg Barclays 1-3 Month T-Bill ETF (BIL), a substitute for cash.

Once a year, you sell down the ETFs that have moved above their 25% weight and buy more of the ETFs that have drifted before. The idea is that the Permanent Portfolio will always have you buying low and selling high.

That sounds good. But does it work in the wild?

Indeed it does.

In the six months up to May 31, the Permanent Portfolio based on these ETFs returned 8.5%. You would have never known there was a world-ending pandemic just a few months ago.

Over the past three, five and 10 years, the Permanent Portfolio would have returned 8.8%, 6.8% and 6.7%, respectively.

Now let me be clear: The Permanent Portfolio is not perfect.

It’s completely arbitrary to set each portfolio weighting at exactly 25%, and 25% allocated to cash is an awful lot of permanent dry power for most investors. It wouldn’t be hard to build a better mousetrap based on the same basic principles, and that’s exactly what Ray Dalio did to grow his firm Bridgewater into the largest alternatives manager in the world.

Dalio’s $160 billion hedge fund essentially just runs a more sophisticated version of Browne’s Permanent Portfolio.

That said, there are a couple of aspects of Browne’s portfolio that I think are particularly well-suited for this climate.

To start, it’s really heavy in gold. With the Fed essentially determined to print its way out of the COVID-19 crisis, I think it’s very likely we get inflation and dollar instability in the coming years, which is wildly bullish for gold.

I also expect a lot of volatility in the months ahead. So, that large 25% cash cushion suddenly seems a lot more reasonable.

I would recommend deviating from the standard Permanent Portfolio in one key way, however. Be willing to rebalance more often than once per year. An epic market crash like March of this year would have been a fantastic time to rebalance and put some of that cash to work.

Charles Lewis Sizemore, CFA is the principal of Sizemore Capital Management, an RIA based in Dallas, Texas.

How Diversification Works

I’m going to let you in on a little secret. For the first time in my investing career, I’m aggressively adding gold to my portfolio.

I’m not betting the farm on it, and I still have most of my cash in stock and options trading strategies. But in today’s macro climate, I think it only makes sense to add the yellow metal to the mix.

This brings up one of the most misunderstood concepts in investing: diversification. Today, we’re going to discuss how diversification works.

How Diversification Works

You understand the timeless wisdom of not putting all of your eggs in one basket. And that’s certainly a big part of how diversification works. But it’s more than that.

It comes down to correlation, or the degree to which two stocks or strategies move together. A correlation of one means the two move together in lockstep. A correlation of zero means they don’t move together at all.

And a correlation below zero means they actually move in opposite directions — when one goes up, the other goes down.

If you’re diversifying the right way, you’re looking for correlations as close to 0 as possible. But anything less than one is helpful.

And here’s why.

When you invest in multiple strategies that aren’t tightly correlated with each other, your risk and returns are not the average risk and return of the individual strategies. The sum is actually greater than the parts. You get more return for a given level of risk, or less risk for a given level of return.

Take a look at the graph below.

how diversification works

This is a hypothetical scenario, so don’t focus on the precise numbers. I literally just made them up. But know that it does work like this in the real world.

Strategy A is a low-risk, low-return strategy. Strategy B is higher return, higher risk.

In a world where strategies A and B are perfectly correlated (they move up and down together), any combination of the two would be a simple average.

If A returned 2% with 8% volatility and B returned 11% with 16% volatility, a portfolio invested 50/50 between the two would have returns of 6.5% with 12% volatility.

That is what you see with the straight line connecting A and B. Any combination of the two portfolios would fall along that line (assuming perfect correlation).

But if they are not perfectly correlated (they move at least somewhat independently), you get a curve. And the less correlation, the further the curve gets pushed out, meaning more return for a given level of risk.

The dot on the curve shows an expected return of about 8% and risk (or volatility) of 10%. On the straight line, that 8% curve would have volatility of about 14%, not 10%. And accepting 10% volatility would only get you a return of about 4% on the straight line.

This is why you diversify among strategies. Running multiple good strategies at the same time lowers your overall risk, and boosts your returns. The key is finding good strategies that are independent.

Running the same basic strategy five slightly different ways isn’t how real diversification works, and neither is owning five different index funds in your 401(k). Diversification is useless if all of your assets end up rising and falling together.

Active trading strategies can also offer the same benefits. You don’t have to dump your index funds and embrace active trading.

But incorporating a little active trading into the mix can actually lower your overall risk… so long as your trading doesn’t move in lockstep with the market!

Charles Lewis Sizemore, CFA is the principal of Sizemore Capital Management, a registered investment adviser based in Dallas, Texas.

The Best Chinese Stocks to Buy and Hold

The following is an excerpt from The 10 Best Chinese Stocks You Can Buy.

This a precarious time to be investing in China. But many Chinese stocks, particularly in the technology and service sectors, look attractive if you’re willing to deal with some volatility.

Even before the coronavirus outbreak, which originated in Wuhan province, relations between China and the West were strained. The U.S. and China have been engaged in a tit-for-tat trade war for most of the Trump presidency, and there is widespread fear in Western capitals that 5G telecom equipment manufactured by Huawei is capable of state espionage.

Trade tensions alone were reason enough to make many investors wary of Chinese stocks. Then the COVID-19 pandemic happened, exposing the risks of a globalized supply chain.

Consider Apple (AAPL). The world’s leading consumer electronics maker has been reporting supply disruptions since February stemming from Chinese factory closures, and JPMorgan recently estimated that the launch of the new iPhone, which usually comes out in September or October, might be delayed by a few months.

Going forward, a lot of companies might be reconsidering the merits of cheap Chinese manufacturing and opt to stay closer to home. But the truth is that China has long evolved past the smokestack stage of development. The country is a major technology and digital entertainment hub, even if the vast majority of its products and services are destined for domestic use.

You have to be careful when investing in Chinese stocks, as shareholder protections aren’t quite up to Western standards. Already this year, major accounting scandals have upended iQIYI (IQ) and Luckin Coffee (LK). But that’s a risk you take when you invest in emerging markets, and that’s why it’s important to diversify and avoid heavy concentration in any single stock.

Here are 10 of the best Chinese stocks on the market right now. Each is poised to do well no matter what happens next in the coronavirus and trade war sagas.

ZTO Express

If you like the idea of owning China’s Amazon, it only makes sense that you would also like the country’s version of United Parcel Service (UPS). Greater demand for e-commerce means greater demand for shipping and delivery services. It really is that simple.

This brings us to ZTO Express (ZTO), the largest player in Chinese express parcel delivery with a market share of 19.1% as of last year. The company has a fleet of more than 7,350 line-haul vehicles serving approximately 30,000 pick-up and delivery centers throughout China.

Like many Chinese stocks over the past few years, ZTO’s growth rates boggle the mind. Parcel volume jumped by 42% last year after jumping by 37% and 38% in 2018 and 2017, respectively. First-quarter 2020 volume figures aren’t available yet, but it’s likely that widespread lockdowns only made ZTO’s services all the more essential. Just understand ZTO might see activity similar to UPS in which a shift in consumer and product mix hamper profits in the short term.

China probably will record its first true recession in decades this year, but you’d never know it by looking at ZTO’s stock price. The shares have continued to push higher all year and are currently at all-time highs.

We don’t know a lot about what comes next in the post-coronavirus world. But it’s safe to assume that in any reality, ZTO and its peers deliver more parcels.

To read the rest of the article, see The 10 Best Chinese Stocks You Can Buy.

When Finance Breaks: Negative Oil Prices

This article first appeared on Money & Markets.

It finally happened.

On Monday, we saw negative oil prices. The price of West Texas intermediate crude oil dipped into below zero and not by a trivial amount. The price of the front month contract fell below negative $40 per barrel.

In movement that should be mathematically impossible, the price fell by 300% in a day. Stop and let that sink in for a moment. Oil producers at these prices are having to pay people to haul the stuff away.

Negative oil prices can’t persist forever, of course. To paraphrase the old joke, oil producers can’t lose money on every sale and then expect to make it up on volume. It doesn’t work like that. Faced with the prospect of a loss, companies simply stop producing until prices improve.

And prices will improve. We saw negative oil prices partly because no one driving and flying while under coronavirus quarantine. There’s so much unneeded crude oil building up, there’s literally nowhere to store it. If you look at futures contracts for later months, prices are positive and healthy.

But some of this also comes down to financial plumbing. Futures contracts are actual agreements to deliver commodities. They’re not just blips on a computer screen. Given that there was only one day to expiration on the May contract, anyone buying was someone who planned to take physical delivery. And as much as I would love to have some oilman pay me $40 per barrel to take his crude away, I would have nowhere to put it and no way to get it there. I can’t just stretch a long hose all the way to Cushing, Oklahoma and fill my swimming pool with the stuff.

So while buyers were few and far between, sellers were abundant. Everyone speculating on oil prices had to sell the contract in order to roll to the next month. And we’re not just talking about wide-eyed speculators. The large crude oil ETFs and ETNs were selling too.

But here’s the deal. Negative oil prices are just the latest instance of the financial markets being broken, and it’s not something that can be explained away by the coronavirus disruptions. Negative interest rates have been with us for years in Japan and Europe, and parts of the U.S. yield curve went negative during the March meltdown. Last year, we even saw the first mortgages with negative interest rates. Homebuyers in Denmark were literally being paid by the bank to borrow money to buy a house.

Negative oil prices and negative interest rates are market perversions. These things shouldn’t happen. Ever.

But they’re happening more often, and there’s a simple reason why. Our policymakers seem to think the cure for a debt problem is more debt… which is a lot like saying the cure for alcoholism is more booze. Sure, it’s a short-term fix. But it’s hard to see that working out over the long-term.

In 2008, the Federal Reserve and its peers lowered short-term rates to zero (or negative rates in some cases) and pushed down longer-term rates with quantitative easing. It arguably helped to goose the economy a little. But it definitely incentivized companies to borrow heavily and buy back their shares. The money was practically free. Why wouldn’t they?

It also inflated the price of homes, making it harder for younger would-be buyers to buy their first property, and helped fuel the income and wealth inequality that made Bernie Sanders a legitimate contender for the presidency.

There’s no way out of this problem. Continuing along this path just makes it worse, yet sobering up and weaning the economy off of debt risks a nasty, multi-year recession that no one wants.

So, what can we do?

As I mentioned recently, I like real estate. It’s a dicey situation today with calls to halt rent payments due to the virus quarantines. But hard assets make sense if you think currency weakness and inflation might be in the cards.

I also like gold as a hedge. I agree with Warren Buffett that gold is mostly useless, but I also believe that having 5% or so of your savings in gold is perfectly rational in this environment.

And lastly, owning shares of the best companies that are the least exposed to financial stability would seem like a no brainer. For the first in years, I’ve been nibbling on Amazon, Alphabet and a host of other big tech names.

Alas, I am not, however, building crude oil storage facilities in my home. I figured that might upset my neighbors.