An Anniversary We’d Prefer to Forget

Men are not always the best about remembering anniversaries, but there are a few that we would all like to forget.  This past Sunday marked the two-year anniversary of the infamous “Flash Crash” of May 6, 2010 that saw the Dow Jones Industrial Average swing by 600 points in 20 minutes. What is perhaps most […]

Men are not always the best about remembering anniversaries, but there are a few that we would all like to forget.  This past Sunday marked the two-year anniversary of the infamous “Flash Crash” of May 6, 2010 that saw the Dow Jones Industrial Average swing by 600 points in 20 minutes.

What is perhaps most remarkable about that incident is that there was never a proper explanation for what happened.  High-velocity “algorithmic” trading is generally credited as the culprit, but what exactly happened?  And what is to prevent it from happening again?  To these questions we have no answers.

The real legacy of the Flash Crash is not the portfolio losses suffered by some investors; in fact, unless you happened to have open stop loss orders that got executed, chances are good that the entire event came and went before you had time to act.

No, the real damage was to Wall Street itself, or rather its reputation.  The Flash Crash made investors cynical, making them feel the market was a casino game rigged against them.   Perhaps never again would they believe that the stock exchanges were what they claim to be: a place for holders of capital to allocate it to businesses deemed worthy of investment.

In truth, the market is a rigged game, and it always has been.  Perhaps we need a good Flash Crash every few years to remind us of that.  But rigged game or not, investors able to keep a level head can still use the market for its ostensible purpose of allocating long-term capital.  Market turbulence is something that can be embraced rather than shunned. 

John Templeton

The late Sir John Templeton had a great strategy for managing volatility and taking his emotions out of the equation.  He would make a list of stocks that he would love to own if only they sold for a substantially cheaper price.  He would then place limit orders to buy them at those prices.  If a wave of panic swept the market, Sir John would not be paralyzed by indecision because the decision had already been made for him.

An investor with a plan like this in place on May 6, 2010 could have made a fortune in a matter of minutes.

A similar strategy that had the added benefit of earning you a little extra income is selling deep out-of-the-money puts on stocks you’d like to own at the right price.  Under normal conditions, your puts will expire worthless and you pocket the premium.  But if prices experience a short-term dip, your options might get exercised, meaning that you would have to buy the shares in question.  Of course, that’s the whole idea.  You’d be buying shares of a company you always wanted to own at a price you weren’t expecting to get.

These strategies work fine for buying on the cheap, but what about investors that use stop loss orders for risk management purposes?  I will address that, but first I want to ask a question: would you knowingly play a game of poker if you knew the other players could see your cards?

You most assuredly would not.  But when you place stop loss orders, you have effectively done exactly that.  Don’t be surprised when the stock price dips just low enough to hit your stop before rallying higher.

I’m not suggesting that investors eschew stop losses; good risk management is essential to prevent small losses from becoming catastrophic ones.  But I am suggesting that you play it close to the vest.  Have your stop losses tracked in an Excel spreadsheet, a website not affiliated with your broker, or even a Post-It note.

Warren Buffett

And finally, while automatic techniques like these are valuable tools, they will never fully replace good old fashioned intestinal fortitude.  An oft-quoted line from Warren Buffett is to “be greedy when others are fearful.”

Today, investors are fearful about Europe, which has me feeling more than a little greedy.  I’ve recommended Spanish telecom giant Telefonica (NYSE:$TEF) in these pages before (see “Investing Lessons from Peru”), and I would like to reiterate that recommendation again today.

Telefonica is one of the finest, most globally-diversified telecom firms in operation today, and long after the current crisis has passed it will be routing telephone calls and paying its investors a fat dividend.  Use any turbulence in the months ahead as an opportunity to accumulate more shares.

Disclosure: Telefonica is held by Sizemore Capital clients and is a holding of the Sizemore Investment Letter Portfolio.

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The Land of the Setting Sun

The rating agency lowered Japan to “AA-,” citing Tokyo’s lack of a coherent strategy for dealing with its soaring debt, which now stands at 200% of GDP.

Japan’s sovereign credit rating was downgraded by Standard & Poor’s in January. The rating agency lowered Japan to “AA-,” citing Tokyo’s lack of a coherent strategy for dealing with its soaring debt, which now stands at 200% of GDP.

For perspective consider that the American federal debt, which is high enough to prompt a government-paralyzing standoff between Congress and the White House, is less than half of that percentage. Yes, Japan owes a lot of money, and the bond ratings agencies are finally starting to question whether it will be repaid.

News of Japan’s downgrade will come as no surprise to long-time readers. Japan is slowly dying.
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The Arab Spring and Demographics

In January, the world watched in shock as a 26-year-old Tunisian fruit vendor lit himself on fire to protest the regime of Zine El Abidine Ben Ali and sparked a revolution that spread across the Middle East like wildfire—today even threatening governments thought to be untouchable, like the Baathist Assad Regime in Syria.

Shortly after the fall of Tunisia’s strongman, Egypt’s idealistic youth toppled the 30-year dictatorship of Hosni Mubarak with a peaceful show of resolve. With the army now in control of the country—and promising free elections—it remains to be seen how events will ultimately unfold. Jeffersonian democracy may spontaneously bloom in the desert, or—more likely—an authoritarian regime not materially different from that of Mubarak might emerge after a period of instability. Only time will tell, but we certainly wish the best for the Egyptian people in this exciting period in their history.

Today we’re going to take a look at the demographics of Egypt and of some of the country’s neighbors in the Middle East. Some of the conclusions drawn will surprise you. First, much is made of the fact that Egypt is a “young country” with the majority of its population younger than 25. But what the media doesn’t understand is that Egypt is actually much older today than it was just ten years ago and that the country is aging rapidly.

Much is also made of the fact that the Arab and Muslim world has high birthrates compared to the United States and Europe; but this too is changing. Egypt’s current birthrate, though still relatively high by world standards, is less than half the rate of the early 1990s.

Continue reading “The Arab Spring and Demographics”

Review of John Mauldin’s Endgame

Endgame: The End of the Debt SuperCycle and How It Changes Everything

“What were we thinking?” ask John Mauldin and Jonathan Tepper in the introduction to their latest book.“In a way, we acted like teenagers. We made the easy choice, not thinking of the consequences. We never absorbed the lessons of the depression from our grandparents. We quickly forgot the sobering malaise of the 1970s… We created liar loans, no-money-down loans, and no-documentation loans and expected them to act the same way that mortgages had in the past… Where were the adults supervising the sandbox?”

In Endgame: the End of the Debt Supercycle and How it Changes Everything, Mauldin and Tepper pull no punches and get directly to the point. The crisis of 2008 represented a “massive reset of the global economy.” Americans, their financiers, and their elected representatives made a series of irresponsible decisions (or perhaps more accurately failed to make responsible decisions) over the past thirty years that culminated in the greatest financial crisis in a century. We weren’t alone, of course. Our counterparts in Japan, Europe, and much of the rest of the world made equally poor decisions. And now, we are left with large debts and no good choices.

Regardless of what our policymakers do, we are looking at a decade of slow growth, high unemployment, and on-again / off-again recessions. The 2008-2009 crisis did not create a garden-variety “business-cycle recession.” It gave us a much more malignant “balance-sheet recession” characterized by a long period of debt reduction.
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