Category Archives: Investiv Daily

image

Is There A Second Chance For 3D Printing?


  • 3D printing stocks are back to the pre-3D printing stock boom.
  • The future of 3D printing looks too good to be true.
  • Microsoft is an example of how it is also a good idea to wait and invest only when the trend is really confirmed.

Introduction

3D printing isn’t currently in fashion in the investing world, but it serves as a perfect example of how investors’ excitement about uncertain future prospects can fuel an incredible stock boom that quickly fades as fundamentals don’t support the excitement.

The most widely known 3D printing stocks are 3D Systems Corporation (NYSE: DDD) and Stratasys (NASDAQ: SSYS) which have a current market capitalization of $1.8 billion and $1.2 billion respectively. Both stocks were booming in 2013, with DDD surging 800% and SSYS 500%, only to fall below their 2011 levels in February 2016 and then surge again. Investors who invested in 2011 and sold in 2013 made great profits, but those who invested around the peak, when the biggest volumes we’re traded, saw huge losses.

Figure 1 3D printing stocks
Figure 1: 3D printing stocks in the last 5 years. Source: Yahoo Finance.

Since May, there has been a new but familiar player in the 3D printing industry. HP Inc. (NYSE: HPQ), the hardware part of the recent HP split, announced its first two 3D printers. The market’s reaction to this unveiling has been minimal which only makes the 3D printing story more interesting.

3D printing will certainly be a part of our future and money will be made on it, but the most important thing is not to overpay. Peter Lynch, who we discussed recently, suggests: “When even the analysts are bored, it’s time to start buying.” As we don’t see any Wall Street Journal 3D printing headlines or Cramer screaming about it, this seems like a great time to take a look at what 3D printing is and see if it is or will ever be a good, low risk – high return investing opportunity.

Overview of 3D Printing 

3D printing is also known as additive manufacturing. It turns digital 3D models into solid objects by building them up in layers.

The technology is not new. It was invented in the 1980s and has been mostly used for rapid prototyping. Recently, the industry has evolved and aims to cut out supply chains by producing all the required manufacturing items at the place where you need it via a 3D printer. The stages of 3D printing development haven’t been as smooth as Christopher Barnatt predicted, but we can see in the graph below the areas where 3D printing will most likely grow in the future.

figure 2 explain the future
Figure 3: 3D printing market segment adoption curves. Source: Explaining The Future.

3D Printing:  The Current Situation

The current situation in 3D printing isn’t stellar as both DDD and SYSS have seen their revenues decline. This could be due to the fact that general business investments have been down in the last few quarters or because 3D printing is not yet what it was expected to be.

In comparison to 2014, revenues didn’t decline much in 2015. Revenues were stable for DDD with a 3% decline in 2015, while revenues declined 8% for SYSS in 2015. Both companies see the current slump as a temporary decline and hope that sooner or later their businesses will thrive. The big reported trailing losses both companies have are due to goodwill impairments as their growth scenarios didn’t materialize.

The new player, HP, plans to revive its business with 3D printers and create a world without waste, warehouses and inventory. You can watch a nice video of what HP sees for the future here.

Conclusion

We have already witnessed one 3D printing investment boom and will probably witness more of them in the future as the 3D printing story seems plausible. However, even if the 3D printing industry gains the kind of traction we believe it can, we don’t know when that will translate into positive returns. The only thing that we can state with certainty is that 3D printing offers a 100 bagger opportunity if the world really adopts 3D printing like the companies believe it will, but you could also lose all of your investment if it doesn’t and the manufacturing world remains as it is.

It’s likely the world will change, as it always has. This would result in another boom in 3D printing stocks. Don’t forget that in the 1990s when PCs were already a pretty normal thing, there was still the possibility to buy Microsoft and have a 20 bagger return over the following 25 years. For reference, MSFT’s price in January 1993 was $2.80 and it is currently is $58.3.

figure 3 msft
Figure 3: MSFT stock price. Source: Google Finance.

Maybe it’s a good idea to wait until things really get traction, but as everything moves much faster these days, maybe it will be too late to make profitable investments if you wait.

If you invested in 3D printing back in 2013 you should definitely think about investing now because the story hasn’t changed, only now the stocks are much cheaper. If you are new to 3D printing, you might want to expose yourself to it with a small part of your portfolio. That way, if you lose, you don’t lose much, but if you win, you win big.

The safest way to take advantage of the next 3D printing boom might be to invest into a company like HPQ which is already an industry-leading and profitable company, and is currently undervalued.

Subscribers to Retirement Revival, a newsletter by Investiv’s Thomas Moore, were issued a recommendation to buy shares in HPQ on January 22, 2016 at $10.41 per share. Today the stock trades at $14.48, a gain of 39% in only 8 months.

In addition to identifying deeply undervalued companies which pay abnormally high dividend yields, like HPQ, subscribers also receive a second income opportunity every month. To learn more about a subscription to Investiv’s Retirement Revival click here.

 

image

If You’re Thinking About Global Diversification, You Should Read This


  • The developed world is depending, and will continue to depend, more and more on the developing world.
  • The focus of productivity and GDP growth is in Asia.
  • The U.S. is the only country with trade deficits since 1976.

Introduction

Nobody knows where the market will go in the next week, month, or year, but what can give investors an edge is to look at macro trends that are bound to influence economies and returns on investments.

In this article we are going to analyze productivity and trade balances among the most important global economic powers, and try to derive a long term trend from it in order to improve the international exposure in our portfolios.

Productivity

Productivity is essential for economic development in the long term, and in the short term is only beaten by credit. But as credit has its cycles in the long term, productivity is what determines if a country is a success or not because credit can only be used up to a point. Productivity is the mechanism through which societies progress.

The issue with productivity is that it is stuck globally. This is because productivity is falling in the U.S. and Japan, slowing down in China, and countries like India still don’t manage to compensate for the declines of these superpowers. However, the trend is clear.

figure 1 productivity
Figure 1: Labor productivity growth rates. Source: Conference Board.

The trend shows how the largest global productivity and GDP growth comes from Asia with some bright spots in Africa. As Africa is still undiscovered as an investment opportunity and complicated to invest in, it is good to focus on Asia for international long term diversification.

Higher productivity means that people are achieving more with their own means, education and capital, which improves economics and living standards. This further improves education and healthcare which creates an upward spiral. As Asian countries have a low baseline, there is plenty of room and time for them to develop and grow.

Jim Rogers, co-founder of the famous Quantum Fund with George Soros, is heavily invested in Vietnam. Of course, such an investment is difficult to make as it has many capital constraints at the moment, but it shows you where smart money is going.

A country that is easier to invest in is India, which had a GDP growth rate of 7.3% and productivity growth of 5.2% in 2015. The fact that productivity growth in the U.S. was 0.7% in 2015 and GDP growth was at 2.4% means that GDP growth isn’t exclusively influenced by long term, healthy productivity increases, as is the case in India, but is also greatly influenced by debt. We all know that debt works in cycles, so sooner or later we will see some deleveraging take place that will send the U.S. into a recession, hopefully later than sooner so that we can still enjoy this bull market for a while longer. The situation is the same in Europe; productivity grew at 0.9% while GDP grew at 2.0% in 2015.

Balance of Trade

Among other factors like productivity and credit cycles, the balance of trade (BOT) is a very important factor for assessing the health of an economy. The BOT is often shunned by economist as one country has had a BOT deficit for 41 years and things seem to still go pretty well there. We are of course talking about the U.S. which saw its last trade surplus in 1976.

figure 2 U.s. balance of trade
Figure 2: U.S. BOT. Source: Trading Economics.

This means one thing: the U.S. is spending more than it is producing which is not news, but is good to have in mind when deciding where to go with your global investments.

Other countries—like the U.K., Canada and Brazil—also have BOT deficits, but they have evened out in the long term with past surpluses, with things being a little bit worse for the U.K.

figure 3 canada
Figure 3: Canada BOT. Source: Trading Economics.

Europe, China and Japan have a surplus in their trade balances.

figure 4 EU balance of trade
Figure 4: Europe BOT. Source: Trading Economics.

BOTs show only one side of the equation where usually net investments cover for the trade deficit. But the current account for the U.S. is also negative.

figure 5 current account
Figure 5: U.S. current account. Source: Trading Economics.

Conclusion

The world will be a very different place in 20 years as global trade, productivity and economic growth shifts from the western world toward Asia. With countries like India and Indonesia reminding us of what China was 20 years ago, we should not be surprised if such a scenario replicates itself in those and other emerging countries.

This doesn’t mean that we should be completely invested in emerging markets, but if we have to choose between a company that has sales only in the U.S. and a company that is selling globally for the same valuation, we ought to go for the global one as global macroeconomic long term trends are clear and unavoidable.

The good news is that emerging markets growth is what will push the currently stuck developed economies forward as increases in global demand will be good for everyone.

 

image

Sunday Edition: The Misunderstood Role of Stock Dividends


In Today’s reprint of Thomas’ Rebel Income newsletter ($1,164 annual subscription), he discusses the often overlooked but incredibly important role dividends play in your overall returns.  

As you’ll see, over the last 25 years, $1 invested in 1990 has grown to almost $10 today including dividends. Whereas that same $1 without dividends has only grown to $6. That’s a 40% difference in overall wealth creation.

In the Rebel Income picks, Thomas always looks to sell put options on fundamentally solid companies that pay strong dividends, since dividends are the single best indicator of true company strength.

Furthermore, a healthy dividend makes it much easier to hold onto stocks, which have been assigned, even if the stock price drops a fair amount below the strike price of the original put option.   

And finally, your overall long-term returns will be much higher once the stock price recovers, and the stock is either sold or called away because of a subsequent covered call trade recommended by Thomas on stocks which have been assigned.  

This three-prong approach is really what sets the Rebel Income system apart from just about any other income generation system. You have the opportunity to get paid 3 or more times on the same stock.  

First from the initial put sell, second from collected dividends, third from covered calls, and finally any capital appreciation on the stock itself.

I believe this is why Thomas has generated near 30% returns over the last two years turning every $100K into $171K as compared to only $112K investing in the S&P 500.

Here’s Thomas:


Week 5: The Misunderstood Role of Stock Dividends

If you’re a student of the stock market, you look for as much information as you can find about different investing methods and systems. Books, newsletters, videos, seminars, classes – you may not use them all, but even if you learn something you don’t end up using, it’s all useful, because it expands the scope of your knowledge, your perspective about the market’s many different possibilities, and your understanding of what fits you best.

One of the things I’ve found interesting over my more than two decades of studying and investing in the stock market is the role dividends can—and in my opinion, should—play in a successful investing system. Directional trading strategies, which usually emphasize relatively short-term trades based on price swings from low to high points that might last anywhere from a few weeks to a few months, tend to ignore dividends altogether, since in many cases you might not actually hold a stock long enough to be counted for a dividend distribution. The same is true of directional investing strategies that focus on equity options, since buying and selling call or put options on a stock will rarely translate to actual ownership of that stock.

Kinds of Stocks that Pay Dividends

Long-term investing concepts usually differentiate between stocks based on the underlying company’s size and scope of business, how much their business has grown in the past and what analyst’s forecast of future growth is likely to be. Large, established and easily recognized companies, like General Electric Co. (GE), Caterpillar Inc. (CAT), and Microsoft Corp (MSFT) among others are referred to as blue-chip stocks; these stocks are usually included in the major market indices including the Dow Jones Industrial Average and the S&P 500. Medium-sized businesses who have been successful at building their businesses but have not yet reached the status or size of a blue-chip stocks are usually called mid-caps, and smaller, up-and-coming companies are called small caps. Depending on how aggressive or conservative you want to be as a stock investor, these different categories present various levels of opportunity as well as risk. Small-cap stocks, who usually have the largest scope of opportunity to grow, generally provide the largest overall growth potential, with mid-caps coming in next, and blue-chips last, since these stocks already have become the 600-lb. gorillas in their respective industries and sectors. In the same way, blue-chips are usually considered to be the safest overall long-term investments, while small-cap stocks are far more speculative since a minority of these up-and-comers ever actually fulfill their potential.

One of the other reasons that blue-chip stocks are considered to carry a higher level of safety comes from the fact that most of them pay a regular dividend to their shareholders. Why do some stocks pay dividends while others don’t? Because companies are naturally allowed to decide what they want to do with their profits. What they actually do with those profits can tell you a lot about the strength of the business and what management thinks about the future. Dividends are one of the simplest and most transparent means companies have to return a portion of their profits back to their shareholders. Smaller, less-established stocks often don’t pay a dividend simply because their profitability can be widely variable from one year to the next. Dividends have to be approved by the company’s board of directors, and they won’t be likely to commit to pay out a portion of their profits if they don’t believe they will be able to maintain a level of profitability that is higher than the dividend.

The most common line of thought suggests that a stock shouldn’t begin to pay a dividend until the business has reached a size and scope of business that makes a dividend easier to maintain. Microsoft Corp, for example, didn’t pay a dividend to its shareholder for almost 20 years after their initial public offering in 1986 despite their domination of the software industry and the mountains of dollars they held in cash. When they finally declared their first dividend in January 2003, MSFT held more than $43 billion in cash; their initial dividend payout was only $864 million of that amount, or about 1.8% of their total cash. To me, this is a good example of why identifying stocks that pay a dividend—even a small one—is so important; it says a lot about management’s confidence in their business as well as recognizing the important role shareholders play in their overall success.

Another interesting aspect of dividends is that while blue-chip stocks are the most likely places you’ll find attractive dividends, it also isn’t unusual to find mid-cap and in some cases, even small-cap stocks that have committed to a consistent dividend payout. I think there is a lot of power in finding these types of stocks, which are even more in the minority than their larger brethren; most of these companies prefer instead to reinvest their profits in their business to keep driving growth. Those that do decide to pay a dividend, in my opinion, are communicating a different level of confidence in themselves and future of their business than those that don’t. They are using the dividend payout to attract shareholders that can buy in to their long-term plan and prospects, which I think is a smart thing. That’s why you’ll see me write about stocks like SLCACBIGME and others as I find them and they meet my other fundamental criteria.

The Real Impact of Dividends Over Time

The fact of the matter is that on an historical basis, dividends have always made up a significant piece of the overall returns the stock market has achieved for decades. As of now, the average dividend yield for all stocks that make up the S&P 500 is 2.02%; the average yield for the past 25 years isn’t too far from that same level, at 2.07%. Over the same period, the index itself has returned an average 11.29% return. If you take dividends out of the equation, that annual return lowers to only about 9.22%. What does that mean in real dollars? Including dividends, $1 invested in January 1990 would grow to almost $10 today; but without dividends, it only grows to a little less than $6. That’s a 40% difference over the last 25 years, and it’s a major reason I include dividends in the criteria I apply to my income generation system.

I get emails quite often from subscribers asking me when I’m going to get out of a stock I’ve been assigned from a put sale that has seen a major drop from the price I was assigned at. My general answer has always been that as long as I see the stock’s fundamentals holding, I will continue to wait for the stock’s price to recover back to my assignment price; my analysis of the company’s business strength still confirms my belief that the value of the stock should be higher than my assignment price. I also want to continue to hold the stock because when it does recover, I should be able to find opportunities to generate even more income with covered calls. Both of these statements are true; but another reason I don’t mind holding these stocks even for an extended period of time is because of the fact I can draw dividend payments from them. Those dividends are extra income I don’t have to do anything to get except to hold the stock before and through the announced ex-dividend date.

It’s true that in general, I don’t expect to hold a stock long enough to see an entire year’s worth of dividend payments on it; even so, the fact that I can enhance my ability to generate income—even if by just a few cents per share—by doing nothing more than emphasizing dividend-paying stocks in my screening process is more than worth the trouble. It is also one more layer of protection I can add to my system, since I can also lower my overall cost in a stock by the per share amount of the dividend.

Dividends vs. Stock Buybacks

Tech stocks, in particular have historically chosen a slightly different tack over paying dividends, which is to implement a large-scale stock buyback program. The result is that shareholders hold fewer shares than before, but also see an increase in the stock price; the increase in buying activity over time will also often create an extra wave of bullish enthusiasm for the stock that inflates the price even higher than the buyback alone would yield. I prefer to look for stocks that pay a regular dividend because it signifies a greater commitment to return value to shareholders on a consistent basis; stock buybacks are really about letting the company maintain flexibility and control over your shares, since the timing of buybacks, how large they are, and what they mean to you is at their complete discretion. With a dividend, you get to decide what to do with the money; you can spend it at your discretion, or you can invest in back in the stock or the market at large.

Another element that can also make a company more attractive from a fundamental standpoint is whether their dividend payout has grown over time, remained static, or decreased. Ideally, dividends should grow as profitability does, and more proactive companies do this either by increasing their regular dividend or by issuing a special dividend on an annual basis. If I’m trying to decide between two different fundamentally strong stocks, this can be a way to delineate between them. Be aware, though that the dividend itself is the main criteria for my income trading system, even if the company has not increased its payout. I also don’t place a lot of emphasis on the size of the dividend, again unless I’m trying to differentiate from multiple candidates.

Dividends provide a strong reason to hold stocks even when they might be in a downward trend. If the company’s fundamentals remain strong, the dividend adds an element of income above and beyond my ability to write covered calls. While there certainly are undervalued, fundamentally strong stocks out there that don’t pay dividends, the presence of a dividend says a lot about that company’s management, their management style, and the relationship they maintain with their shareholders. That’s why dividends are a big part of my system.


As you can see, dividends are critical to achieving long-term returns that far outpace other investing strategies which ignore this important source of income and overall return.  

Thomas’ subscribers recently got paid 9 different times on Archer Daniels Midland (ADM), by selling puts, writing covered calls and collecting dividend income.  

The total cumulative return on this one trade was 15.38% in only 7 months. In today’s zero yield world, those kinds of returns are nothing short of spectacular.  

We understand that at $1,164 per year, Thomas’ Rebel Income newsletter is out of reach for many investors.

That’s why a little over a year ago we asked Thomas to launch a second newsletter called Retirement Revival as a way to introduce investors to income generation through selling puts, writing covered calls and buying high dividend paying undervalued companies.

Retirement Revival is a monthly rather than weekly publication. Each issue contains one put sell recommendation and one undervalued stock pick.

As of now there are 12 open stock positions with the average gain per trade of 9.56% with one stock up more than 38% in less than a year.  

Eight of these stock picks are still in our recommended buy range with several paying dividends between 4% and 5%.

The average gain per put sell has been 2.54% in less than 30 days. Compounded and annualized that works out to be 35.12%.

Thomas is currently offering new Retirement Revival subscribers a 1-year subscription at an introductory rate that’s less than you’d pay for dinner for two at a modest restaurant.

To learn more, click here.  

Regards,

Shane Rawlings
Co-founder, Investiv

image

How Dangerous Is Common Retirement Advice?


  • Things are much different than they were 10 or 20 years ago but everyone seems to follow the same retirement investing advice.
  • As retirees are in need of more security they are now forced into more risk as bonds have become riskier than stocks while also giving a lower yield.
  • If you’re looking for security, cash may be your best bet.

Introduction

You’ve likely heard the advice that as you get closer to retirement you should move toward having a bigger chunk of your portfolio in bonds rather than stocks. Most retirement funds are structured in that way. Vanguard Target Retirement Funds allocate 90% of assets in equities and 10% in bonds if you are going to retire between 2058 and 2062, thus 45 years from now. For those with 20 years until retirement, the division is 80/20. The ratio is 75/25 for those with 15 years, 65/35 for those with 10, 60/40 for those with only 5 years, and 50/50 for those of retirement age. For those in retirement, the division is 64% in bonds and 36% in equities if you’re younger than age 73, and 70% in bonds and 30% in equities if you’re older than 73. You can see this represented in figure 1 below.

figure 1 vanguard asset allocation
Figure 1: Vanguard Target Retirement Fund asset allocation per age group. Source: Vanguard.

The example above follows the standard and traditional retirement advice issued by the majority of financial institutions and retirement specialists. In this article we are going to analyze if that advice still holds up in the current financial environment, what the risks related to it are, and finally, what can be done differently.

Don’t forget that it is a given in the financial world that if an advisor gives the wrong advice but the advice is the same as what the majority does, there will be no negative implications for the advisor’s career if and when things turn for the worse. On the other hand, if you point out risks but nothing happens, your financial career is in jeopardy. Think of the movie The Big Short and the guys shorting A rated credit institutions.

What Has Changed In The Last Two Decades? Bonds.

The common advice outlined above comes from an environment that was significantly different than the one we have today. The first major difference is that yields have gone down and bond prices have gone up in the last 20 years.

figure 2 bond yields
Figure 2: Thirty-year treasury yield. Source: FRED.

The current yield on 30-year treasuries is 2.24%, which is a record low. What is significant is that yields have been declining since 1981 and before that yields had only been increasing.

The declining yields trend pushed bond prices upwards. The net asset value of the iShares 20+ Year Treasury Bond ETF (TLT) has gone from $103 at the end of 2013 to the current price of $140. This means that if yields go back to the levels they were at the end of 2013, of around 4%, the value of 20+ bonds will decline by 29%. It would take more than 10 years for the increase in yields to cover for the decline in value. So, by being long bonds, you are risking a loss of 30% for a yield of 2.24%.

Yes, bond prices can go higher if the U.S. becomes like Japan or Europe where negative interest rates are the new normal, but with the FED contemplating interest rate increases and an employment rate of 4.9%, which is half of Europe’s rate, we could say that the chances are more in favor of higher yields.

The retirement strategy that was formed a long time ago didn’t have to account for global negative interest rates, treasuries yields below 2.5% and the fact that bond yields could jump up or decline 50% in a matter of a year.

figure 3 volatility
Figure 3: Thirty-year treasury yield volatility in the last 5 years. Source: FRED.

What Has Changed In The Last Two Decades? Stocks.

Stocks are in the same asset bubble as bonds. Low bond yields push investors to seek better yields elsewhere. The S&P 500 has a PE ratio of 25.23 which implies a yield from stocks of 3.96% which is, the same as with bonds, the highest level ever reached if we exclude the 2000 tech bubble and the depressed earnings in 2009.

figure 4 s&P 500 multipl
Figure 4: S&P 500 PE ratio. Source: Multpl.

The Shiller PE ratio, which takes into account 10-year earnings averages in order to eliminate cyclical influences, is even worse and at 27.08.

figure 5 shiller
Figure 5: Shiller PE ratio. Source: Multpl.

To put it simply, if bond yields go to 4% and we attach the historical stock premium of 2.29% for stocks, the expected yield from stocks would be 6.29%. With current earnings, it would imply a PE ratio of 15.97 and an S&P 500 value of 1,380, or a decline of 37% from current values. This means that for the current S&P 500 earnings yield of 3.96%, you are risking 37% of your stocks portfolio if the FED reaches its 2% inflation target.

Conclusion

Given the risk versus reward outlined above for both bonds and stocks, one clearly has to be prudent with their savings, especially for those close to retirement. Many retirees watched their retirement savings get cut in half during the last financial crisis and unfortunately it looks like many will go down the same road again because they follow the same old rules without questioning them.

Low yields force investors to hold a greater percentage of their savings in assets that produce some form of yield in order to reach a satisfying retirement income, but if you look at risk as a function of price and not volatility you see that those assets become more and more risky as their prices go up and yield goes down. As we described in our article about Carl Icahn, smart investors continue to warn us about the long-term negative effects of low interest rates as they threaten to bankrupt pension funds and retirement incomes. Those low interest rates force people to save more as they will need more money to retire safely.

The main point of this article is to make investors think and to show them the risks they are running by just following the old investment dogmas in a different world. If you are close to retirement, assess your future needs, assess the risks you are currently exposed to and create a portfolio that you can sleep well with no matter what happens.

An asset that is pretty safe but that no financial advisor will ever recommend because you do not get any commission on it, is cash. Something to think about in this new world.

There is one additional strategy, which happens to be one of our favorites, where the bulk of your retirement savings sits safely in cash, yet still allows you to earn high double digit yields on your capital. Click here to learn more.

 

image

The Future Will Blow Your Mind. How Can You Take Advantage Of It?


  • Global GDP has quadrupled in the last 35 years and will probably do so again in the next 35 years.
  • By 2050 it’s expected there will be 10 billion people on earth and most of them will be living a western lifestyle.
  • While the forecasts are pretty certain, the issue is that the way towards those forecasts will not be linear. Investors should be careful not to get excited and jump into bubbles.

Introduction 

Investing is both complicated and simple at the same time. Today we are going to show the simple side of investing by analyzing a few factors that are almost certain and that will have a huge influence on your investing returns. By analyzing a few global demographic and economic trends we can see where the world will be in the future and connect that with our investments pictures, a scenario that is actually mind-blowing. Keep reading…

Global Population & Economic Development

A number that is essential for investors is the following:

figure 1 global population
Source: Worldometers.

 

What is even more important is that the population is growing and will continue to grow. Global population is expected to reach 9.7 billion by 2050. The biggest expected growth is in Africa, followed by Oceania, the Americas and Asia.

figure 2 global population forecast
Figure 2: The World’s population. Source: The Economist.

 

This simply means that the global market for companies and global demand will be at least 31% larger in 34 years. On top of the increase in the global population, the economic structure and growth forecasts for the majority of the global population are astonishing.

The list below shows the current top 15 countries by population and their respective GDP per capita.

figure 3 data
Figure 3: Population and GDP per capita. Source: Worldometers, World Bank.

 

Of the 15 most populous countries, only the U.S. and Japan have a GDP per capita higher than $10,000. Countries like Indonesia, with 260 million people, have to grow 10 fold to reach the Japanese standard while India has to grow 20 fold. Thankfully, all of these currently underdeveloped countries are growing at amazing rates.

figure 4 global gdp growth
Figure 4: Global GDP growth. Source: The Economist.

 

If we look at where the global GDP per capita average was 35 years ago we can only imagine where the GDP will be in 35 years with the explosive growth in emerging markets.

figure 5 glboal GDP per capita
Figure 5: Global GDP per capital in current US$. Source: World Bank.

 

If GDP per capital quadruples in the next 35 years like it did in the last 35 years, in 2050 we will have an average global GDP per capita of $40,000, which is higher than what Japan currently has.

A higher GDP will make many things available that are currently unavailable. Many people will want a car and we can only imagine what will that do for the car industry. Of the 15 countries mentioned above, only the U.S. and Japan have reached a level of car per capita saturation.

figure 6 cars per capita
Figure 6: Global cars per capita. Source: Charts Bin.

 

Cars, homes, infrastructure, software, hardware, travel, fashion, medicine, food and who knows how many more things that we can’t even imagine at the moment will be a normal in 2050 for the majority of the global population.

How sure can we be that this will become a reality in the next 35 years? Facebook gives us a clue. Their data shows the fastest growth rates in the Rest of the World and Asia which means that people there are more and more informed about a western lifestyle which will encourage them to seek such a life.

figure 7 daily users
Figure 7: Facebook’s global growth in daily active users. Source: Facebook.

 

We can clearly conclude that the world will be a much different place in 35 years, especially when we look at how different the world is now compared to how it was 35 years ago. Just to gather the data I’ve listed above would have taken me a year or longer to gather 35 years ago, while today I can go online and have everything in front of me in an instant. Globalization, a larger population and inevitable economic development are the trends that will undoubtedly influence your investments in the next 35 years.

What Investors Should Do

If you’re in it for the long-term, you have nothing to worry about especially if you are well diversified and have made smart investments. What do we mean by smart investments? The global growth discussed above is pretty certain, but what is uncertain is the linearity of it. Going back to figure 5 we can see that from 1995 to 2002 there was very little improvement in global GDP.  Only after 2002 did it explode. This means that the road to quadrupling global GDP will not be smooth.

An investor has to be careful not to overpay for an investment. Many people see the above numbers and get very excited. This is what creates bubbles. As we will have many recessions in the next 35 years, it is wise not to get too excited about the numbers above but to invest at maximum pessimism. Currently there is excitement about healthcare, social networks, and consumer discretionary, and negativism in agriculture, food, energy, mining and shipping. With the growth described above, there is more certainty that demand will grow for commodities than for social networks which is a perfect example of how investors get carried away.

Charlie Munger, Buffett’s investment partner, continually restates that investing should be like watching paint dry and that if you want excitement, take $800 bucks and go to the casino. All the inevitable economic and demographic developments are pretty certain, but will slowly grow into the forecasted numbers. If your investment horizon is long you can afford to be invested in the sectors that will surely benefit from the structural trends and wait for the booms. What you should avoid is to be invested in bubbles because those are the destroyers of long-term returns.

For more specific information about a sector that we believe has just reached a point of maximum pessimism and is trading dirt cheap, but is sure to benefit from the massive future growth in global GDP, click here.

 

image

Carl Icahn Is Right, But When Will The Market Learn?


  • Carl Icahn has been warning us how dangerous low interest rates are as they create bubbles.
  • The most important bubble is the earnings bubble.
  • Repatriation and inversions are two crucial issues for the U.S.

Introduction

We are continuing with our series of articles on successful fund managers. You can read more about Ray Dalio here, George Soros here and Peter Lynch here. Looking at what these successful managers are doing gives us a better understanding of the market, its potential and its inherent risks.

In today’s article we are going to look at Carl Icahn’s investing style and look at his current positions through his latest SEC filing.

Carl Icahn –  An Introduction

Icahn’s investing style is one that cannot be easily replicated by common investors. Few among us are able to invest enough to get a controlling position which is exactly what Icahn does. This tactic has given him the nickname “corporate raider” and the ultimate “barbarian at the gate,” but the $16.7 billion in wealth he has accumulated in his life makes him a person to listen to.

He has taken substantial or controlling positions in various corporations including RJR Nabisco, TWA, Texaco, Phillips Petroleum, Western Union, Gulf & Western, Viacom, Uniroyal, Dan River, Marshall Field’s, E-II (Culligan and Samsonite), American Can, USX, Marvel Comics, Revlon, Imclone, Federal-Mogul, Fairmont Hotels, Blockbuster, Kerr-McGee, Time Warner, Netflix, Motorola and Herbalife.

His activist actions are well received by shareholders as companies that he takes an interest in usually go through the “Icahn lift,” which is the Wall Street name for the bounce in price.

But more interesting than what he has done is what he thinks of the current market.

Carl Icahn – Current Opinion

His major investing thesis is that corporate management is dysfunctional. Therefore, he looks for broken companies that have management issues that he can influence.

Icahn is worried that politicians in general are focusing too much on the short term. We are going to skip the election related political issues but mention two issues that are very interesting for investors, repatriation and inversion.

Icahn sees a great opportunity for the U.S. if companies were allowed to repatriate foreign profits which currently amount to $2.3 trillion. Companies don’t repatriate that money because of the 35% tax on cash repatriation.

Repatriation leads to another issue, inversions, where companies move their headquarters abroad. As many U.S. companies have more revenues from abroad, it pays to move their headquarters to countries where you pay less in taxes.

Since 2012, 20 companies have made an inversion with the most notable examples being Medtronic, which became Irish, and Burger King, which became Canadian. Pfizer also tried to acquire Allergan and move to Ireland but was stopped by the government.

figure 1 invesrsions
Figure 1: Inversion deals completed each year. Source: Bloomberg.

Icahn is opposed to low interest rates because it maxes financial engineering. With low interest rates, companies are more encouraged to buy other companies or do buybacks than they are to invest in new equipment and machinery. This phenomenon inflates earnings for the short term but is detrimental in the long term.

On top of the financial engineering issue, Icahn is also frustrated with the fact that companies manipulate earnings by taking various costs out of the picture which distorts the true earnings figure. Management is especially guilty when it comes to earnings guidance.

figure 2 guidance
Figure 2: Earnings guidance is without the following items. Source: Carl Icahn.

This short-term activity can be seen in the current earnings guidance from the S&P 500 companies, 71% of which have issued a negative guidance for Q3 2016.

figure 3 guidance
Figure 3: Earnings guidance by sector. Source: FACTSET.

Low interest rates and financial engineering have managed to consistently increase earnings since 2009, but it hasn’t worked in the last 5 quarters and, according to guidance, it will not improve anytime soon.

Icahn also states that the majority of companies should not be doing buybacks because they are just a short term fix. Companies that should be doing buybacks according to Icahn are Apple, which has a PE ratio of 9, and companies that trade below book value. By doing buybacks at higher valuations or above book value, management weakens the balance sheet which is a disservice to investors in the long run.

Low Interest Rates

Icahn is in favor of immediately raising interest rates because low interest rates cause bubbles in real estate, stocks and even the art market. Low interest rates further push people to search for yields in very risky markets—like junk bonds—where very few people really understand what is going on. The iShares High Yield Corporate Bond ETF (HYG) has a yield of 5.57% and it has outperformed the S&P 500 in the last 10 years as people are desperate for any kind of yield. The S&P 500 is up 40% since 2007 while the high yield bond ETF is up 63% and has a higher yield than the S&P 500 dividends.

figure 4 high yield bonds
Figure 4: iShares high yield bond ETF performance since 2007. Source: iShares.

Icahn warns investors that any problem in the economy will create a rush for the exits and people will want their money, but there will be no market for junk bonds at that moment even if they appear very liquid today. Icahn’s cartoon below reveals this situation better than any words could.

figure 5 icahc on low interest rates and high yields
Figure 5: High yielders going towards a cliff. Source: Carl Icahn.

Icahn says that he saw the same pattern evolve in 1969, 1974, 1979, 1987, 2000, and 2007, and warns us that a time is coming that might make all those years look pretty good. His main message is that those who do not learn from history are going to repeat it, and that he is afraid that we are going down that road again.

Conclusion

One of the perks of being above a certain age is that you can say whatever you want, without fear of a lawsuit over what you say, as you will be long dead by the time those lawsuits are resolved. What we can learn from Icahn is something fresh while also getting an opinion from someone that has been around for a long time.

The question is not so much if all the negative things will happen, that scenario will for sure hit us eventually as boom and bust cycles are human nature. We are wired for instant gratification, even if that means less gratification in the future, therefore no one is going to stop the party by raising rates or lowering credit availability. That will happen sometime, but it will be very sudden and people will wonder why they didn’t listen to Icahn.

But, why don’t we listen? Because we don’t know if the negative scenario will present itself today or 10 years from now. If we immediately heed Icahn, sell everything and the bust cycle doesn’t come in the next 5 years, we will look stupid.

The main point is that Icahn is right, but all the folks buying stocks at high PE ratios and high yield junk bonds are also right for the time being, because no one can be right on the most important thing, timing.

If you own high yield ETFs, or stocks that use lots of the cheap leverage to do buybacks and acquisitions, know that there is also a risk of losing a big chunk of your money if credit tightens. Just be aware of the risks you are taking for the higher yield you are getting.

image

Are You An Investing Optimist? Check Your Portfolio


  • Investors are very optimistic in bull markets and allocate much of their portfolio to stocks, increasing their risk.
  • Analysts and economists expect more spending which will consequently push GDP and inflation up, but low rates push people to save more for their retirement.
  • If the GDP and earnings don’t grow as expected, we could see a bear market in 2017.

Introduction

Stock markets keep going up while fundamentals keep going down and the economic situation isn’t that great either. The S&P 500 is dancing around new highs despite corporate earnings for Q2 falling by 3.6%, and the economy only growing by 1.2% on an annualized basis. Economic growth for the whole of 2016 is only at 1%.

So, what is pushing stocks higher? The simple answer is optimism. It is assumed that next quarter’s earnings will be exceptional and economic growth will blow off the charts. In this article we are going to elaborate on the forecasts and assess their probability in order to take a look at what optimism can do to investors.

About Optimism

Being an optimist is nice. Optimists are happier, have a more positive view of the world, are ready to take risks in life and optimism helps one to cope with life’s uncertainties. We can say that in life, it pays to be an optimist. On the stock market it also pays to be an optimist but it pays even more to be a rationalist.

An old research project (1999) by behavioral scientists Benartzi, Kahneman (Nobel prize) and Thaler explains perfectly how investors approach stock markets after a few years in a bull market. Based on 1,053 Morningstar subscribers of which 84% were male with annual household income averages of $93,000, they found that investors had an average allocation to stocks of 79%, and 95% of their pension contributions were directly allocated to stocks. This bullishness derives from investors’ optimism. When asked what they focused on when thinking about financial decisions, a staggering 74% of investors focused on positive returns.

figure 1 optimism survey
Figure 1: Thinking about potential return or potential loss. Source: Behavioral Finance.

By being an optimist, you make bold investment decisions, but investors should also think about risks. Don’t forget, one of the most quoted of Buffett’s pearls of wisdom is: “Rule No. 1: Never lose money. Rule No. 2: Don’t forget rule No. 1.” The reason behind this rule is that if you lose 50% of your investment, it takes a 100% return just to get you even.

Optimistic Forecasts

Yes, earnings have declined and the economy isn’t growing fast at the moment, but analysts are highly optimistic that in the next quarter or the one after that, everything will grow. On June 30, most analysts expected earnings to return to growth in Q3 2016.  Now analysts expect a 2% earnings decline in Q3 2016 and don’t expect earnings to return to growth until Q4 2016.

figure 2 earnings
Figure 2: Forecasted earnings growth for Q3 2016. Source: FACTSET.

The same analysts that consistently revise their estimations downwards as actual earnings results are released expect S&P 500 earnings to grow 13.3% in 2017. At the end of June, the expectation was at 13.5%.

figure 3 earnings growth 2017
Figure 3: Forecasted earnings growth for 2017. Source: FACTSET.

The expected increase in earnings comes from an expectation that oil and other commodity prices will inevitably increase and push earnings higher, and that no sector will see earnings decline.

Additionally, GDP is expected to grow at a rate above 2% from this quarter onwards. The current 1.1% yearly growth is just a temporary slowdown according to interviewed economists.

figure 4 wsj gdp
Figure 4: Forecasted GDP growth. Source: Wall Street Journal.

But not all economists agree on that rosy view. Economist Stephanie Pomboy stated that analysts and economists are wrong because they use pre-financial crisis frameworks to make their estimations and the world has changed a lot since then. Despite the fact that interest rates have severely declined, people spend less and save more. Less spending means inevitable declines or slower GDP growth.

figure 5 savings
Figure 5: Total saving U.S. deposits. Source: FRED.

Why are people saving more? Well, with lower interest rates you need to save more to reach a satisfying level of income for retirement. As the population is getting older, they will save more and more. This speaks to how low interest rates have been beneficial for businesses but very detrimental for savers and an aging population.

In such an environment we cannot expect GDP growth and earnings to increase just because interest rates are low as it is clear that low interest rates have not worked thus far to stimulate economic growth.

If the GDP does not reach the expected 2% growth rate and corporate earnings continue with their decline, Pomboy sees a bear market in 2017, especially in discretionary stocks.

Discretionary stocks have really high PE ratios and, yes, if the growth from the past 5 years continues, those ratios might be justified, but any kind of bad news could quickly send those stocks down. Amazon (AMZN) has a PE ratio of 188.4, Home Depot (HD) 23.8, Starbucks (SBUX) 30.9, and Nike’s (NKE) is at 27.3. All these stocks could easily fall more than 50% if a recession comes along or people spend less because of their high valuations based on optimistic future projections.

Conclusion

It is good to be an optimist, but in investing it is also good to be a realist, or a diversified optimist. A diversified optimist is an investor that is positive about his returns, fully invested but well diversified among various uncorrelated assets and prepared for any economic environment.

The main point of this article is for you to assess your optimism and look at the risks in your portfolio. When you look at each component of your portfolio, ask yourself how much you can lose. Write that number down and then go through the list again and ask yourself how much you can gain. Where the potential risk is much higher than the gain you might want to look for other assets.

image

The Important Insights From The FOMC Minutes No One Is Talking About


  • The FED’s “protect the market at all costs” attitude minimizes the risk of a severe bear market but increases the risk for an inflationary environment.
  • Trade deficits and low productivity are not good signs for the long-term, no matter the positive data from the labor market.
  • Until the focus shifts from central banks to real structural reforms, sluggish GDP growth could easily turn into a recession.

Introduction

There are more important insights that can be gained by going through the FOMC minutes than by just reading the news about an eventual interest rate increase. An interest rate increase of 0.5% won’t change much. It will give the news something to talk about for two weeks and from then onwards it will be business as usual. Structural risks and what the FED is ready to do or not do in the case of turmoil is what will determine our investing returns.

The Patient Needs Stronger Medicine

The FOMC minutes start with a discussion about the implementation of a monetary framework, clearly stating that since the 2009 crisis, heavier intervention is needed to stabilize the markets and the economy. Before the crisis, a few rate cuts or increases and minimal market asset purchases were enough to reach stability. This can be clearly understood by having a look at the FED’s balance sheet. It increased fivefold from 2009 to 2014.

figure 1 fed balance sheet
Figure 1: FED’s total assets. Source: FRED.

 

For investors, this is important because it tells us that the FED will use all the tools at its disposal to keep the economy and markets stable. This minimizes the risks of a severe bear market as capital injections will be immediate, but it also increases the risks for an inflationary environment.

The Economy & Inflation

The economy shows mixed signs. On one hand it is doing very well with the latest jobless claims data at only 262,000, extending the period below 300,000 to 76 weeks which is the longest since the 1970s. On the other, weak manufacturing data, a trade deficit and growth from consumption alone keep the FED from decisively increasing rates.

The unfortunate thing is that adding jobs is easier than solving structural issues. With low productivity and a trade deficit, it is difficult to expect miracles from the U.S. economy in the long term, which again indicates that some international diversification and inflation protection should be welcome in the long term.

Inflation is still only at 1% indicating that something isn’t working as planned. Low interest rates and lots of cheap capital have spurred investments which increases the supply of goods, sending prices down, not up. Such a situation enables the FED to keep rates low and sustain the economy, but nobody knows how long such a situation will last. The FED is just postponing the reach of the 2% inflation target, which is now set for beyond 2018.

The sluggish GDP growth forecast and an economy relying on easy-to-hire jobs and consumer spending indicates that monetary easing did what it can do and now it is time for something else to step in. Structural reforms, lowering student debt and investing in infrastructure might be reasonable ideas, but until the focus is on monetary policy, the risk is high that this slow growth will turn into a recession.

The Situation in Europe

The European central bank released its policy meeting minutes a day after the FED. Europe is still a few years behind the U.S., asset purchases and direct financing programs are the norm but have no influence on inflation or economic growth. Inflation in the EU zone is at 0.8% while industrial production is contracting and GDP growth is below 1%. For the ECB, the good news is that unemployment has decreased from 10.2% to 10.1% and youth unemployment is “only” at 20%.

Similar data clearly indicates that other actions are necessary for the reach of sustainable economic growth. The terrible unemployment rate signals severe structural issues that cannot be amended by monetary policy. At least the situation in the U.S. looks much better after taking a look at Europe.

Conclusion

Everyone expects miracles from central banks, but those miracles only work for a short while. Hopefully structural reforms will enable future economic growth. Until then, we have two situations on our hands as investors.

  • Situation Number 1 – Central banks will intervene at any sign of market and economic weakness with more stimulus, minimizing the risks for long term investments. This means that we can stay long, but we have to be careful to watch for the point in time when the majority of people in the markets understand that monetary policies do not suffice.
  • Situation Number 2 – Global economies are not that healthy, especially in Europe. Severe structural reforms are necessary in order to create real growth, not just financially engineered growth.

The primary conclusion then, is that you can stay long and grasp eventual price declines for rebound trades as central banks state that they will do whatever is necessary to keep things stable. In the longer term, as monetary policy is not working, watch out for the moment when somebody yells: “The emperor is naked.”

 

image

Sunday Edition: Stop Losses and Value-Oriented Income Generation


Today’s Sunday Edition discusses the biggest reason why your investments might be underperforming, and why the Rebel Income system isn’t subject to this one fatal flaw, which might explain the nearly 30% annual returns over the last two years.

In a study conducted by Dalbar Inc.—the nation’s leading financial services market research firm—through 2014, the 20-year annualized S&P return was 9.85% while the 20-year annualized return for the average equity mutual fund investor was only 5.19%, a gap of 4.66%.

The biggest reason for the underperformance, according to their research, is psychology. The study also defined nine of the irrational investment behavior biases specifically, with the biggest culprit being:

Loss Aversion – The fear of loss leads to a withdrawal of capital at the worst possible time. Also known as “panic selling.”

Investing in mutual funds is a little different than investing in individual stocks, however, I believe the fear of loss is heightened when dealing with individual stocks as opposed to mutual funds, since mutual funds have greater built in diversification.

However, 95% of individual stock risk can be mitigated simply by owing a basket of 8 to 10 quality and uncorrelated companies. But that discussion will be saved for another time.  

Today’s focus is on “panic selling” and why the Rebel Income system is designed to help you avoid this fatal mistake, which can kill your overall returns.

The majority of the put sells Thomas recommends do expire worthless, and subscribers just keep the income. However, there are times when the stock price drops below the assigned price, and sometimes by quite a bit. 

For example, Thomas sold a put on CSIQ with a strike price of 29 and the stock dropped to $19 before reversing and moving back above the strike price, allowing us to exit with a profit. Another example is ANF which was assigned at 27.50 and dropped down to $16 before moving higher resulting in a profitable trade.

On average Thomas is assigned a stock 25% to 30% of the time, meaning the stock drops below the put option strike price.  

Of course he never succumbs to “panic selling,” which has even drawn criticism by a few subscribers because he chooses not to use stop loss order to protect capital. But it’s hard to argue with his track record.  

In today’s reprint of Thomas’ Rebel Income newsletter (annual subscription $1,164), he discusses when he believes a stop loss order should be used, but why he chooses not to use them with the Rebel Income system, which has closed 98 winning trades with only 3 small losers and outperformed the stock market 10 to 1 since inception (last two years).

Here’s Thomas:


Stop Losses and Value-Oriented Income Generation

Occasionally I get emails from subscribers about my approach to stop losses on the stocks I hold in my portfolio. If you’ve followed Rebel Income for a while, I expect that you’ve noticed I never write about stop losses on stocks I am assigned from my put selling trades. This isn’t a simple case of omission, but instead a deliberate piece of the income generation system I use. I don’t use stop losses on any stock I am assigned on purpose.

This might sound a little foolhardy or possibly even irresponsible at first blush… especially if you are a new subscriber and are still trying to get used to the system I use and write about. I think that in order to understand why stop losses aren’t useful for my system, it is important to talk about where they are useful first and why in those cases you should never place a trade without them.

When it comes to the stock market, we are all conditioned to think in very directional terms. Buy a stock at a low price, hold onto it a while, and hopefully sell it sometime down the road at a higher price. For a lot of investors, that is the entire scope of their investing experience. If you’ve traded options, you’ve been able to expand your perspective quite a bit more, but again you are still generally encouraged to work with a directional bias: buy call options if you think a stock will increase in price, or buy put options if you think a stock will decrease in price. This directional bias is what drives most of the investing activities of the general public; in this context, stop losses are absolutely critical and should never be ignored.

Most directional trading strategies are designed with a very short-term timeframe in mind. Most focus on trying to take advantage of short-term swings along a trend line or a breakdown of a stock’s current trend, which usually marks the beginning of a new opposite trend. The problem with strategies that are designed around trying to predict what direction a stock is going to follow in the near term is that they have a very low probability of success; a 25 – 30% success rate is considered normal even for the most experienced and skilled technicians and traders. Speaking for myself, in more than 15 years of options trading, I have never been able to achieve a success rate higher than 30% with any of these types of strategies.

To be clear, it IS possible to make money with these kinds of methods, even with such a high degree of failure. It requires a high level of discipline and patience, however, since a low probability of a winning trade also means a high probability not only of one losing trade, but of several in a row. In the short term, losing streaks often seem to mount the losses to the point that the few profitable trades you will see can’t possibly make up the difference. The only way they can is to keep a long-term view and make sure that you apply a hard stop loss on every trade you make. Where the stop loss is set will vary depending on the system you’re using, and I’m not going to take space in this post to elaborate on that detail. The point is that the stop loss is designed to limit the loss per trade enough so that even if you do see a major losing streak, the sum of your losses will be limited enough to keep you in the game for the winning trades.

I write a lot in Rebel Income about how I use put selling as a gateway to value-oriented stock ownership. If you look around the web, you’ll see that even a lot of long-term, value-focused investors use stop losses as well. In fact, if your sole purpose of holding a stock for the long-term is to be able to ride a long-term upward trend, you should absolutely be using a stop loss. I think that in this case, not using a stop loss is irresponsible and foolhardy, because you are still thinking in directional terms.

The stop loss should be wider than it would be a with a short-term trading strategy, because you have to be willing to give the stock enough room to fluctuate in price quite a bit as it rides along its trend line. I think that in these cases, setting a 25% hard stop below your initial purchase price is smart. If the stock moves above your purchase price, recalculate your stop loss; do it each day the stock makes a new high above your purchase price, but once it is raised, it is never adjusted lower. If the stock experiences a short-term swing downward, leave your stop loss at its last adjustment (which should be 25% below the highest price in the last peak). If you get stopped out, so be it; if the trend holds, the stock should swing back upward and eventually move above that last peak, so you can adjust the stop loss higher again. The nice thing about this approach is that you don’t have to worry about “how long do I let the stock go up before I get out”; you just wait until you get stopped out of the trade.

Understand, the method I’ve just outlined requires just as much discipline as any short-term trading strategy. The good thing is that if the stock does form a long-term upward trend, you may see it increase in price by two or three times, or possibly even more. Even waiting for a 25% drawdown from the trend’s highest point means being able to capture a big chunk of the trend. The caveat is that not all stocks will form the kind of long-term trend you need, or move high enough before you are stopped out to make the trade profitable. The probabilities for this system are a little higher than for the shorter-term strategies I mentioned, but generally not by more than 10%, which means that you should still expect to see more losing trades than winning ones. Again, this is why the stop loss is so important; in those trades, you’ll need to make sure your loss is limited enough that your winning trades will be able to make up the difference in the long-term.

I’ve just spent several paragraphs talking about why stop losses are so important and critical to directional systems. Now I’m about to tell you to forget all of that information… at least for the trades you make following my system. I’m not doing this to imply that I know better than people who have been using directional trading strategies; I have made a lot of friends over my years in the market who have been very successful following those systems and continue to make a lot of money with them. I know those methods work. However, I also believe that most investors will not make money following those systems because of the difficulty—emotional and financial—that is associated with the losing side of those systems.

Think about it, if you are the middle of a prolonged losing streak, and watching your account get smaller and smaller with every trade you make, do you think it will be easier or harder to keep the big picture in view and stay the course? Most investors have a limited amount of capital to work with, and watching our hard-earned capital disappear into thin air again and again just isn’t something most of us are equipped to deal with. This isn’t a criticism of human nature, but simply an acknowledgement of reality. It is a fact that only a small percentage of investors have the emotional makeup required to endure the kind of prolonged losses that are normally associated with directional investing and trading. While I’ve used directional strategies in the past and am very familiar with them, the truth is that I put myself in the larger percentage of investors – those that generally shouldn’t be dealing with directional investing. I know how to be successful with directional trading, but it is very hard for me to maintain the discipline it requires. I have to fight my emotions on a regular basis, which only adds stress to my life. I don’t believe investing should create more stress than life brings every day all by itself. That is why my system is built the way it is.

I differentiate between my system and traditional, directionally based value investing by the fact that my approach looks first to generate income by selling puts, and factors stock ownership into the equation second. By selling puts against a fundamentally solid stock trading with a great value proposition, my goal is use the directional bias of most investors in my favor. If that bias keeps that stock above my put option’s strike price through the duration of the trade, the option expires worthless, my first purpose (income generation) has already been achieved and I move to the next trade.

If the stock is below my put option’s strike price at expiration, that doesn’t mean that the market’s natural directional bias isn’t working for me, but it does mean that the second piece of approach—stock ownership—comes into play. This is where the other major difference between what I do and what even most value-oriented, long-term investors do, because I don’t work with a stop loss. Why wouldn’t I work with a 25% hard stop loss, when this number actually sounds pretty reasonable?

My first answer goes back to my first objective: income generation. I emphasize dividend-paying stocks exclusively in my system, which means that when I am assigned, I become a shareholder of record in the stock, which means I receive dividend distributions as they are paid. Some of the stocks I’ve been working with, like BBY, JOY, and others are currently paying dividends in excess of 3% per year – which is better than what you’ll get by putting your money into a CD or money market account at the bank right now.

The other part of the income argument is the second major piece of my system: covered calls. One of the first things I look for an opportunity to do when I am assigned a stock is to sell a covered call and keep the income generation machine churning. Subscribers to Rebel Income have seen me write about several covered call trades that have helped me generate a significant amount of immediate income on stocks I’m currently holding in my portfolio. Unless you’re approved for margin trading and have adequate reserves to cover the trade, most brokers don’t allow you to set a stop loss on a stock you’ve written a covered call against, no matter how far away from the current price it is. This is because if you get stopped out of the stock, the calls you’ve sold are now naked, leaving you exposed to an unlimited amount of risk for the duration of those contracts.

There is a third part of my reasoning for not using stop losses, too. Those who have followed along with my trades for the last year or so know that there are a number of stocks that have seen long, protracted declines in price after I was assigned their shares from a put sale. JOY, SLCA, ANF, CBI, and HAL are just a few examples of stocks I’ve watched drop far more than 25% below my initial purchase price. I’m still holding shares in several of those companies today, not because I’m stubbornly unwilling to admit I was wrong, but because my fundamental analysis of those stocks continues to lead me to believe their long-term value is much higher than even the price I was assigned at. The only circumstance that will ever lead me to finally throw my hands in the air and close the position at a loss is if I see signs of a significant deterioration in the strength of their actual business operations. As long as the fundamentals remain strong and point to a higher intrinsic value than my entry price, I am willing to continue holding these stocks. In fact, readers will have noticed that I’ve used some of those protracted drawdowns as opportunities to sell more put options, since being assigned again would mean that I can average my price even lower than my initial purchase price. Using this third element on JOY, for example, enabled me to average my actual cost in the stock significantly below the $40 per share my initial assignment occurred at. Being able to average my cost down made the position easier to manage and a lot less stressful than it might have been otherwise. When JOY recently announced it had agreed to a buyout at $28.50 per share from Komatsu Ltd. (a new event that clearly changes the value proposition for the stock), the fact I had been able to average my price below the stock’s current price made it possible to close my position with a modest net gain.

This is a pretty long explanation of why I don’t use stop losses, I know; but I think it is important to make sure that you have all of the facts associated with the Rebel Income system as possible. The fact is that even though I don’t use stop losses, I do think about risk management every day. It’s why I’ve built the system the way I’ve outlined, and it’s why you’ll see me continue to provide as many details about the different pieces of the system as I can.


If you are like most investors, the emotions involved in directional trading are simply too powerful to control on a consistent basis.  

Why not follow a system that mitigates the emotions that cause “panic selling” and allows you to sleep well at night?  

Not to mention generates returns that far outpace buy and hold investing, yet keep the bulk of your money sitting safely in cash the majority of the time?

To get a first-hand look at how Thomas manages his put selling trades, we’ve arranged for you to follow his picks for the next 30 days for only $9, with no obligation to continue. You’ll also receive two incredible bonus items free. Click here to get started.

Regards,

Shane Rawlings
Co-founder, Investiv

image

The U.S. Dollar: Should You Stick To It Or Diversify Now?


  • The dollar has been positively correlated with stocks for the last 4 years which is unusual.
  • Potential FED interest rate increases don’t make international diversification a great idea right now.
  • Any sign of a U.S. recession should be a good time to think about international diversification with emerging markets.

Introduction

On big news sites like Bloomberg you often come across headlines related to the movement of the U.S. dollar. The headline below is a good example.

figure 1 bloomberg news

Such headlines relay what has been going on in the few hours before publication but are completely irrelevant for investors that aren’t trading pips on forex. This article is going to investigate the longer term relationship between the dollar and stocks, and discuss the best option for maximum return with minimal risk.

Recent Dollar & Stocks Movements

Before 2012, as the dollar strengthened, stocks went down and vice versa. The reason was simple, a strong dollar meant U.S. exports were less competitive and businesses suffered, while a weak dollar made U.S. goods cheaper across the world and increased corporate earnings. Since 2012, however, the story has been a little bit different. The dollar has gotten stronger and stocks have gone higher.

figure 2 fred dollar stocks
Figure 2: U.S. dollar vs. S&P 500. Source: FRED.

The reason behind this is the fact that no matter what we think of the FED, it is the most globally coherent financial institution. In an environment where the European central bank is continuing with stimulus and the Japanese think about printing money for direct spending, the FED is the only institution that contemplates raising interest rates. So the positive correlation between the U.S. dollar and the S&P 500 comes from the relative success of the U.S. economy and the global faith in the U.S. dollar as the only safe currency.

On one hand, the strong dollar lowers corporate revenue. But on the other hand, it also lowers corporate costs, something CEOs never talk about when reporting earnings. As the U.S. has a net trade deficit, the strong U.S. dollar makes everything around the world cheaper and therefore expenses should also be much lower. Don’t forget this in the next earnings season.

Long Term Dollar Strength

The long term perspective is a little bit different than the above. Since 1975, the dollar has slowly but consistently weakened in relation to foreign currencies.

figure 3 long term dollar
Figure 3: Dollar index since 1975. Source: FRED.

The slow decline of the dollar means that global trends are shifting, which is also normal given the development in China and other countries. As the rest of the world is expected to grow at a faster rate than the U.S., the long term trend for the dollar is clearly and slowly downwards. This point is essential for international diversification. We have discussed many times how ChinaIndia and other fast growing emerging markets are essential for healthy diversification.

Forecasts & Economic Factors

In the short to medium term, it looks like the dollar is going to continue to strengthen. If the FED increases interest rates and others continue with their stimulus, the dollar will surge even higher. The most recent FOMC minutes clearly indicate that we could see a rate hike by the end of the year. But, eventually the strength of the dollar will kick back as exports will be more expensive and the trend will turn and continue to follow the declining line seen in figure 3 above.

What To Do

There are two options with currencies. They go up or down and do so for longer periods until the structural influences rebalance on a global scale. With interest rates low and good news from the U.S. economy, the FED will eventually raise interest rates and send the dollar higher. The moment of maximum strength of the U.S. economy and the dollar will be the time to diversify to other currencies but until then, sticking to the dollar is not a bad idea, especially for the majority of our readers who are living in the U.S. If the U.S. economy slows down and the dollar weakens, you will still have most of your assets in your home currency which will not represent a real change to your portfolio. But if you are exposed to other currencies and the dollar gets stronger, you will have to look at losses, which is never pretty.

Conclusion

U.S. investors have the benefit that if the dollar gets weaker, international diversification is just a missed opportunity while if the dollar gets stronger, it was a good idea to stay at home. International investors have to play it differently. With the FED eventually increasing rates, the dollar has no other direction to go than up which is a great diversification play when looking at the stimulus in Europe and Japan which weakens their currencies.

In the long term, it pays to be exposed to the currencies of the countries that are going to grow at a faster pace than the U.S. economy, i.e. emerging markets. We have seen the Chinese Yuan get weaker in the past two years due to some fears about China slowing down, but the longer term trend is clear.

figure 4 cny usd
Figure 4: Chinese Yuan per 1 USD. Source: XE.

With the economy expected to grow at a pace of above 6% in the next 10 years and the Chinese getting richer, there is only one way for their currency, up. Think about international diversification, but only when the dollar strength reaches its structural limits and the U.S. is close to a recession.