Harry S. Dent Jr.'s Blog, page 151
May 30, 2015
Virotherapy: How to Turn a Bad Virus Into a Good Cure
Remember when you first learned in grade school that when you add two negative numbers it creates a positive one? But then your Mom told you that “two wrongs don’t make a right?”
For most adults that are not mathematicians, it is counter-intuitive for us to combine two negative items to create a positive one, but that is exactly the kind of creative thinking scientists are using to cure cancer.
We don’t think of viruses as a good thing, but on May 26 the Journal of Clinical Oncology
May 29, 2015
Bubble After Bubble, They All End the Same!
Will this bubble burst anytime soon? Will we have inflation or deflation? There are lots of questions up in the air… but they’re the wrong questions.
I’ll never understand how economists and financial analysts don’t get the most basic principle of cycles. We’ve been in this bubble era since 1995. How could so many be arguing that we’re not in a bubble when we have seen one bubble after the next rise and then burst as they always do?
May 28, 2015
China’s New Plan: If You Can’t Beat ‘Em, Force ‘Em
Danger Here, Danger There, Danger Everywhere
Until Tuesday, the bond market was looking for rising inflation as a reflection of “better” economic conditions. Our economy is still anemic after more than six years of central bank meddling, but traders don’t trade on truth — they trade on perception.
Reports still seem solid. Inflation is ticking higher as consumer prices rose last month to 1.8% on an annualized basis. The Fed’s target is 2%. Unemployment is down to 5.4%, participation in the labor force rose to 62.8%, and even wages have risen a bit.
In fact, job openings have surpassed the level they were before the financial crisis in 2008. As Harry and Rodney have noted many times over the years, consumers drive 70% of economic activity here in the U.S. So, when the labor market finally tightens to the point that wages move higher, economic growth follows. When our economy grows, inflation follows.
But while bond traders were keeping their eyes on wage growth, inflation, and economic growth, they weren’t waiting on those things. They were already pricing that future growth in. Yet, bond yields dipped lower Tuesday.
May 27, 2015
Consistency and Management: Two “Secrets” to Investing Success
I’m going to share with you the big secret to investing success: There is no secret. Rather, there’s no “one-size-fits-all.” There’s no Holy Grail.
Investing success is based on following principles and following them religiously. We’re not machines, and you can’t program us to all trade the “best” way, because there is no best way. We can only find which principles matter to us, and stick to them.
That’s why the biggest impact on your portfolio has more to do with a consistent process and how you manage a position, not the actual securities you trade. My own methodology relies on both long and short investing. In general, they are complementary to each other. When one doesn’t work, I have the other.
The key here is that I know when to short a trade, and I know when to stick around awhile longer. I consider all of my variables, and I stick to that style consistently. There are times when your personal strategy might under-perform. By the same token, sometimes just a few trades account for the majority of your returns.
I don’t mean a person has to immediately decide what kind of investor they want to be and follow that to death or glory. This can take years to solidify. But once you know what works and what works for you, you don’t let a few losses deter your style. That’s why consistent, unemotional application is crucial. The problem for most people is, they get too attached to their stocks.
Visit any message board and you’ll find it full of people cheerleading their positions higher. While they’re busy waving their pom poms, they usually miss the warning signs that danger is right around the corner. That’s because emotion leads one to do the wrong thing at the wrong time.
A consistent, well thought out process can help you avoid getting caught up in the emotional rollercoaster that is the stock market. The important thing is to not obsess over short-term swings in performance or gyrations in the market.
To me, a stock is a trade, nothing more. You shouldn’t own Deere & Company stock just because you like their lawnmowers. Bearish or bullish, owning a stock is just an expression of a trade. The notion that you own a piece of a business just because you own a few shares is total lunacy. Unless you can effect change in a corporation, you don’t own anything.
I could care less what a company does, who owns the stock, or how qualified the CEO is. If it looks like the stock’s reported numbers aren’t being represented in the proper light, then I’ll short it. I think of it like a game of blackjack where the odds are already in my favor. I know when to hold, and I know when to short. That’s my edge. By playing as many hands as possible, I’ll have some bad runs and lose money — everyone does — but over time, my edge will take hold and I’ll end up ahead.
Of course, you should never go in blindfolded. Just because you have a style that works, doesn’t mean you don’t practice good risk management.
For starters, never take too big of a position. No stock position should keep you up at night, lead to excessive stress, or create problems in your relationships or marriage. If you’re worried about the stock, then the position size is too large. Start small — you can always add to the position later!
Another way to reduce worry is to use protective stops. If the stock hits your stop, get out and reassess. Don’t let a small loser turn into a huge loser. You can always get in later after you’ve looked at the situation more objectively. What you shouldn’t do, is add to a loss assuming it’ll climb back up any day now. That’s wishful thinking. The market will tell you quickly whether you’re right or wrong. Meanwhile, if your winners are winning, leave them alone! They’ll pick up the slack.
In my opinion, that’s the secret. Consistently apply your process and use proper risk management so you don’t get carried away with your bets.
I stress risk management’s importance in What’s Behind the Numbers?, where I show you how to identify a stock that could potentially be poisoning your entire portfolio. Dent Research is offering to send you a
May 26, 2015
Central Banks: The Root of All Economic Evil
France was in a bind.
In the early 1700s, the country had run up astronomical debts from endless wars with the British. They needed money… desperately.
So, John Law — the first central banker in France — turned the Mississippi territory France had just acquired into a stock company.
Stocks were a new trend. People weren’t prepared for the crash that comes when stocks teeter too high. So, they went all in… and what resulted was one of the fastest, most exponential bubbles to build and just as quickly burst that the world has ever seen.
It took just two years for this venture to became a popular get-rich-quick scheme. Shares or parcels of land were sold to the public and financed by the government at lower-than-market rates.
Little did buyers know, the land was basically a swamp, far away so no one could see what they were getting.
May 25, 2015
Wall Street’s Financial Chicanery, and How You Can Avoid It
Wall Street gets a bad rap. Much of it is deserved. But not necessarily for the reasons you might expect.
You see, to many, Wall Street’s suit-clad warriors appear to be nothing more than money-sucking leeches… draining the pockets of Americans’ hard-earned dollars through their fees, commissions and kick-backs.
Whether this is a fair characterization or not, Wall Street’s worst give haters plenty of ammo. Martin Scorsese’s The Wolf of Wall Street epitomized the greed-driven, ethics-bending (and raunchy) culture of 1990s Wall Street.
The film grossed nearly $400 million at the box office, giving Scorsese his biggest “winner” to date while confirming that people, in general, love a good villain.
“Is that really what it was like?” my wife asked me, after we watched the movie.
Upon realizing she was not being sarcastic, I replied: “Yup… still is, to some extent.”
Sure, Wall Street is now more heavily regulated than it was during Jordan Belfort’s golden years. But is that enough?
Just last week, the United States Justice Department vowed to fine Wall Street banks something like $5.8 billion for rigging currency and interest rate markets.
A long scroll of instant message conversations confirmed the manipulation was coordinated by many Wall Street insiders. And the most arrogant of the bunch even went as far to pontificate:
“If you ain’t cheating, you ain’t trying.”
You get the picture… this is the “worst of the worst” of Wall Street’s notoriously bad actors.
But there’s another, less overtly sinister aspect of this story.
“What’s good for me is…”
Dan Ariely, Ph.D. is a psychology and behavioral economics professor at Duke University. His extensive research on dishonesty provided the framework for a newly-released documentary titled Dishonesty: The Truth About Lies.
Basically, Dr. Ariely concluded that “dishonesty is almost always caused by a conflict of interest.”
When such conflicts arise, it’s common to want to please both sides of the situation, even when that’s impossible.
The “right” thing to do is to respond with complete honesty. Sure, you might not get what you want, but at least you were honest.
But that’s an uncomfortable scenario for many. So the natural defense mechanism, of some, is to lie… to tell both parties: “Don’t worry… I’ll give you both exactly what you want… there’s no conflict here…”
Whatever justification the liar provides may be well-intentioned. They don’t want to hurt either party’s feelings or interests… but it’s still a lie.
As I see it, this construct might work well to explain the oft-cited disconnect between “Wall Street” and “Main Street” — outside of Wall Street’s most purposeful and villainous cheats.
You see, I actually believe that a majority of individuals who work in the Wall Street machine are good people.
They’re ambitious and hard-working. They’re analytical and detail-oriented. They’re problem-solvers!
These traits, in and of themselves, are good things. And when focused toward a respectable goal they can produce great, meaningful results.
The problem comes when Wall Street’s goal is not well-aligned with investors’ goal… a la conflicts of interest.
Arguably, regulators have tried their hardest to properly align the interests of investors and Wall Street.
For instance, Registered Investment Advisors (RIAs) are held to a higher standard than brokerage firms, in that they have a fiduciary duty to their clients. This means they must act solely in their client’s best interest.
Fiduciary duty prevents these advisors from putting clients into a high-fee product, when a low-fee product is more suitable for the client.
That’s a great start… but I believe individual investors need to take one additional step to ensure they’re in a “no conflicts” relationship with their investments.
To be frank, this final step requires a fair amount of trial-and-error… and a great deal of work and determination.
What is this step?
Simply put: As an investor, you have to “find yourself.”
By this, I mean you must clearly define who you are as an investor.
Are you aggressive or conservative?
Are you looking for income or capital appreciation?
Do you believe in diversification, or concentrated investments?
How do you react to losses? Do you have discipline, or are you quick to panic?
How much time can you make available to actively manage your portfolio?
There are dozens of questions like this. The point is, only YOU can decide what will work for YOU.
Personally, this is a journey I’ve been trekking for years…
I’ve learned I’m more successful operating “systematic” strategies than discretionary ones.
I’ve learned I’m better as an active trader than a passive investor.
I’ve learned I get better results when I’m able to quantify my probability of success, rather than assume my subjective feelings are a reliable gauge.
All told, I’ve learned — through the process of trial-and-error — what works for me (and what doesn’t).
To bring this home… my message today is simple: Take ownership of your investment strategy.
Make the commitment to figure out what works for YOU, because only you can determine that.
Wall Street — whether villain or saint, biased or unbiased — can’t tell us the investment strategy best suited to you.
And in many ways… this is the ethos of Dent Research.
Our goal is to offer you a wide variety of unique investment strategies. We do this because we know that not every investment strategy will be a “perfect fit” for every investor. It isn’t necessary.
If we can provide an environment in which you can explore a number of approaches, allowing you to ultimately settle on a few that are well-suited for YOUR needs… then we’ve met our goal.
And I promise you this… once you’ve found an investment approach that fits you like a glove, you’ll be too successful to bother worrying about the wolves on Wall Street… and you’ll no longer feel like the sheep.
Adam
May 22, 2015
Stock Buybacks: Better in Theory Than in Practice
In the world of investing, so many things work better in theory than in practice.
Executive stock options were originally billed as a way to align management and shareholder interests. Now, they’re reviled by investors as a way for management to quietly loot the companies they are paid to run.
Not only do these puppies massively dilute the value of shares over time, they also suggest the company isn’t focused on the long haul. They incentivize management to fixate on raising the company’s stock price in the short term, at the expense of planning for the company’s long-term future.
Along the same lines, share repurchases — or stock buybacks — have become popular in recent decades as a tax-efficient alternative to cash dividends… but even these have become corrupted.
The reasons for doing buybacks are obvious.
Earnings paid out as dividends are taxed twice, at both the corporate and individual investor levels…
But when a company uses that same cash to buy back its own shares in the open market, it can boost earnings per share without creating a taxable event.
And unlike dividends, which are usually paid quarterly, stock buybacks can be done sporadically as cash allows.
Then there’s the fact that companies view raising dividends as risky because they’re a firm commitment. Management doesn’t want to be in that awkward position of having to slash the dividend later if conditions take a turn for the worse.
Buybacks, on the other hand, occur quietly behind the scenes and can be stopped at any time without drawing too much unwanted attention.
Again, it sounded good…in theory.
But in practice, companies tend to have awful timing.
They buy their stock when prices are high and sentiment is good. But in a market panic, when prices are low, they don’t, or can’t. Money that might have been used for a savvy buyback ends up getting hoarded. And if times get really bad… and the company finds itself short of cash… it might have to issue new shares, effectively selling when they should be buying. .
Buying high and selling low. It’s not exactly a formula for maximizing shareholder value. Still, we saw plenty of it during the 2008 crisis and its aftermath.
But that’s not even the most insidious aspect of stock buybacks…
The worst part is that they often fail to reduce the number of shares outstanding.
Hold the phone… how exactly could a share buyback not reduce the number of shares outstanding?
Simple. The buybacks are essentially used to “mop up” new shares that are created to satisfy executive stock options and employee stock purchase plans.
If that sounds bad, you haven’t heard the worst of it. Those new shares created to satisfy employee stock options and stock purchase plans are sold at a discount… whereas those bought via buybacks are bought at full price. It’s another case of buying high and selling low… and the shareholder is the one that gets screwed.
If that sounds like highway robbery to you… it’s because it is. And, sadly, it’s perfectly legal.
And it’s a bigger problem than you might think.
Let’s take a look at the most recent buyback data compiled by Factset. The companies of the S&P 500 have collectively repurchased a little over 3% of their shares outstanding in each of the past two years. That means that their shares outstanding should have dropped by around 6%.
Except the number of shares outstanding has only fallen by 1.5% over the past two years.
In that vein, only a quarter of stock buybacks actually do their job of increasing shareholder value by decreasing the number of shares outstanding!
But I’ll give you this — not all companies are equally guilty here. There are plenty that are legitimately using their excess cash flow to reduce their shares outstanding.
No funny business with the accounting and no debt-fueled binges. Just solid cash management to the shareholder’s benefit.
But these companies are the exception. Market-wide, the boom in buybacks is mostly a farce, aided and abetted by Wall Street and the financial press.
So, before you get excited about that next buyback announcement, do a little homework on the stock in question. If their actual share count reductions have failed to keep up with their buyback announcements, view the company with a skeptical eye.
Buybacks can also be used to stealthily hide a slowdown in sales. This month in Boom & Bust, Adam O’Dell teams up with renowned short seller John Del Vecchio to expose one of America’s supposedly bluest of blue-chip companies for using share buybacks to mask a major deterioration in its business. You might be shocked that this company has managed to fool even the venerable Warren Buffett!
You can download the latest issue of Boom & Bust by clicking here.
Charles
May 21, 2015
3 Economic Reporting Lies Revealed
I’m not much for glossing over the true state of affairs just to make things look better, which is why I take issue with many government reports.
When it comes to providing clear information on the economy, the U.S. government is more late-night pitchman than serious news anchor. And to make matters worse, many of the numbers they peddle have been “adjusted” so that reports show better results.
Statistics in this category run the gamut from gross domestic product (GDP), to inflation, even to employment. We don’t have to look far into the numbers to find questionable changes.
When it comes to measuring the growth of the economy, no report is bigger than GDP. It sounds straightforward — add up the value of production in the U.S. over a calendar quarter, and adjust it for inflation to determine the real rate of growth.
But apparently that’s not good enough.
In the mid-1980s the Bureau of Economic Analysis started adjusting the cost of computer equipment to reflect increasing capacity in later versions of the same equipment.
Even though consumers might have been paying roughly the same amount for a new computer as they would have before, the bureau adjusted the price higher when calculating GDP.
The idea was to show how much more buyers were getting with increased capacity, even though they didn’t pay any extra.
Got that?
This type of adjustment is called “hedonic.” It now adds over 20% to the value of GDP and affects items as far flung as clothing — or back when this was established, videocassette recorders.
This chunk of money that is added to GDP never changes hands. It’s simply estimated as extra value received by the purchaser. Anything to make GDP seem better.
The same sort of thing is done with inflation… but opposite. They want GDP higher, and inflation lower, so they fudge the numbers accordingly.
For example, a television with improved components in later models will have its price adjusted lower in inflation reports, whether the actual price stayed the same or even increased. What you paid $1,000 for, they may write down as $800.
Effectively, consumers are told: “TV’s cost less, you just can’t buy one for the lower price.” If it’s not available to me, then how can it count as something I would purchase? What if I don’t want the extra features? Too bad.
The inflation rate includes another curious adjustment — Owner’s Equivalent Rent.
This piece of mathematical fantasy represents what a homeowner could rent his home for if he chose to. The number is included as the cost of shelter in the calculation of inflation.
Instead of performing all these mental gymnastics to arrive at an estimate of housing costs, the government could simply survey home prices. That’s what they used to do.
But here’s the thing. Rents don’t climb as fast as home prices. So if you’re battling inflation, you magically adjust the cost of shelter to reflect rent instead of what it takes to actually buy a house.
It’s no coincidence the adjustment showed up right after a period of strong inflation in the U.S. that was very evident in home prices in the late 1970s. Guess it was too much for the BEA to take.
Then there’s one of my favorite economic adjustments: employment.
Each month the Bureau of Labor Statistics (BLS) estimates the number of people with jobs and those who are unemployed. They conduct a phone survey of roughly 60,000 people to ask about their work. Again, this too sounded straightforward… Do you have a job? If not, do you want a job? But as with GDP and housing costs, this proved to be too simple.
If you don’t have a job, but want to work, there are a few more questions they have to ask. How long have you been out of work? If more than four weeks, then what have you done in the last four weeks to find a job? If your answer doesn’t include filling out an application somewhere, then magically you are no longer counted as unemployed. You still don’t have a job, of course, but for the purposes of the Labor Bureau, you no longer count toward the unemployment number. Brilliant!
GDP, inflation, unemployment… these are just some of the big economic releases that move markets and sway people’s opinions about the health of the economy.
And yet, the numbers reported by the government include all sorts of fudges and fixes to make the statistics more attractive than the raw numbers would be.
This is why we have to do our own homework. It is why we have to break down each report to the raw data, and then decide for ourselves where things stand.
It takes a lot of research, but the payoff is worth it. With it, we can make more informed decisions for our businesses, our investments, and our families.
I’d say that’s worth the extra effort.
Rodney
May 20, 2015
The Truth Behind Many of Wall Street’s “Winners”
I have a confession to make. I like betting against companies. I enjoy it! There’s nothing more thrilling to me professionally than catching a company’s management team with their hand in the cookie jar and watching the stock price implode when their shenanigans are exposed. But, just because I’m a short seller doesn’t mean I’m a “permabear.”
There are appropriate times to allocate to stocks and there are times that aren’t so good. In my opinion, right now we are in one of the latter times.
That’s why I’ve written so much lately in my Thursday column for Economy & Markets that, right now, we’re in the riskier end of the spectrum, and allocating to equities at this point is likely to yield well below average returns.
In the past six years, the stock market has gone nearly straight up. To make money, all one had to do was buy the glossiest growth story and hang on for the ride. Many investors are still foaming at the mouth over these successes.
But, let’s take a look at what happened in one of the biggest bull markets of all time.
One of my favorite studies is called the Capitalism Distribution, which suggests a very small minority of stocks are responsible for nearly all of the market’s gains. It was presented by BlackStar Funds.
In it, they showed that from 1983 to 2007, the Russell 3000 was up 900%. But not all of those stocks were winners.
In fact, 64% of stocks under-performed…
39% of them outright declined…
19% fell by 75% or more…
And only 25% accounted for all of the market’s gains.
To a certain extent, that’s just capitalism.
For every Microsoft, there are 40 dead software companies that didn’t make it through the personal computing revolution.
For every Wal-Mart, there’s dozens of retailers that no longer exist because of inferior distribution, pricing power, and technology.
What’s more, the leaders from one cycle are seldom the leaders of the next. Kodak, General Motors, Polaroid, Bethlehem Steel and many other former giants were once core stock holdings that spiraled to $0. And that was during the best market of many of our lifetimes!
But that just goes to show, what looks like a winner may in fact be a loser waiting to happen.
And that’s the truth behind many of Wall Street’s “winners.” Sometimes, it’s strong fundamentals that send a company to publicly traded status and keep them there. Other times, these companies just know how to make themselves look good.
As a forensic accountant, I’ve boiled it down to a few simple things that can help you spot a real winner, from one that’s just really good at faking it:
Read the company’s quarterly and annual reports. Believe it or not, many professional investors skip the basic process of reading the SEC filings. That’s where all the bad stuff is buried. A little difficult to uncover if you’re not looking for it…
Track cash flow. Companies may report great earnings, but management cannot spend earnings. They can only spend what’s coming into the company’s coffers. If you compare quarterly cash flow to quarterly profits and analyze the trends, you’ll quickly see how the company’s actually doing.
Pay close attention to the quality of revenue. Did the company change its revenue recognition policy? Is it taking longer for them to collect receivables? Is the backlog piling up? When management teams play games with the revenue line, it usually indicates demand for their product is slowing. Revenue is far more important than earnings.
There are several other variables you can check to measure the true health of a company. How’s inventory? Is the company adequately selling their product, or is it piling up on the warehouse floor? Is the company experiencing an artificial profit boost by playing games with their margins? Is it making a series of incomprehensible acquisitions?
These are just a few pointers that you can look out for quarter-to-quarter to help spot trouble before it shows up in the stock price.
John Del Vecchio
