6/29 Kelly Letter Topics
⇒ Weekly market review
⇒ S&P's lost decade
⇒ GM at 1950s prices
⇒ Alternative energy
⇒ IRS mileage deduction
⇒ Financial sector
⇒ Celestica
⇒ VIX is saying what?
⇒ Morningstar outlook
⇒ Robert Torray
⇒ Watching for bargains
There's a debate raging as to whether Crocs, maker of the famous Croslite clog, is a dead fad or a value at its current stock price just over $7. The stock is down from $75 last Halloween, but the business sports an operating margin of 23%, revenue growth of 40%, insider ownership of 11%, and an impressive line of footwear beyond the original clog -- it even includes women's shoes with heels. Look at all the styles at the Crocs website.
Here at The Kelly Letter, I began building a position in Crocs last month to howls of protest from some and cheers of encouragement from others. Those protesting said the original Crocs clog was a fad killed by cheap imitations. Those cheering said the original clog itself was no fad because it's very comfortable and, furthermore, the expanded line of styles speaks to the company's long-term plans and prospects.
I decided to start buying shares because it looks like Crocs is making strides towards establishing its name as a desirable brand. There will always be knock-offs, but are they as good as the original?
Where I live and work in Japan, the knock-offs have shown up from China but they feel different. People who've gone on comparison shopping trips for me reported that true Crocs are softer both in terms of pushing down on them with one's feet and in terms of rubbing their surface with one's fingertips. The Croslite material is better.
Too, teachers and mothers at schools near my office report that mothers do not want their children seen in knock-offs. They buy for them either real Crocs or an entirely different kind of shoe, not an imitation. That's branding at work.
These are anecdotal observations, but they're useful. I'd like to know the word on the street from other parts of the world as well. If you have access to a shopping area and can compare Crocs with imitations that are available, please send in your impression. I'd also like to hear what people say in your neighborhood. Is there value in the Crocs brand, or is it just a maker of a fad shoe that's now been flanked by knock-offs?
In early 2006, a friend of mine named Mike wrote to me saying he was worried about the Federal Reserve's decision to stop publishing M3 money supply statistics. He thought it could be a prelude to inflation and trouble for the stock market.
The M scale is a way of measuring money, proceeding from M0 on the narrow end of cash to M3 on the wide end including foreign deposits. Here's how they stack up:
M0: This is the most liquid measure, and looks at just the actual cash sloshing around the economy.
M1: Includes M0 and checking accounts.
M2: Includes M1 and small time deposits of less than $100k, savings deposits, and individual money market funds.
M3: Includes M2 and large time deposits of $100k or more, institutional money market funds, repurchase agreements, and dollars held at banks in Canada and the United Kingdom.
In March 2006, the Federal Reserve stopped publishing M3 data, saying that doing so would save it money and that M3 added no additional useful information about the economy beyond what M2 already showed.
But, is that true? You don't have to be an economist to see from the list above that M3 is the broadest measure of money in the economy. For more than two years, we've had no official data for deposits of more than $100k, institutional money market funds, repurchase agreements, or dollars stashed in Canada or the U.K. The worry voiced by Mike and others was that by hiding the growth of big money, the Fed made it easier for itself to inject billions of digital dollars into the economy without anybody noticing.
They wouldn't do that, though, would they? Sure they would. Even back when M3 was tracked, the Fed grew it at a rate of 8% per year. A chart showing 8% annual growth jumps off pages to even uneducated eyes, so away went the chart. Growing the money supply by so much is bound to have an impact on inflation, so the consumer price index was replaced in 2000 by "core inflation" as the way the government reports inflation. Core inflation checks the price of everything except energy and food.
Of course, that makes sense, because only people who turn on lights, drive cars, and buy groceries are affected by energy and food prices. Surely you're not part of that odd bunch.
So, by hiding the rising cost of energy and food, and not reporting the growing supply of dollars each year, the Fed cleared a nice path toward opening the money spigot to full blast. Corporations are all for this recipe because they award salary increases based on the cost of living which now does not include energy or food, so they can freeze or even lower wages. Higher prices for goods and services sold, coupled with lower employee wages equals more profitable companies, which must mean a healthy economy. Ta-da! Just like that, the economy is a gem again, thanks to the working stiff.
As investors, we're supposed to think like corporate management in the pursuit of all profits all the time. We're not supposed to care about workers. To hell with them. The less our companies can pay for their productivity, the better. You know the old saying: pay them just enough so they won't quit.
In theory, then, the rising money level combined with fudged inflation stats to create more profitable companies should lead to higher stock prices. It hasn't, though.
Since M3 stopped being tracked in March 2006, it has gone parabolic. You can't get data from the Federal Reserve anymore, but other organizations have pieced it together from weekly Fed reports. For example, the key stats section of nowandfutures.com provides charts showing that M3 was $10.25 trillion in March 2006 and has risen 32% to $13.50 trillion now. That's a big expansion of the money supply in just 27 months.
By chance, have you noticed anything getting more expensive during those 27 months? You have to look carefully, so let me help.
According to the Energy Information Administration, the average price of a gallon of regular grade gasoline in the U.S. was $2.25 when M3 data disappeared. Today, it's $4.10 and approaching $4.50 in some areas.
According to the Bureau of Labor Statistics, a pound of white, all-purpose flour cost 33 cents when M3 data died. In May of this year, it was 53 cents. A dozen grade A large eggs went from $1.30 to $1.93.
Inflation is here. Another way to put it is that a dollar is worth less today than it was a couple of years ago. That's true at gas stations and stores, as shown above, and also at the currency exchange where 27 months ago one euro bought $1.20 and one dollar bought 119 yen. Today the euro buys $1.58 and the dollar buys only 106 yen.
Which might explain what the Federal Reserve was really up to. The dollar is still the world's reserve currency. We pay for imports with dollars. Those sending us the goods and collecting the dollars as payment, such as China, deposit the dollars in central bank coffers or convert them to local currency. The central banks take the dollars and buy U.S. Treasuries. The U.S. government wants to pay that debt back with dollars as cheap as possible, which has been arranged.
What are the practical implications for individuals?
One is that this financial engineering may mean little to the stock market. On the one hand, rising profits from an inflated money supply and stagnant wages should get stock prices moving higher. On the other, higher energy prices could offset the savings from low wages.
Indeed, when we look back at the history of M3 in America, we see it rising steadily from about $0.80 trillion in 1970 to $4.00 trillion in 1995, then taking off to its current $13.50 trillion. During that time, we've seen bear markets, flat markets, and bull markets in stocks. We've also seen runaway inflation in the 1970s and benign inflation in the 1990s.
So, while Mike was right about the end of M3 data kicking off a race higher in the money supply, it's not clear that it's an automatic stock market killer. What is clear is that the situation is not good for American workers.
Courtesy of Martin comes a Macleans article from which I took the following excerpts:
While [Americans have] been out conquering the world, here in Canada we've been quietly working away at building better lives. While they've been pursuing happiness, we've been achieving it.
Believe it or not, we now have more wealth than Americans, even though we work shorter hours. We drink more often, but we live longer and have fewer diseases. We have more sex, more sex partners and we're more adventurous in bed, but we have fewer teen pregnancies and fewer sexually transmitted diseases. We spend more time with family and friends, and more time exploring the world. Even in crime we come out ahead: we're just as prone to break the law, but when we do it, we don't get shot. Most of the time, we don't even go to jail.
The data shows that it's the Canadians who are living it up, while Americans toil away, working longer hours to pay their mounting bills.
The wealth numbers, in particular, are shocking. As of 2005, the median family in Canada was worth US$122,600, according to Statistics Canada, while the U.S. Federal Reserve pegged the median American family at US$93,100 in 2004.
Those figures, the most recent available, already include an adjustment for our higher prices, and thanks to the rising loonie Canadians are likely even further ahead today. We're ahead mainly because Americans carry far more debt than we do, and it means that the median Canadian family is a full 30% wealthier than the median American family.
Here in Canada, the average amount of personal debt per person is US$23,460. In the U.S. it's a whopping US$40,250. And all those numbers are from 2005, just before their housing market slipped into a sinkhole. If you looked at the numbers now, you'd find that Americans are even further behind, because their largest asset -- their home -- is worth less.
Meanwhile in Canada, not only are we wealthier, but we don't even have to work as hard to make that wealth. In 2004, the average Canadian worker put in 35 hours of work per week, while our American counterparts put in 38. Only 30% of Canadians work 45 hours a week or more, compared to 38% of Americans. We also get -- and take -- much more vacation time. Employed adults in Canada get about 17 vacation days a year, and we take 16 of those days, leaving just one on the table. In the U.S., they get 14 days of vacation, but they only take 11, making them the world leader in yet another category: the working drudge.
While Americans are putting in overtime to pursue the American dream, we're at the pub having a few pints with friends. They may have bigger cars and bigger homes, but they're living under a mountain of debt. They look richer, but the numbers prove that they're not. The truth is that all of that competition, all of that keeping up with the Joneses, can take its toll.
With the financial sector still under pressure and the broader market following it lower, lots of people are looking for bargains. It never hurts to review one of the most basic ways of finding bargains among large companies: dividend yield.
For that, I suggested to frequent site contributor Dave Van Knapp that he write an article on the subject, which he did:
Question: Can dividend yields help you find bargains in the financial (or any other) sector?
Answer: A qualified yes.
You all know (I hope!) what dividends are: Cash payments by companies to their shareholders out of company profits. Paying dividends is one of the four principal things that a company can do with its profits -- the other three being (1) building a war chest, (2) reinvesting in the company (organically or by making acquisitions), and, (3) buying back its own shares.
Dividend yield is a simple calculation from two pieces of information: Total dividends over the past twelve months divided by the stock's current price. So, if Dividend Co. pays $1-per-share annual dividend, and today's stock price is $40, its current yield is 1/40, or 2.5%. Every stock's current yield is readily available on every financial website and in the newspaper.
Current yields change daily, that's why they're called current. The yield changes any time either of its two components changes. Most dividends are paid quarterly, so most changes in that piece -- the annual dividend -- happen just four times per year. But the stock's price changes continually whenever the market is open. If Dividend Co.'s price goes up to $41 today, its current yield drops to 2.4% (1/41). Just for a benchmark, as I write this, the current yield of the average stock in the S&P 500 is 2.6%. Companies in certain sectors -- such as finance and energy -- have become known for paying healthy dividends. Other sectors -- such as technology -- generally pay few dividends, if any.
So, can dividend yields help you find bargains? Well, there is an entire investment strategy -- the Dogs of the Dow -- based on the proposition that the highest-yielding stocks in the Dow Jones Industrial Average at any given time represent the best bargains. The theory, popularized by Michael O'Higgins in 1991, is that large, well-established companies (such as those in the Dow) do not alter their dividend payout policies very much, so therefore their dividends reflect management's long-term outlook for the company -- that is, they can spare the money rather than plow every cent back into the company. Therefore, if the yield is high, it must be because the price is "low" (compared to the stock's real value), and so the stock is a bargain whose price is likely to rise.
A popular technique is to invest in the ten highest-yielding Dow stocks (the "dogs"), hold them for a year, then sell them and buy the new ten highest-yielding stocks. Repeat annually.
One site devoted to this strategy (dogsofthedow.com) claims that the strategy has generally outperformed the Dow itself over many years by several percentage points.
I found that in using dividends to identify bargains, you must look beyond the yield itself. You must be able to achieve high confidence that in addition to being substantial, (1) the dividend is reliable, and, (2) the business model itself is sound. This takes some old-fashioned fundamental analysis -- otherwise the best stocks to buy would always be the highest yielders. You can find these on any stock screener, but yield alone does not tell the whole story.
It so happens that financial stocks right now illustrate the point perfectly. Citigroup is the poster child (aka whipping boy). At the end of last year, it had a sky-high yield of 7.3%. It was The Top Dog of the Dow. Say you bought it on January 1, 2008. As Dr. Phil would ask, "How'd that work out for you?" As of yesterday's close, Citigroup is down 40% for the year, and to add insult to injury, it slashed its dividend earlier this year. It simply couldn't afford it. (For comparison, the Dow itself is down 13.7% on the year.)
We know the reason, of course. Citigroup has been one of the hardest-hit banks in the subprime mortgage and credit mess. It turned out that it failed both of the criteria: Its dividend was not reliable, and its business model was not sound. The end of Citigroup's story is not yet in sight.
But Citigroup, you say, is an extreme -- perhaps unrepresentative -- example. And I would agree with you. Most of the time, a high-yielding stock suggests a good bargain. But you can't stop there. The key is making sure that the other criteria -- reliability of dividend and soundness of business -- are in place too. In Citigroup's case, by the end of last year, both could be seen to be in jeopardy by anyone who did just a little research. But other high-yielding financial businesses, such as JP Morgan Chase (which largely sidestepped the subprime mortgage disaster), or high-yielding businesses outside the financial sector, such as Kinder Morgan Energy Partners or McDonald's, have sailed along pretty smoothly. The latter two have delivered both high yields and decent price appreciation, while JP Morgan Chase has suffered much less than many other financial stocks.
Bottom line: High yields can be a good starting point in locating bargains. But look beyond yield alone. Ask yourself if the dividend is in jeopardy: For example, is it way high compared to what the stock normally yields? (Citibank was.) And take a look at the stock's business: Does the company have a good story? Are its numbers trending in the right direction?
Questions such as these will help you decide whether the high yield itself is a good omen or a flashing warning of high risk and decay.
Thanks to Dave for good work as always. To read more about his methodical approach to dividends, take a look at the review I wrote of his new book last month.
Did you read Thomas L. Friedman's Sunday column in The New York Times yet? He referred to President Bush as our oil "addict-in-chief" and said of Mr. Bush's new plan, "It is hard for me to find the words to express what a massive, fraudulent, pathetic excuse for an energy policy this is."
About a month ago you wrote an article looking at geopolitical risks, and identified a strike on Iran as the most pressing current situation. Any updated thoughts on that?
Yes, I wrote to subscribers last weekend about what an Israeli strike on Iran could mean to oil prices. I concluded that it would probably bring a spike higher, but that such a spike might finally be the blow-off top needed to get the price moving lower again "once everybody sees that no barrel of oil was harmed in the making of this movie."
Also over the weekend, Barron's agreed with the general idea that the price of oil is near a top. In his article "Bye, Bubble? The Price of Oil May Be Peaking," Andrew Bary wrote:
In the next decade, oil indeed may hit $200 a barrel. But prices could fall to $100 a barrel by the end of this year if Saudi Arabia makes good on its pledge to increase production; global demand eases; the Federal Reserve begins lifting short-term interest rates; the dollar rallies, and investors stop pouring money into the oil market. China raised prices on retail gasoline and diesel fuel by 18% Thursday, in a move that is expected to curb demand.
Keep in mind that neither Mr. Bary nor I were discussing the longer-term trend in oil prices, which is higher for the simple reason that rising demand is meeting static or declining supply. We were discussing the potential for medium-term price relief.
Others are not nearly as sanguine. The BERR Assessment made clear to The Oil Drum Europe that current high energy prices and associated inflation are not "a transient blip when the UK seems to be in a terminal dive towards insolvency" from an accelerating deficit in oil and gas surpluses. Euan Mearns wrote:
We should hopefully by now have reached a point where all stake holders in UK, European and Global energy are able to grasp the simple fact that we are now in the early stages of a full blown global energy crisis. The focus is currently on oil but this will soon turn to concerns over natural gas and coal supplies.
This crisis has been turned into a state of emergency by the indifference of political leaders in the UK (and throughout the world), fluttering in the wind of poorly informed public opinion while they have prevaricated about expanding renewable energy resources and building new nuclear power stations. All warnings of this pending energy crisis have been ignored in favor of pursuing popular policies that created the illusion of prosperity whilst the fundamentals of our nation's security and well being have been draining away.
That's the fragile backdrop against which we need to consider the impact of a strike on Iran.
The worst case scenario is that a strike would finally push the needle firmly to stagflation, the poisonous pairing of stagnant growth with rising inflation.
On that front, perhaps nobody has written more pointedly than Nouriel Roubini:
Stagflation requires a negative supply-side shock that increases prices while simultaneously reducing output. Stagflationary shocks led to global recession three times in the last 35 years: in 1973-1975, when oil prices spiked following the Yom Kippur War and OPEC embargo; in 1979-1980, following the Iranian Revolution; and in 1990-91, following the Iraqi invasion of Kuwait. Even the 2001 recession -- mostly triggered by the bursting high-tech bubble -- was accompanied by a doubling of oil prices, following the start of the second Palestinian intifada against Israel.
Today, a stagflationary shock may result from an Israeli attack against Iran's nuclear facilities. This geopolitical risk mounted in recent weeks as Israel has grown alarmed about Iran's intentions. Such an attack would trigger sharp increases in oil prices -- to well above $200 a barrel. The consequences of such a spike would be a major global recession, such as those of 1973, 1979, and 1990. Indeed, the most recent rise in oil prices is partly due to the increase in this fear premium.
Mr. Roubini concludes that without such a jarring negative supply-side shock, global stagflation is "unlikely" because of robust growth from Chindia and other emerging markets.
That leaves us with speculating on the odds of a strike against Iran.
The Jerusalem Postreported yesterday that former U.S. ambassador to the U.N. John Bolton said that Israel is likely to attack Iran in the time between the November presidential election in the U.S. and the inauguration of the new president. Mr. Bolton also said that he does not believe the U.S. will participate in the attack.
That's not the tone struck by CBS. It reported yesterday:
Israelis are mounting a full court press to get the Bush administration to strike Iran's nuclear complex.
CBS consultant Michael Oren says Israel doesn't want to wait for a new administration.
"The Israelis have been assured by the Bush administration that the Bush administration will not allow Iran to nuclearize," Oren said. "Israelis are uncertain about what would be the policies of the next administration vis-à-vis Iran."
Israel's message is simple: If you don't, we will. Israel held a dress rehearsal for a strike earlier this month, but military analysts say Israel can not do it alone.
"Keep in mind that Israel does not have strategic bombers," Oren said. "The Israeli Air Force is not the American Air Force. Israel can not eliminate Iran's nuclear program."
The U.S. with its stealth bombers and cruise missiles has a much greater capability. Vice President Cheney is said to favor a strike, but both Mullen and Defense Secretary Gates are opposed to an attack which could touch off a third war in the region.
It's easy to see why I still consider the Iran strike issue to be the most pressing geopolitical concern for investors.
At some point, most of us wonder if it's possible to quit our day job and become a full-time stock investor or trader. That moment comes usually after a big win or, more often, a string of big wins. The first time my annual investing income exceeded my business income, I thought about re-orienting my life to focus on managing my money.
Recently, a reader named Michael wrote to both Dave Van Knapp and me asking our advice on whether he should make the plunge to full-time management of his money. Both Dave and I replied to him separately, Dave in more detail than I. Below are all three notes plus a follow-up from me.
Michael wrote:
During the dot-com crash, I lost 100% value in most of my investments, and I forgot the stock market completely for many years.
For some reason this past February something sparked in me (maybe turning 50 did it), and I dove back in head first. I started a learning frenzy -- buying books, reading articles and such, watching CNBC, Bloomberg, etc. Wow, what a hodgepodge of information! There is a lot of conflicting information and nonsense, but also some really good stuff.
I opened two brokerage accounts and started investing again. Unfortunately, prior to some of my investment decisions, I was not aware of my now two favorite sources for investment information (Jason Kelly and Dave Van Knapp). I made some really bad decisions and some good ones along the way. In each portfolio I have some stocks that are up a bunch and some that are down a bunch.
I have just completed reading one of your books, and I am reading a second on dividend investing. I really enjoy this stuff, and if I could would be a full time trader (do you think that it is possible to do stock investing/trading as a full time career?).
My biggest concern now is a way of backing out of some of my bad decisions and not losing my shirt. I am using margin heavily and wish to eliminate this and to start using sensible techniques to manage my portfolios. Any thoughts would be appreciated and I look forward to many years of profitable investing.
Dave replied:
Hi Michael,
Thanks for writing.
There is a lot in your letter, and it leaves me with the impression that you are caught in a variety of modes of investing, particularly as to how much risk you take on and how you manage that risk. I was struck by the fact that you expressed interest in both dividend stocks and living the life of a trader. Those two modes of investing are very different in terms of their goals, time horizons, amount of activity, and the like. I am glad that you find Jason's and my books and newsletters helpful, because while our tactics differ, we both advocate a sensible, realistic, risk-aware, and methodical approach to stock investing.
This will sound like a pain, but I suggest you take a step back and think about, and then write out, your investment goals, both long range and short range. Once you have your goals firmly in mind, write out the strategies you think would help achieve them. I consider this exercise a foundational step for any sensible stock investing, and I refer to the documents as "constitutional documents." Just as with our nation's constitution, yours can be amended from time to time. The exercise need not be long -- I bet you can boil it down to a page. Review it often (to remind yourself of your investment policies), but keep changes down to about once a year.
The point is, I do not want to see you go off in 50 investing directions at once. That's not to say that someone might not trade "risky" stocks with part of one's money and invest another part in "safe" dividend stocks. But you should do so with your eyes open as to the benefits and risks of each approach, what percentage of your "stock money" you want to devote to each, how much time you have to spend, and so on. Any investments you make along the spectrum of high-risk to high-safety stocks should strive to reach your investment goals. Only you can articulate your goals.
In general, the shorter your average holding period, the closer you are to being a "trader," and the longer your average holding period, the less you are a trader. In my higher-risk investments, I use sell stops to protect myself on the downside. My holding time for a stock may be anywhere from a few days (for a mistaken pick) to many years. My approach focuses on Buffett's Rule #1, not losing.
In my dividend-stock investing, on the other hand, I do not use sell stops, relying instead on a semi-annual review of my portfolio for suitability and the continued dividend-paying ability of the stocks. In "pure" dividend investing, one is far less concerned with what the portfolio is worth at any given time than with the reliability of receiving continually increasing dividends. The dividends can be reinvested or used as current income.
I applaud and encourage you to continue to move away from using margin, especially since you have suffered deep losses in the past. Margin simply amplifies everything, the bad as well as the good. In all of the hedge fund "blow-ups" that I have ever read about, and in things like the recent collapse of Bear Stearns, excessive use of margin has always been involved. I have never used margin. That said, many successful investors do. I know that Jason is a proponent of leverage. He buys funds that are themselves leveraged rather than using margin (borrowing directly from a broker to fund investments).
As to backing out of your bad decisions (by which I think you mean mistaken investments), I have two suggestions: First, conduct a portfolio review. Examine each stock and decide whether it advances your investment goals or not. That will be relatively easy after you have written out your goals. You will probably conclude that some stocks were mistakes and should be sold. Second, you must sell them. You may find it psychologically difficult to sell stocks at a loss. Many people do. Selling at a loss is a well-known but self-defeating hang-up for many investors. But you must sell the stocks that do not fit your investment strategy.
As a technique, you might consider setting a very tight sell-stop, like 2%, under each stock you intend to sell. That way, if they catch a temporary updraft, you can squeeze every last nickel out of each one. Keep re-setting the sell-stops just under the stock's price. Before long, they will hit their stops and sell. Many investors find that psychologically easier, because it takes some emotion out of the transaction. The sale takes place "automatically" according to the rules you set up when you are emotionally detached.
Again, thanks for writing, and best of luck in your investments!
I replied:
Hi Michael,
I think it is exceedingly hard, but possible, to make a living as a trader. I also think it's not a very fulfilling life, but some people swear by it. My friend succeeded at it financially but returned to work because he felt so isolated in front of his computer all day, nobody to talk with, and without anything in common with people anymore.
As for margin debt, I would eliminate it and never use it again. Warren Buffett said that if you're smart you don't need it and if you're dumb it'll kill you. I don't know what your positions are, but I would think carefully about what you can do to get rid of that debt for good. Maybe selling the losing positions makes sense because then you can get a tax write-off even as you use the cash to pay down the debt. Every little bit helps.
Even though Dave offered clarification between margin debt and leveraged products, I want to expand that a bit here. You won't amass margin debt using leveraged funds or ETFs like the ones offered by ProFunds and ProShares. You won't have to pay interest on borrowed money with leveraged products because all of the leverage happens within the funds and ETFs. You hold them the way you hold any other investment bought with cash, and there's never a margin call.
That being understood, the dangers of leverage still apply because the investments themselves change price with greater force (usually 200%) than their underlying target index. If that index gains 10%, the 200% leveraged fund or ETF will gain 20%. If that index loses 10%, the 200% leveraged fund or ETF will lose 20%. The tracking won't be that precise in practice, but that's the idea.
Leverage is risky. Those using it believe that the risk is more than counterbalanced by the potential for a higher return. For instance, if a sector or the broad market has sold off hard and an investor has enough time to wait, buying a leveraged long fund or ETF at cheaper levels can be a great way to ride a recovery to stellar performance. For the chance at that, some investors like me are willing to expose themselves to the downside risk of leverage.
One way that leveraged funds and ETFs are better than margin for using leverage is that you can't lose more than 100% of your investment in the funds and ETFs. You can lose only what you put in. With borrowed margin money, it's possible to lose everything you invested, plus what you borrowed, and still need to pay interest on what you borrowed. That situation can be a life wrecker.
Hats off to Dave for a nice technique to back out of losing positions. I like the 2% stop-loss ratcheted up daily to squeeze as much money as possible out before selling. Longtime readers know that I'm a big fan of limit orders precisely because they take a lot of the emotion out of this emotional business.
Finally, understand that trading is extremely hard. Even well-known pros get it wrong from time to time, as this recent gaffe by Jim Cramer illustrates:
One way to help yourself decide whether to put money to work in the beaten-down financial sector is to see how its individual stocks are rated by analytical firms. I did exactly that in yesterday's note to Kelly Letter subscribers. I looked at Morningstar's analysis of the top ten components of the Dow Jones U.S. Financials index.
With the news around subprime, capital raising, write-downs, the still struggling housing sector, and stagflation being so bleak, you might be surprised at the results.
If you'd like to take a look at yesterday's note and to see my suggestion for how to position money now, come on board the letter. It's only a penny for the first month and then just $5.48 per month thereafter, and you can cancel at any time. You probably won't, though. A full 85% of people who try it for a month stick with it. From the information page:
Why the high satisfaction? Because it's cheap, it works, and it's pleasant. So many investment services are unapproachable or mysterious about their methods, as if they're doing something that ordinary folks wouldn't understand. Don't fall for it. They're not doing anything that's beyond anybody else. Just look at their results to see.
Now's a great time to give the letter a spin, at least if you have an extra penny to spare. We'll roll out the welcome mat when you click here!
This is my last article this week. I'll be away from the free site until next week, but will be sending The Kelly Letter to subscribers this weekend, as usual.
More on our current theme of America's future comes from historian Jonathan, who wrote:
Your reader [Marcel from Monday's article] evidently doesn't understand what became of the Roman Empire. It split in twain, and (excepting my folk hero Julian the Apostate's brief efforts) remained that way.
The western portion could certainly be considered to have fallen in a sense, given that Alaric the Visigoth and his homies sacked Rome (by which time the administration was at Ravenna anyway) when hardly anyone could be bothered to defend it. Later that century it fell to a Scirian barbarian king, then became an Ostrogothic kingdom, and in general we watched the rise of Germanic-speaking people -- Franks, Goths, Vandals, etc.
But an interesting thing happened there. When those successors finally produced a new empire, they called it the Holy Roman Empire. I am not contending that the HRE was any form of direct descendant of the Empire of Vespasian and Diocletian, of course. I am contending that in one form or another, the western Roman Empire hung on quite a long time -- even if only as an idea.
But that was the weak side of the split.
The eastern portion could not be considered fallen at all at the same time as the western. It became the Byzantine Empire, a thriving place, and endured for a millennium after Odovacar the Scirian contemptuously told the last western Emperor: "You can run along now, son."
Of course, it's not good enough to just tell the history; part of the task is to draw lessons and inferences. I think your British example is a reasonable one; I think it's a worthy topic of discussion which former major power we resemble more.
I am greatly fond of pointing out to Americans that our Francophobia is ironic in light of the fact that we so resemble the French. We are unilingual, we overrate ourselves, and we're often insufferable about both facts. We ought to view the French as kindred spirits, because they're the only other people in the world as abrasive and difficult and annoying as we are. (Then there's that little part about us probably losing the Revolution without them, us helping Napoleon, a big statue, then two major wars together. If ever two nations were meant to be friends it is us and France.)
I do not think that the U.S. faces the fate of the western Roman Empire, or even the eastern. I do think that the world contains a finite number of resources, an issue Americans have often been able to ignore for domestic purposes but which was enough of a deal-breaker for Japan to lead her to war against us. The Japanese know (because, so far as I know, they have almost no natural resources).
I also think that the underdeveloped world wants to live like the developed world. Chinese and Indians want to live like Japanese and Americans. So do Bolivians and Botswanans. The rest of the world is hurrying to catch up, and that means significant amounts of infrastructural and consumer spending as homes get their first indoor plumbing, water faucet, phone line, microwave, electric socket to power a microwave, etc. Therefore, we will see them grow at a faster rate for some time -- probably into my retirement years (I'm 44 now).
But that doesn't mean America is in decline. It may mean that America's growth slows; it may mean that other nations grow faster. If someone wants to consider that relative decline, I suppose they can, but they're applying too much spin by putting it that way.
What it does mean is that Americans will have to get over their Suite Madame Blue [lyrics and live performance] delusions and realize that our national military and economic power has limits. What it means for the American investor is that there's profit to be had investing overseas, at least for those few Americans who understand or care what's going on overseas.
The rest are the mullethead in the flag do-rag and shades we've all seen in the pic holding a sign that says, "Get a Brain Morans." They're the same Americans who think that because fuel prices have now finally reached equivalent levels to the early 1970s, death and destruction will rain upon our land. Odd. I was a boy in the early 1970s. I remember long gas lines but I don't remember death and destruction. (Watergate, yes.)
As for those who don't realize that a portion of the Roman Empire survived intact for nearly a millennium after the exile of Romulus Augustulus in the west, it might profit them to check their analogies before using them.
A great history lesson, and consistent with the main message of Fareed Zakaria's new book, The Post-American World: It's not so much that America is declining, but rather that other countries are finally catching up. Zakaria calls it the rise of the rest.
America will remain the sole superpower for a long time yet to come. Will it use that position to its advantage, or get sidetracked and become the buffoon in the room that everybody else is snickering about?
There's been a lot of snickering so far this century. Some fine statesmanship would be a pleasant change of pace.
Yesterday's article on why I think America is not in decline prompted thoughtful replies from readers.
John wrote:
I found your article particularly interesting as I am British, and agree somewhat with your opinion, but remain skeptical about America's future.
One topic you and many others constantly overlook is America's appalling immigration blunder. This is not a minor problem, as it's going to affect the US's future. This nation is where it is thanks to immigrants from western Europe, primarily Germans. In the 18th and 19th centuries, 50 million Germans came to the USA. They were the most industrious, qualified immigrants any nation could have welcomed, and this country should be eternally grateful to that group. It's also interesting to note that it was Wernher von Braun (a German) who was the brains behind the US space programme.
The current crop of immigrants does not come anywhere near the desirability of the people who came here during the period I mention. This is the ultimate reason the US will not compete in this century.
I understand you live in Japan. Have you been here recently to take a close look at the infrastructure? The shocking condition of the road-railway systems is straight out of the 1890s -- worse, in fact. There's no public transportation of any note, a failing school system, and political correctness has been taken to the point of absurdity.
The US enjoyed a power surge after World War II as it was the only industrialised nation standing. I am 73, and lived through the war in the UK, and will be eternally grateful to the US army and the USAF for their tremendous effort -- that's the America I remember and liked.
I felt compelled to write this letter because many Americans are still under a degree of denial about their country. As an ex airline guy who has traveled and lived extensively abroad, I was aware of the decline that was taking place several years ago.
You appear to be an interesting young man, Jason, and are no doubt living in Japan for your own reasons. Whatever they are you must be very aware of what is happening in that part of Asia -- I think we are going to be very surprised at the events that occur in the next 10-20 years.
Discussions with my grandparents and others of their age have instilled in me the respect for the World War II generation that John conveys in his note. There was something almost magical about the greatest generation, and comparing their handling of WWII with nearly every U.S. conflict since then is a sure path to frustration. Who would you rather have in charge, Franklin D. Roosevelt or George W. Bush? It's a rhetorical question.
On that score, I share John's point of view. Ditto the poor quality of the U.S. transportation system, which I wrote about on May 22.
Regarding immigration, however, I don't find the current situation quite as grim as John does. Every country would prefer that most of its immigrants be highly educated geniuses cut from the von Braun cloth. That's not a reasonable preference, though. The current crop of immigrants to the U.S. may not bring the same contributions brought by the Germans and other European immigrants, but it does get America around the declining demographic problem faced by other developed nations.
By 2030, according to Nicholas Eberstadt at the American Enterprise Institute, the U.S. population will grow by 65 million people. Europe's, however, will remain stagnant and end up with twice as many seniors over 65 than children under 15. Developed populations around the world have either already stopped replacing themselves or are near that point, leaving immigration as the primary way of keeping demographic trends healthy. Too few children today means too few workers tomorrow.
The UN reports that a native-born American woman bears 1.9 children, less than the 2.1 rate needed for replacement. Without immigration, the American population would not be growing today.
Also, we should keep in mind that at any point in history the most recent wave of immigrants is viewed with suspicion. The newest newcomers somehow never stack up to our retrospective view of the prior newcomers. Part of that is due to the prior newcomers now considering themselves natives and looking with disdain on the next wave of people doing precisely what they once did.
Recall the "No Irish Need Apply" signs of the 1850s and 1860s in England and America to realize that the impression of European immigrants as being high quality people wasn't always dominant.
From the Opposing Viewpoints book on Immigration, edited by Mary E. Williams: "By high margins, Americans are telling pollsters it was a very good thing that Poles, Italians, and Jews emigrated to America. Once again, it's the newcomers who are viewed with suspicion. This time, it's the Mexicans, the Filipinos, and the people from the Caribbean who make Americans nervous."
That said, I think it's easy to support John if we restrict our dislike to illegal immigration. Nobody opposes immigration when we're talking about Indian software developers, Japanese automotive designers, German rocket scientists, British journalists, French engineers, and Brazilian business leaders. Let's be honest: the problem is illegal aliens who sneak into the country, produce a litter of children supported by social programs, and never generate enough economic value to offset their drain on the country.
John wondered if I've been back to America recently to see its current state. Yes, I get back two or three times a year. One of my most frustrating experiences has been accompanying a group of Japanese visitors to Los Angeles International Airport where they were eager to begin using the English they'd studied so hard, only to find that half of the "Americans" they met didn't speak English. One of them asked me why she couldn't catch any of the words the man on the street was saying to her.
"Is it an English dialect?" she asked.
"No, it's Spanish," I answered.
The image that Japanese people have of Hollywood is left over from the days of Marilyn Monroe and Audrey Hepburn, whose pictures still adorn brand new movie theater walls in Japan. That impression is gone by the time the sun sets on the first day in Los Angeles.
Is it so shocking, though? Look at the name of the city.
Even the hard line against illegal immigration can run up against second thoughts the first time you get to know a good person who came to the U.S. illegally. A friend of mine in Los Angeles owns an office equipment store, is married to a white American woman, has a son in the military, and would do anything in the world to help me. He came illegally to the United States from Honduras, with the help of a "coyote" (smuggler). He spoke no English. To learn, he joined a Toastmasters club. That's where I met him, and I've enjoyed listening to his speeches in perfectly good English.
I know his story is anecdotal to the national discussion, but it's not to me. Even as we form national policy, it wouldn't hurt to keep compassion close at hand.
As a thought on whether the U.S. is in danger of being swamped by immigrants, keep in mind that the foreign-born share of the population in 1900 was 20%, twice as high as the 10% share it sits at today.
I agree with the spirit of John's note. The U.S. needs to get smart about immigration, not to cut it off. The country needs to decide who's going to improve the national situation and who's going to make it worse.
Here in Japan, I have to periodically prove to the country that it's worth letting me stick around a while longer because I'm writing something of value about the culture. I didn't sneak in, nor do I stay surreptitiously. The authorities know where to find me and I have every document required to be here.
Is it too much to ask that immigrants to America show the same respect?
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