How To Pick Stocks
“The four most dangerous words in investing are: this time it’s different.” -Sir John Templeton This week is the eightieth anniversary of the Battle of Britain. During these somber times, we find inspiration in those who overcame adversity in the past. Investing would be easy with the benefit of hindsight, right? Well yes literally, but what if we asked you, knowing what you know about history, to guess when the British stock market bottomed in the Second World War. What would be your guess? Probably after it became clear that the British were not going to be annihilated, right? Wrong. Would you believe us if we told you that the British stock market bottomed a month before the Battle of Britain even began? How hard would it have been to buy at that period of time? Pessimism ruled. That means that through the fire-bombing of London, V1 and V2 Rocket attacks, The Blitz, the U-Boat Blockade, The Fall of Singapore, and the failed cross-channel raid at Dieppe, the upward trend of the market went unbroken. As we face a comparably grim moment, and indeed the most significant exogenous shock to the market since World War II, it behooves us to remember both what commentators were saying would happen in the markets, and to recall what actually happened. Better still, let’s remember how they diverged. The last ten times the market made a comparable drop to the March lows, it was followed by a ‘V’ Shaped economic recovery. We see no reason why this time will be different, even in the face of rising COVID-19 cases. What we see is as an unprecedented contrarian opportunity to buy stocks with the intent of owning them. We understand why the glum sentiment on much of the Street exists, but we find the data refutes it. We do not think stocks will make another bottom, and we believe the market has a good chance of making new highs this year. While the current situation is undoubtedly terrible, we find much of the commentary from bears to be long on emotion and short on fact. They have to squint more and more to see their negative narrative; all the while markets go up. The data is often ‘less bad’ than initially anticipated. Pullbacks are often short and healthy, not panicked selling, and we haven’t hit the breakers in a while. Then a lot of the people spread fear that the morally profligate Fed, sooner or later, will destroy us all, in some way or another. They rarely offer alternative action on what the Fed should have done. The discourse across the financial world is very bearish and capital across the system is positioned so short that some fund managers could fall into their loafers. We think you should be skeptical of commentary like this, which may or may not be self-serving, and we’ll explain why. Markets are functioning and markets are free, that is something we should be grateful for. Inspiration From Previous Dark Times To give our readers some perspective, we’d like to take you back in time. To a time when the freedom of markets was threatened not by Jay Powell’s dovishness but by the jingoism of Adolf Hitler, Benito Mussolini, and the Empire of Japan. In June 1940, the Nazis had achieved the pinnacle of their success, soundly defeating the entire French military, resulting in that nation’s abrupt and ignominious surrender. The British Expeditionary Force narrowly escaped without most of its means of making war by using primarily civilian boats to evacuate from Dunkirk. The German forces were by every measure more modern, better trained, and better equipped. The ‘Blitzkrieg’ offensive brought France to its knees in six weeks. This dazzled Europeans whose last conflict had been an intractable, bloody stalemate, marked by agonizingly slow and expensive military progress. To those experiencing these events, there was extraordinarily little reason for optimism. Far less than we have in today’s markets. Few of the times’ pundits and analysts predicted a positive outcome for the Allies at this point. Optimism was the gaudy possession of a few leaders, by no means all, and the masses they led. It seemed that the future would be ruled by Fascism. The freedom of markets was truly in danger. One voice of optimism was Winston Churchill, who had previously been considered political dead weight after planning the botched Dardanelles Campaign and his association with other high-profile bumbles. His optimism was met by many, including the more respected politicians of the day, with skepticism. He was traduced and lampooned by opposing politicians for failing to see reality. He was derided and pressured to seek peace with the Nazis. On June 18, 1940, he gave an address before the House of Commons defiantly against the bleakest of backdrops. The very building he spoke in would be destroyed only months later. While few could see the light at the end of the tunnel, the worst for Britain had not yet begun, Churchill uttered the following description of the situation; which deviated significantly from consensus expert opinion: In casting up this dread balance-sheet, contemplating our dangers with a disillusioned eye, I see great reason for intense vigilance and exertion, but none whatever for panic or despair. During the first four years of the last war the Allies experienced,…nothing but disaster and disappointment, and yet at the end their morale was higher than that of the Germans who had moved from one aggressive triumph to another. During that war we repeatedly asked ourselves the question, “How are we going to win?” and no one was able ever to answer it with much precision, until at the end, quite suddenly, quite unexpectedly, our terrible foe collapsed before us. -Winston Churchill, June 18th, 1940 Winston Churchill is one of the great orators that democratic society has produced. The words he offered had an uncanny ability to decipher the optimism and energy of the masses in the face of pessimism from his colleagues and expert commentators. During the gravest threat ever faced by Western Civilization, his inspirational words fomented optimism in the face of seemingly impossible odds. An example of the prevailing pessimism can even be found in a former titan of finance Russell Lefingwell, one of JP Morgan’s (the person) main partners during the pre-war period that said, “The Allies cannot subjugate the Germans. There are too many of the devils, and they are too competent”—and at the time, there was little reason to doubt his logic. This opinion was widely held throughout the elite corridors of high society in America and Britain. However, Churchill gave a series of defiant addresses laden with hope and a call to national duty and unity. It inspired optimism where it mattered for Britain in the struggle to come: in the hearts and minds of the citizens that would operate the factory lines and fly the Spitfires. Churchill’s optimism seemed to be out of the blue; he derived direct inspiration from the people and channeled it into his defiant speeches. However, as Winston Churchill projected hope and strength from the unmitigated, and many experts would have said unwarranted, optimism of the steadfast British people, this hope also began to be reflected in the British stock price. Curiously, it bottomed after a long and precipitous fall in June 1940, about a month before Britain’s harshest and most harrowing period of the war began. It should be noted that around this low point, there was a backlash against the Royal Air Force, and it was widely cursed by members of the Royal Army who’d suffered humiliation at Dunkirk and sought a scapegoat. As bad as things were in the times to come, every day the RAF held back the onslaught, it was outperforming the expectations of all who observed. The outcome was undoubtedly awful; half of London’s population slept underground as bombs fell from above, but it was less bad than what had been initially anticipated. The Nazi conquest of Britain was as yet incomplete. In this time of fear and widely held doomsaying, we must acknowledge the uncanny historical ability of markets to make sense of available information in ways that are at odds with the emotional fog of the present, in ways that obscure clarity to even the most astute contemporary observers. So what does this have to do with stocks? Well, when commentators today harp about the market’s insouciance in the face of rising coronavirus cases, you can remind yourself that the British stock market went up when German bombs were leveling whole city blocks in London. This is not anomalous. Similarly, shortly after the Battle of Midway (which in retrospect was the major turning point in the Pacific War), the US bear market of 1939-1942, caused primarily by geopolitical instability, abruptly ended. At the time, it was impossible to determine that Midway was as strategic a junction in the conflict as we see with the benefit of hindsight. Even the German Bourse, vestige of its democratic past, seemed to peak at the absolute height of their territorial expansion when no one yet realized what an awfully bad idea it is to pack light for a Russian winter. Even that wayward and belligerent nation’s own prominent investors sensed over-optimism and that perhaps their opponents were more resolute than their initial successes indicated. So, what is behind the prescience of Democracy’s Delphi? No one knows exactly, and no one is saying the stock market is flawless in its predictions or always right. The facts seem to indicate that the aggregation of many opinions into an average is generally more accurate than any one of them alone. How To Pick Stocks: Know Thyself, Nothing In Excess, Surety Brings Ruin So then, how do you pick the best stocks? It’s easy! Just find the companies that are going to outperform their peers and remain profitable in the future in the face of risks you cannot possibly anticipate! The ease with which we provide our response is intended to be a comically simple answer to one of the most challenging and debated questions in Christendom and beyond. To put it lightly, there is widespread disagreement on how to best pick stocks. We get it. Everyone wants to be right. Many investors may have pipe-dreams of a contrarian master-piece like John Paulson’s great call during the GFC or some variation of something they saw in Michael Lewis’s The Big Short. We get it, it’s cool to call the market going down when everyone thinks it’s going up but there’s something even cooler; like someone calling the bottom on March 24th and going headlong into some names that consensus deemed little better than future bankruptcies with great success. Ah-hem! FS Insight Team clears throat. We think it is always easier and more likely that you will make money on the way up. Owning stocks over the long term has pretty much always been a good deal, and some prominent tech stocks are beginning to have risk adjusted returns that rival some of the safest assets available. We have great ways to pick stocks for all different risk appetites. We’d gently say to you that going long when consensus is overly bearish is an easier and better deal than trying to time and short the market. Glass Half Full: Please Can I Have Some More? The headline unemployment numbers we currently have, amongst other numbers, are enough to make even the brave blush. However, the Nasdaq is also making new highs. It’s a hard market to make sense of. Did you know that because of how wealth and unemployment are distributed in the United States that it is possible that after all is said and done that the Global Financial Crisis (GFC) may result in a more significant loss of income than the coronavirus crisis? We bet that was not your first thought. This seems like it is impossible. How can this be with such a high unemployment rate? The majority of job losses have been suffered by workers who have low incomes, many being minimum wage. Higher paying jobs have not been lost in great numbers so far as they were in the GFC, which resulted in an outsized loss of income due to their higher than average salaries. Notably, the government stimulus to individuals in many cases results in many of these workers actually having more income than before. Consumer confidence has stayed at a way more elevated level than it sank to in previous bear markets, and this solidifies our analysis. It remains much higher than the reading of 20 that was registered in the dog days of the GFC. It might be easy to forget after so long that the entire reason we pay attention to the unemployment number is its proxy effect on income. We have been telling our members that employment numbers would dramatically overstate the loss of income experienced by the economy. We also pointed out to our clients that even if all ‘social distancing casualty’ companies were to permanently shut their doors that the US economy would still operate at 93% of its pre-crisis capacity. This is an example of how we translate state-of-the-art data analysis into actionable insights for our investors. We adapt, and we pivot to markets and relevant developments in real-time. These insights, along with the immense amount of capital on the sidelines, largely informed our decision to recommend some of the best performing stocks since the market bottomed. We provide our rationale and thoughts regularly to our subscribers. While we primarily aim our insights toward giving our investors stock picks, we believe our diverse analysis is useful for anyone who can benefit from sound investment advice, from day-traders to brand new investors. Whatever your trading strategy, we can help. How We Pick Stocks Bottom-up investing is looking for stocks based on their idiosyncratic fundamentals and financials, essentially picking stocks of financially sound and stronger companies that will outperform their peers and deliver to shareholders. Top-down investing, particularly crucial in times of uncertainty, is working downward from macroeconomic data and determining how those conditions will affect stock prices. At FS Insight, we combine the unique and beneficial aspects of both these kinds of analysis, and others like our premier technical analysis, to provide versatile and actionable investment advice to our clients, including single stock names derived from combining diverse types of intersecting analytical criteria. We provide detailed macro-guidance (it seems lately our job has been more akin to Virology than equity analysis at times). However, we think this ability to pivot on data and to react and inform investors on what appears to be causing price movements gives our clients a better edge in investing than any other service. Check us out, some of our more prominent clients will verify our approach. During the Internet Bubble, people made money by avoiding everything that had suffered the worst drop in value. In the Global Financial Crisis, running directly into the burning building and buying banks and financials gave you the highest return. If an analyst only does one of the analysis methods, they can easily get stuck in a logically defensible strategy that loses them money. We also like to look to the recent past in less definitive and headline-grabbing ways than some of our competition. For example, we take a lot of stock in the experience of one group of companies that were recently hit by a virtual complete stop in demand; prognosticators and market talking heads vehemently proclaimed the imminent collapse of the Homebuilders in the early days of the Financial Crisis. How could they possibly deliver to shareholders with the collapse in demand? The homebuilders exceeded even the most bullish expectations, and by Q1 2010 they had the same operating income with 69% less revenue. We think that the same remarkable ingenuity demonstrated by the Royal Air Force in the face of the bleakest odds, the Homebuilders in the wake of the GFC, and many of the stocks at the ‘epicenter’ of this crisis is something that as it was historically, is currently being grossly underestimated. Human beings can do amazing things when faced with profound adversity or ruin. We identify the strongest of the hardest-hit companies to our investors as some of the best places to put your money to work. From March 24th to June 9th, our picks outperformed even the wider market’s impressive comeback significantly. We believe that upward movement will continue, perhaps jaggedly, into year-end and into 2021. While we’re on World War II, we’d also like to point out that bears are betting against the largest singular collection of private and public resources toward a single objective in human history. That is right, the accumulation of scientific and intellectual capital aimed toward curing or developing a therapy that reduces the Coronavirus’s impact definitely exceeds what was done in the Manhattan Project. We want to think of ourselves as in the business of betting on human ingenuity, not against it. We’re certainly not urging our clients, as many bearish commentators are, to assume there will be no vaccine. Vaccine news has been positive and we believe continued positive news in this area will be a strong positive binary event for markets. Exogenous Versus Endogenous Economic Factors The discussion of these types of investing lends itself to another key difference that we believe many investors are struggling with. Most of the time, by a long shot, the market is more affected by endogenous economic cycles rather than exogenous economic shocks. Most investors do most of their planning based on these more predictable events; these cycles are perennial, while each shock is unique. The difference can be illustrated quite easily. Regular endogenous economic cycles of boom and bust are driven by FOMO and the wealth management industry’s tendency to pile into ‘crowded’ trades (that we can help you avoid) until they cause a correction that is usually greatly amplified by investors being over-leveraged and unable to meet their commitments. The result is the thing that causes prices to go lower than any war, plague, or catastrophe so far; forced liquidation. Hyman Minsky’s famous Financial Instability Hypothesis is an economic model that explains booms and busts within the context of internal dynamics unique to capitalist economies, perhaps the quintessential description of the herd behavior and mania that bears love to focus on. Prices go down mostly because of the irresponsible accumulation of private debt in Minsky’s model and unbeknownst to many bears apparently, also as a prerequisite for their grim price targets and predictions coming true. For the type of downward price movements to occur that ‘bubble-spotters’ and ‘perma-bears’ love to foretell, markets need to be over-leveraged, and a significant proportion of market participants need to meet the definition of a ‘Ponzi borrower’ thus resulting in forced liquidation that drives all correlations towards one. The Global Financial Crisis is a good fit for demonstrating what happens in Minsky’s model because of an endogenous shock. An astute analysis by Economist Paul McCulley described how Minsky’s theory was expressed perfectly by the subprime mortgage crisis; with the hedge borrower being represented by those holding traditional mortgages, the speculative borrower holding interest-only loans, and the panic borrowers holding loans with negative amortization features. This situation is clearly not what we are in today. Consumer confidence didn’t plummet, rent and mortgage forbearance are occurring widely, loans are flowing out of banks, and another part of Minsky’s hypothesis seems to be coming true as well; regulators seem to have done well in their role of improving the functioning and stability of markets. The government’s most significant effort to do so since FDR was in charge was tested by this crisis and, in many ways, passed with flying colors. The mandated recapitalization of the US banking system, for instance, seems to have paid for way more than it cost. It May Not Seem Like It, But Endogenous Conditions Cause More Price Movement Believe it or not, since World War II, aside from perhaps actions of OPEC in the ‘70s, there does not seem to be an exogenous shock that has affected markets so significantly as the Coronavirus. For example, the Cuban Missile Crisis caused roughly a 7% drop. The peculiar way markets price exogenous events is perplexing, and it certainly doesn’t comport with our typical understanding of what will be ‘bad’ for the economy and what will not. Otherwise, the prospect of nuclear apocalypse surely should have caused a more significant drop than the inexplicable 2010 ‘flash crash’ of about 9%, right? Nope. We believe the discipline and heterogeneity of our diverse analysis methods give us a key edge that provides our clients with actionable insights that they can understand. We must also remember that markets have tended to overestimate the economic damage caused by exogenous shocks in past decades. The refulgence of re-illuminated risks causes people to see the ‘glass half empty.’ For several reasons, we think this will prove to be the case again, despite the horrendous human and economic toll we see playing out before us. As in the Battle of Britain, every day that the worst possible outcome did not manifest itself seemed to be a bullish development. So, remember markets don’t need good news to go up, they just need ‘less bad’ news than they were initially expecting. Forecasts usually take the path from bad, to less bad, to outright good. The possibility of millions of American deaths was initially projected as a possibility, as bad as things are going, that still seems unlikely. The mentality that seems to be pervasive on the street is one of bearishness and false contrarianism. We want to let you in on a little secret. It is not contrarian to be bearish when everyone else is. Also, people making moral arguments about those purchasing equities (denigrating Robin Hood traders and the like) seem to be missing how markets work. Be suspicious of those attacking new investors and not trying to help them. The whole point of the market is, people with different risk appetites and different analysis methods will buy things that others would not. The market is democratic with an added stake; you’re voting to get a healthy return on your money back. Many folks will always take that vote more seriously than the one they cast for political office. Avoid Commentary That Is Nasty, Brutish and Short (On data) Thomas Hobbes once described the human condition on Earth as nasty, brutish, and short. He was definitely a glass-half-empty guy! Despite all the challenges and risks we face in our current predicament, his description of the human condition would be better applied to a lot of market commentary from bearish hedge fund managers. Life in a modern capitalist society, especially for hedge fund managers, is pampered, ‘refined’ and long (unless you include burning man, then it is nasty too). However, their commentary is still nasty, brutish, and often short (positioned short rather than long). They are nasty in that they tacitly approve of the Fed and US government’s extraordinary and well-timed intervention, but shake their finger at it, as if taking some kind of moral stand for the freedom of markets. They are brutish because they extrapolate wide-sweeping conclusions that are clearly distorted by biases, fear, and questionable analysis. Many crude comparisons with history, this crisis and that crisis, are woven into fallacious arguments meant to appeal to fear and ego rather than reason. It seems like quite a lot of pontificating and opinions rather than giving investors macro-insights they can benefit from (which we thought this was all about). They are short in that they all appear to provide dire warnings to investors that the market, any day now, will be meeting the dire moral reckoning they foretell, at the very least will retest March lows, and that the world will probably abandon the dollar as a reserve currency too, for good measure. We find both of these scenarios to be highly unlikely. We actually predict that after all is said and done that the US Government’s debt service will be lower than before, which is another bullish harbinger of things to come. So, if government debt is not having its typical adverse effect on private sector spending and stimulus is plugging demand that had to be suspended to protect commerce, then why is everyone so testy? Many ascribe fear-mongering language that is usually reserved for the moral hazard that occurs in the regular, endogenous boom-bust cycles of markets, not a great national emergency more reminiscent of the Second World War than the 2008 Financial Crisis, at least in terms of its significant interruption in daily life and economic activity. The nasty, brutish, and short nature of a world where hedge funders can’t rely on models that have mined, now useless, historical data to predict ups and downs of endogenously motivated economic cycles, is just too much for them. If they can’t rush in to exploit market anomalies using market power, algorithms, high-frequency trading, and other tools most investors couldn’t hope to have, then what kind of messed up, unfree world are we living in? According to many market bears, the forces of totalitarianism have apparently won: by giving the economy useful and timely aid and staving off a much worse economic disaster, which could have resulted in a much more ‘Hobbesian’ outcome had fiscal and monetary authorities not acted as effectively. We Prefer Minsky Over Hobbes Being faced with the worst brings out the best. Hobbes’s grim description of the human condition is the basis of his political advocacy for an absolutist monarchy. Think about when he wrote it. Life has gotten continually better, albeit in a jagged but always upward fashion. We think the stock market will continue to reflect this truth. One of the government’s critical roles has always been to facilitate and protect commerce, and for all that is currently wrong with our government, it has at least done that very well on the monetary and fiscal front. The foot-dragging on assistance in the GFC caused some of the worst down days of that crisis; amazingly there was little delay or partisanship in the fiscal response this time. This and taxes are what markets primarily care about when it comes to the government, so don’t be alarmed if they don’t seem to echo your personal outrage. We believe unequivocally that investors who are willing to brave this harsh investing environment and own stocks for the long haul will find that as in previous dark times, American stocks will remain one of the most exceptional and lucrative stores of value in the world. While the benefit of historical retrospect allows us to dismiss Hobbes’ political prescription and point to the fact that democracies, despite their dramatic fluctuations and processes, have actually been more stable, more prosperous, and better at preventing the ‘state of nature’ that Hobbes uses to justify tyranny than any other system. Despite his erroneous solution, his atomistic approach to demonstrating the value of, and defining, the heart of the social contract was one of the most significant insights in Western Political thought up to that time. One of the useful ideas he had is that by sharing burdens, society can create a much better environment for commerce. For example, the government can and should protect commerce from the realities of living on Earth that can threaten it, such as plague, famine, and war. This, we think, is what the Fed did, and effectively at that. Nothing more, nothing less. We struggle to see the immorality of the Fed acting as the lender of last resort and promoting financial stability in the grievous situation we together face. Ah yes, even many seasoned Fed watchers forget that, like the Holy Trinity, the Fed often has a mysterious and overlooked third mandate; to promote financial stability in the United States (along with a gaggle of other financial regulators). While perhaps not as awe-inspiring as the Holy Spirit, in the financial universe, the Fed is pretty darn close. So, is it more likely that markets retraced nearly all their losses and are on the verge of imminent collapse? Or that since the financial crisis regulators got better at preventing shadow-banking activities from accumulating into systemically threatening time-bombs that cause forced liquidations and thus mute downward price movement? Does better regulation by the government create dividends and promote financial stability just like Hyman Minsky said? And, is that a large part of the reason markets are functioning not only freely but effectively? We think so. Hard Times Come, Hard Times Go, Keep Stocks, In Your Portfolio There are stocks on US exchanges that have not missed a dividend since the War of 1812. When, and in what state Hobbes wrote his masterpiece, Leviathan, illustrates how sound human logic can often arrive at false conclusions when surrounded by traumatic events and with fear running high. The first point illustrates that equities are an amazing store of value even through all the turmoil we as humans can come up with and endure. The terrible loss of human life and rampant violence occurring in Hobbes’s world as he authored Leviathan was clearly his primary influence. Similarly, when we are woken up to harsh realities we can have an overly glum and pessimistic response. The factionalism and civil war that was shattering his way of life led him to take an emotionally satisfying but incorrect path in trying to prescribe solutions. We can sympathize with his sentiment, but history has taught us better. Does this make him a fool? No, it makes him human. Like Hobbes, we think the majority of today’s market commentators are by no means stupid, but we do believe they are wrong. One human’s opinion is subject to bias, error, miscommunication, and miscalculation. However, when you start to aggregate a diverse group of people’s views, you may actually begin to get some insight. Democracy is a messy political process: it is not always pretty, and it is not always easy. Still, the wisdom of many has repeatedly triumphed over the understanding of the one or of the few. We believe that the ‘wisdom of the crowd’ embodied by Democracy is very similar to the reason the market gets right so often what many ‘experts’ get wrong. As Napoleon Bonaparte, once quipped, “The only one who is wiser than anyone is everyone.” We find this a surprisingly humble quotation from a man who is synonymous with egoism. Perhaps some of the world’s great investment commentators who make blanketed and fearful prognostications should take a cue from Napoleon’s humility! It seems, as human society progressed and technology and innovation have solved many problems and greatly improved our quality of life so much so that we often tend to forget that Hobbes’s state of nature is always, at any time just one black swan event away and that for all of our progress and advancement, the human race is as much as ever at the mercy of nature and our own limitations and flaws. Coronavirus is one of the ‘once-in-a-lifetime,’ exogenous shocks to the economy that renew our innate understanding of our own powerlessness in the face of certain events that can wholly or partially elude our always increasing, but also always limited human faculties. The illumination of remote risks we are usually able to disregard or wholly discount does something to the human psyche that it necessarily should. It makes us reconsider many other threats that we deem remote, and it forces us to reevaluate logical short-cuts as we see the potentially devastating consequences of them in real-time. We also realize we have gained from them and try to protect those fruits. In other words, the risks we face appear more refulgent when we’ve been made painfully aware of our processes’ flaws. The unknown propagates the heightened consideration of more, previously ill-considered, unknowns that have really, if you think about it, always existed.
Bitcoin Investing: Is It a Good Investment and How Much Should I Invest?
Now, what is this action—which is very technical—what does it mean for you? Let me lay to rest the bugaboo of what is called devaluation. If you want to buy a foreign car or take a trip abroad, market conditions may cause your dollar to buy slightly less. But if you are among the overwhelming majority of Americans who buy American-made products in America, your dollar will be worth just as much tomorrow as it is today. The effect of this action, in other words, will be to stabilize the dollar. –President Richard M. Nixon, August 15th 1971 Turns out, devaluation was more than just a ‘bugaboo.’ The gold window was officially closed, though few Americans were tuned in that Sunday evening to see Nixon’s address. Even fewer understood the long-term significance of his historic announcement. He had already made a big network splash the month before by announcing his visit to China that would forever change the world, and while that was meant for fanfare, this announcement was made on purpose with few watching. President Richard M. Nixon withdrew the United States from the Gold Standard to the chagrin of classical economists. This would launch a brave new world with floating exchange rates and a fiat reserve currency and would ultimately lead to the demise of the international financial order of the day. History debates the merits of the move greatly but one thing is clear, the value of the dollar was not stabilized, in the short, medium or long-term. What is undebatable is that the dollar began a precipitous decline, along with interest rates that would last for the next fifty years. At the time of the announcement, the American public was much more focused on the soon-to-be-announced fate of Lt. William Calley of his military tribunal for war crimes related to his actions in the deplorable My Lai Massacre. This bold move was a politically motivated one not spearheaded at the Federal Reserve but instead by Nixon himself and Treasury Secretary John Connally, who would later go personally bankrupt in the economic devastation that would follow. In the first recorded conversation on the subject, which was on July 27, 1971, Nixon said “One way to work Arthur [Burns] (Federal Reserve Chairman at the time) on this, knowing his ego, is to get him to think the idea was his.” Connally obediently replies “That’s right.” Burns never quite came around, when he discovered Nixon’s intentions he famously said “What a tragedy for humankind.” Milton Friedman would famously refer to him, because of his uncouth and self-serving betrayal of conservative economic principles as “The most socialist US President of the 20th century.” The move was popular with the public at the time. Nixon successfully spun perhaps the most consequential economic moment in the second half of the twentieth century as a patriotic defense of the dollar against foreign speculators. His authenticity isn’t supported by his subsequently documented efforts to exert political pressure on the Fed to secure election. By the end of the 1970s, the dollar had lost a third of its’ value and the United States endured the worst economic recession since the Great Depression; the notorious period of “Stagflation.” According to Keynesian theory at the time, the robust fiscal program of the Nixon administration should have alleviated the situation but instead it created one that was previously considered theoretically impossible, stagnating growth occurring simultaneously as rampant inflation. This toxic economic mix caused conservative investors, or ‘gold bugs’ as they were disparagingly called, to favor an asset above the fray of national assets. Which at least in their minds was gold. Investors wanted something at the time that was independent from the machinations of Great Powers and the personalities leading them. The period of economic misery that followed led to an eventual changing of the guard at the Fed, and Milton Friedman’s monetarists would have their great success in the early 80s, turning the US economy around by taking the political poison pill of a recession in 1982. This time the President did not interfere with then Chairman Volcker to his credit. When inflation went down the Fed reversed policy and Regan streamlined the Federal government and reduced taxes, resulting in strong growth. Many want a hedge against the uncertainty of future government policy today, many did in the past as well, particularly many who’d lived through the Great Depression and the era that Americans were legally prohibited from owning gold, not to mention the Second World War. That experienced had conditioned them to distrust financial institutions and government policy around assets, Gold to them seemed safe, everyone wanted gold. Indeed, during the Second World War (also that generations second crisis) when commerce broke down many people across the globe had to resort to storing wealth in jewelry; diamonds, gold, silver and of course art. Much of this was plundered and appropriated. It seemed to many the ultimate insurance policy in a less stable world. What’s All The Bugaboo About Bitcoin? Tom Lee and Fundstrat focus on the stock market not cryptocurrency markets. I don’t get what’s going on! What does this have to do with Bitcoin, digital currency, and the blockchain? Bitcoin’s price and properties as an asset has made a lot of people pay attention, including us. Blockchain technology is one of the most significant inventions in personal finance ever. The recent acceleration and introduction of new market infrastructure like Coinbase, and other cryptocurrency exchanges have multiplied quickly. ‘BTC’ is now an investable asset and can be purchased passively without the hassle of digital wallets. Scandals have come and scandals have gone but digital assets keep proliferating. Ethereum is a new exciting asset in the space. No one at this time necessarily predicted the continued supremacy of the dollar; after all America’s payment imbalances were caused largely by war expenses in Southeast Asia, a conflict which was ending without victory. Hopes were not too high for continued American financial dominance and very few people realized the significance of a technological protocol created by a group of American banks called the Society for Worldwide Interbank Financial Telecommunications (SWIFT) in 1973. No one could have known it at the time, SWIFT is one of the main reasons banks have been able to maintain profitability despite the aforementioned multi-generational decline in interest rates. If you are looking for something that conceptually helps you understand what Bitcoin is, this obscure protocol may offer a decent metaphor, but at the same time, Bitcoin was a monumental leap in human ingenuity that solved one of our most enduring economic problems; the persistent incentive to violate trust to maximize individual gains. Because of this perpetual problem, digital financial transactions have always needed a trusted third-party to act as an intermediary. Bitcoin was created in the heat of the GFC when trust of those third parties was at an all-time low. SWIFT and other inefficient payment oligopolies will maintain their dominance for a while but there is now a proven technological alternative that has the potential to eliminate problematic economic rents charged by the financial industry to individuals for the privilege of using the system. The cost of this in the United States is about $1,000 annually per capita. Will bitcoin replace credit cards and bank accounts? We don’t think that will necessarily be the case, but we do think the technology has the potential to create unprecedented efficiencies in the economy. We’ll give you an example of how we think about it. This simple protocol, literally a system of connecting unique identifiers to express information necessary for international financial transactions, is an antiquated technological solution that maintains dominance because it was effective and it was first. It replaced a system called Telex that’s was plagued with human error issues. SWIFT’s generation of unique codes overcame these issues and allowed individuals and businesses to accept payments on an unprecedented scale. This then led to a massive network effect. How’s Bitcoin doing lately? Bitcoin remains firmly ahead of gold as the best asset class on a YTD basis. Bitcoin outperformed the S&P 500 in 2019, one of it’s best years in a generation, by about three fold. Wait is that a mistake? No, it is not. Not only is it not a mistake, but Bitcoin’s performance in 2019 was its fourth worst annual performance (less than average for an asset with a life of about 12 years). This is why we are interested in Bitcoin, we believe it is one of the best risk assets you can own in your portfolio and we recommend going OW compared to its typical slice of the investment assets pie. We realize some investors may have been spooked from the massive 50% drop that occurred during the worst days of COVID-19. The market infrastructure and demand impressively weathered that hit and bitcoin exchanges are functioning healthily again. We told our members to buy when the price of bitcoin was around $5,000, those who did have seen a significant retracement of the loss. We are the first, and currently only, independent analyst on Wall Street to cover cryptocurrency. We obviously believe in both the current, and long-term value of it as an investment. We cover the entire asset-class from Litecoin, Ethereum, bitcoin mining developments, bitcoin price targets, and when to buy and sell bitcoin. With that being said, it is a very difficult market to navigate and has many unique rules unto itself that we work hard to identify and provide to our subscribers. We have some members that only trade cryptocurrency, and we have other members who may be looking to it as a new and exciting asset to add to their portfolio for diversification. So, don’t give your financial advisor heartburn and make him do any more extra work. This is not an easy asset class to navigate. Let us help your cryptocurrency investment be the star of your portfolio. The Triffin Paradox Nixon was trying to fix what had become a persistent problem with the Bretton Woods agreement of 1944, a structural problem known as the ‘Triffin Paradox’. This is the natural tendency of nations who have reserve currency status to have inherently conflicting interests between it’s short-term domestic political objectives and the objective of long-term international financial stability, and retaining reserve currency status. Foreign nations constantly needed excess supplies of our currency as the network effect of the dollar, and it’s central role in global commerce was cemented by American-funded economic expansion and rebuilding in the wake of the War. This led to a situation where dollars in circulation necessarily exceeded gold in US reserves. What we now look back on as the ‘Great Inflation’ had then begun in 1965 and wouldn’t end until 1982. One of Nixon’s intentions ironically was to curb inflation, which he did in a crude way for the first time not during a major war, by implementing wage and price controls, which shortly thereafter failed miserably. The role of the dollar as global reserve currency was under threat. Keynes had predicted the imbalances problem and suggested an internationally sanctioned, stable reserve currency called the Bancor. Many Bitcoin enthusiasts may be surprised by this. The tension between a national political agenda and long-term financial stability of the international system creates a potential for political abuse of the reserve currency status. Fiat currency, many theorize, only exacerbates the potential for political abuse and inflation that can cause serious social and political problems if unchecked. The political machinations involved with this momentous decision surely make some of our crypto enthusiasts cringe. Ok But I Still Don’t Understand Exactly What Bitcoin Is? There is no doubt that Bitcoin started out as a political statement and many initially viewed it as closer to a toy than a store of value early in it’s history. The easiest way to describe it would be in the context of a class of stocks we’ve been recommending on the equity-side, casinos. These were out of the risk-tolerance of many in March, but those who took our advice profited handsomely if they purchased them. Now imagine the entire economy is a casino company. What would happen to the economy, and the operating leverage of the company, if the chips kept track of themselves? The Bitcoin White Paper authored by a pseudonymous author who referred to himself as Satoshi Nakamoto, was a modern-day economic equivalent to when Martin Luther nailed his Ninety-Five Theses to The All Saints Church in Wittenburg on the 31st of October, 1517. Once nailed, it could not be undone and the consequences for human society could not have possibly been comprehended at the time. Thesis number 86 was stated, when translated into English as the following: “Why does the Pope, whose wealth today is greater than the wealth of the richest Crassus, build the basilica of St. Peter with the money of poor believers rather than his own?” The primary practice that provoked this first act in one of the greatest ideological transformations in human history was the unseemly practice of the Church charging indulgences to poor parishioners in exchange for their ‘assistance’ in getting God to move the souls of their loved ones from purgatory to the eternal Kingdom of Heaven. Many see a similarity between the obviously corrupted incentives in this arrangement and the incentives of the state with a limitless printing press. Governments have tended to inflate away their debt, at the expense of the lower income quintiles, with the alchemical Central Bank power that seems to flout the incontrovertible law of scarcity. Hence the employment of Luther’s 86th thesis in our description of Bitcoin, and what it was created to achieve. Unlike fiat currency which can be magically shifted from ‘purgatory’ or the Fed’s balance sheet, to member banks and inflated and printed with abandon, Bitcoin is inherently scarce (by virtue of it’s innovative design) and is deflationary. This means, as long as users continue to go up and there is consistent demand, compared to most demand assets it’s pretty easy to determine what the long-term path of Bitcoin will be; up. Don’t Fly A Plane Without Instruments— Seriously Cryptocurrency investing is not for the faint of heart, or at least it hasn’t been in the past. While at times it has been correlated to mainstream investment assets, at other times it hasn’t. This is why we advise investors to think of crypto-investments and Bitcoin in particular in the long-term. We treat it like a stock you want to own, or an emerging market you want to invest in; after all we are well-established equity analysts. If you are used to investing in equities, our rules and analysis will make sense to you and we also think that a lot of our crypto analysis dovetails nicely with our wider macro-analysis. Many people ask us how we can be bullish on US Equities and Bitcoin at the same time. Isn’t Bitcoin a countercyclical hedge, like gold? While a similar relationship has been observed during some past market conditions, one of the benefits of Bitcoin as an asset is that it is not highly correlated to other major asset classes, making it an excellent diversifier in portfolios that provides a lot of upside. We have developed proprietary valuation models for Bitcoin that we believe approximates it’s fundamental value in a way equity investors can understand. We certainly wouldn’t want to invest in the crypto market without the tools we’ve developed. We are bullish on Bitcoin and think the US dollar will maintain its reserve currency status. We are bullish on US equities for other reasons we won’t elaborate on too much here, but we will say that we believe Bitcoin is a generational trade. You may hear through media coverage or other crypto sources that adoption is way higher than we think it is. We think about half a million people trade cryptocurrency regularly, which is quite a nascent market. We can offer investors wishing to learn about and invest in the space better tools, capabilities, and analysis than any other service. We also have Tom Lee’s 10 Rules Of Investing In Bitcoin which is the first quantitatively informed roadmap investors can use as a firm and actionable guide when investing in Bitcoin and other cryptos. Additionally, some of our proprietary tools like our Bitcoin Misery Index. Our Senior Crypto-Research Analyst David Grider has also developed a proprietary valuation model for Bitcoin that we think will be particularly useful for veteran equity investors. Bitcoin Is Not Your Grandfather’s (Or Your Parents) Asset, But It Will Be Going Up For The Same Reason The internet had very few users in the early 90s. Those few users, in its early stages were associated with low stock prices of names that are now the bluest of the blue-chips. We did an in-house study to determine what was behind the rise of the best performing stocks on the market like the FAANGs. We surprisingly determined that about 75% of the gains from those stocks actually has very little to do with company management, new features or the like and more simply to do with the global adoption of the Internet. In other words, the growth that you are getting exposed to in the best of the growth stock is network growth; the growth of the internet users, by being monetized, is what outperformed wider economic growth. In the early 1990s the internet had tens of millions of users and today it has 4 billion. This is why those companies went up so far in value. They held valuable digital ‘real estate’ in a new economy at the dawn of the information age. If you bought exposure to the internet you did well. Bitcoin’s platform is currently dominated by a first generation of users, that will change. As long as human beings are consistently using computers, Bitcoin is more permanent than anything including seemingly mighty political orders and values. The intrinsic value of a de-centralized ledger that creates enormous potential for new economic efficiencies is what we are buying. The network effects that benefitted the FAANGS will also benefit Bitcoin, because it is a proven protocol that works. Privacy is diminishing and the premium on privacy for legitimate and illegitimate reasons will persist and increase. Like SWIFT, Bitcoin is the first, and like SWIFT we believe that there’s a lot of value to being the first in the situation at hand; where network effects drive returns. One key characteristic that they share is that even though technology exists to have a better process than the monopolized payments system in the US (you can transfer money instantly from phone to phone in Somalia), the network effect gives continued relevance and value to the platform. Given the magnitude of the problem that Bitcoin solves, and the changing dynamics of whose and what economic activity goes in and out of favor with the state over time, and which currencies fall and so forth, there will always be a need for Bitcoin, and there will always be a community of people who will find and store value in it. The Halving The fundamental valuation model we created for Bitcoin suggests that 2020 will be a good year. Halving events are subject to a lot of opinions and speculation, but we are unequivocal that it is bullish for the medium and long-term. We also do a lot of analysis on the supply side. We find it can help make the conceptual connection from one investment class to another, because after all, although Bitcoin’s origins, uses, and history may be cloaked in mystique and notoriety at the end of the day it is a supply and demand asset like anything else. We calculate that the available supply to the market will be significantly diminished leading to upward price pressure. This is the thrust of our analysis. We genuinely love to provide analysis in such a new and exciting market. If you’re a trader and you like to time the market, we’d love to help you though we don’t advise it for beginners. Timing the market for Bitcoin correctly is very hard and if you sell at the wrong time, even if you buy shortly after you can miss out on the bulk of your potential gains. We’ll help you avoid making that mistake with our easy-to-follow, actionable rules. Bitcoin is the most prominent of all cryptocurrencies and for investors new to the space, it is the easiest to invest in. Over the last few years the market infrastructure has significantly developed; there are now futures and options exchanges for instance. It has been almost 12 years and there has not been a single fraudulent transaction on the block chain. This in itself, we believe, demonstrates the value of Bitcoin, and despite its’ volatility and some past associations with unseemly actors or activities, we stand by our view that Bitcoin is potentially one of the best long-term investments you can put in your portfolio. In fact, the very reason that people use Bitcoin in highly risk-prone criminal transactions is precisely the reason it has value. Despite it’s association with the criminal, if you buy Bitcoin Goldman Sachs isn’t going to be able to aimlessly (and criminally) shift your deliveries around to jack up their storage fee. Or what about the greatest bank robbery of all time? We’re talking of course about when the banks robbed everybody and got away with it with pretty minor slaps on the wrist, the Libor Scandal. These two episodes illustrate why some people don’t trust the ‘trusted’ third parties that they have to use. Now they don’t have to. The Ultimate Momentum Play: Most Of What You Think About Bitcoin’s Future is Wrong Many investors think incorrectly in our opinion in ‘Bitcoin versus the dollar’, or simply of it as ‘Bitcoin instead of the dollar’. Many investors incorrectly think of it as only good for a hedge asset. We do find it makes for an excellent uncorrelated hedge asset. However, most hedges typically don’t consistently outperform the wider markets returns in a variety of conditions, they are supposed to mitigate downside loss, not give extra risk adjusted return to your portfolio. So, thinking of Bitcoin only as a hedge might not be the optimum portfolio strategy, particularly if you’re young and intend to follow our Hold On For Dear Life (HODL) strategy, which we greatly advise over getting fancy for those new to crypto. Despite the often infernal response we can receive from the notoriously cantankerous Bitcoin community, we maintain (and so does the data) that despite the previously observed counter-cyclical protective characteristics Bitcoin has had in the past, it is 100%, firmly and indisputably a risk-on asset. Many people buy Bitcoin for an emotional reason, or perhaps as a political statement, but if you’re still thinking of it that way we urge you to stop. If you’re doing that, it is fine, but that’s not how your supposed to treat investments. We have firm rules of when to add to your position and when not to that will help keep your cost-basis low to gain exposure in your portfolio in the most quantitively driven way that is available to individual investors. Perhaps US monetary policy and the prospect of a future of Modern Monetary Theory makes you just about as mad as anything else in the world. That’s not a reason to buy Bitcoin, sorry, it may have been in the beginning but it’s well passed time to stop considering this high-performing asset a toy or political statement. Political philosophy is not investment strategy, and we want to help make this incredible feat of computer engineering work for you and your portfolio. Let us help you. You won’t regret it. We think it is highly unlikely that the Federal Reserve or fiscal authorities will blow up the dollar’s reserve currency status anytime soon. We pay a lot of attention to debt markets since equity, being junior in the capital structure tends to follow bonds. We constantly watch out for issues that could cause market panics, like potential negative interest rates, but as of now we see equity markets and the policymaker support of them on good and stable footing. Part of this is the natural tendency of the reserve currency to be the asset investors prefer during flights-to-safety. What this effectively means is that the United States gets enormous capital inflows whenever markets are bad or uncertainty is high, even during the 2008 Financial Crisis which was largely a result of abuses and regulatory oversights within its national financial system. Another reality that many who make investment decisions off of political beliefs or apocalyptic predictions should remember is that many foretold that Japan’s Central Bank would surely not be able to operate effectively at the Debt/GDP ratio that the world’s third largest economy had. These predictions were wrong and BOJ showed Central Banks can defy gravity, at least for a time. Tesla was considered a risky, millennial stock with a valuation way too high. It was also singled out in the 2012 election as the premier example of lousy government investment sense. The stock is a perfect example of an asset ‘of the future’ being priced in the ‘markets of today.’ We believe Bitcoin is one such asset, but because of unique characteristics it possesses, we understand the upside could significantly exceed what is traditionally available to investors in equity markets. That being said, we typically recommend that investors only comprise 1% to 2% of their total portfolio in cryptocurrency assets. Within the crypto-class, we are currently OW on blue-chip Cryptos, including Bitcoin. TSLA was dead money for a long time despite consistently improving sales, production and other key metrics. If the fundamental rules of stock valuation were the only thing driving price, then it should have been going up in line with those metrics. What was far more important for TSLA was when it would meet certain thresholds that would make it an appealing addition to the portfolios of Russel 1000 money managers. Many analysts and others wrote off the stock and management strategy as departed from reality, and in a way it was, it was departed with secular realities of the past. This can be hard for markets to spot, it may be a good predictor in other ways, but markets and investors often miss transformational moments. A lot of people speculate the crypto institutional adoption is just around the corner. We think you should listen to us on this rather than other sources. We specifically service over 200 major institutional financial clients and we happen to know for a fact that they are constrained from participating in a way that many people theorize until the crypto market is much bigger. We estimate that the crypto market still has a long way to go and needs to increase by about ten-fold in size before major institutional adoption comes. However, when this adoption does come, we think that Bitcoin’s price action will be similar to the recent parabolic moves upward for TSLA, or the long upward slog of the best growth stocks on the market. We think of Bitcoin as a major growth investment that will not replace currency, although it will for some transactions and in some communities, but what it will really do is create a lot of economic efficiency and replace a lot of the monopolistic services banks force customers to pay for. And An Emerging Market Play? Remember when BRICs were all the rage? A basic tenet of economics is that capital flows from more developed economies to less developed, in many cases, because of something called the ‘catch up effect’ which essentially means capital will have higher returns, and will be more productive at of course the cost of greater risk, in developing economies compared to their more developed counterparts. This is why the first to brave the litany of risks that come with such investments often get wiped out or rich, and often not much in between. Certainly, wild swings and coup d’ etas give investors more heartburn then your typical plain vanilla ETF and have always been at the riskier end of the spectrum. We believe Bitcoin is literally an extension of the digital economy. Like many emerging market investments risks are plentiful and attention grabbing, but returns and the ability to HODL made many bold investors very good, above-market returns. We believe this analogy captures our attitude toward Bitcoin as an investment and we would love to help you get exposure in the best way possible.
Understanding The Stock Market: What Is It And How Does It Work
(And Why We Think It Will Continue Going Up) Philosopher: And what kind of business is this about which I have often heard people talk but which I neither understand nor have made efforts to comprehend? And I have found no book that deals with the subject and makes apprehension easier. Shareholder: I really must say you are an ignorant person, friend Greybeard, if you know nothing of this enigmatic business [stocks] which is at once the fairest and most deceitful in Europe, the noblest and the most infamous in the world, the finest and the most vulgar on earth. It is a quintessence of academic learning and a paragon of fraudulence; it is a touchstone for the intelligent and a tombstone for the audacious, a treasury of usefulness and a source of disaster, and finally a counterpart of Sisyphus who never rests as also of Ixion who is chained to a wheel that turns perpetually. Confusion of Confusions, Joseph de le Vega, 1688 The stock market is hard. Really it is. There is perhaps no other institution where the cold, inhuman objectivity of all the available information speaks indiscriminately and for itself. When it does, it does so with a force that can scarcely regard our irrelevant emotions or biases. When people tell you that the stock market is easy and to ‘just listen to their easy formula!’ they usually are trying to swindle you, or at least charge you for information that won’t help you much. The reason they are trying to deceive you? The stock market was too hard for them, and now they need to get your money using an unscrupulous method. This highlights one of the risks consumers face in the market. However, the stock market has also created more opportunities and wealth than perhaps any other institution of Western Civilization. Hence, you’re quite right to be interested in it as a means to augment and protect your wealth. The introductory passage is from the first book ever written on stock markets, The Confusion of Confusions. The title is apt. It is incredible to hear de la Vega’s 17th-century descriptions of market dynamics still so prevalent and similar to that of contemporary markets. He describes bulls, bears, “opsies” or options, margin accounts, and even penny stocks of the day. He even describes the 17th century version of a state-sponsored bailout, “appealing to Frederick.” Yes, markets are always changing. For example, in the 1970s, the trading week was reduced because of a back-log of paper trades known as ‘the paper crunch.’ This is obviously no longer a problem. However, the underlying human behaviors and incentives remain conspicuously perennial. There are two ancient Chinese ‘blessings’ that also double as a curse. The first ‘may you live in interesting times’ seems positive until you realize that consistent peace and prosperity is uninteresting from history’s perspective, then interesting takes on a more ominous tone, like the ‘interesting’ markets of March 2020. The other is, ‘may you get everything you wish for.’ How could this be bad, right? Well, when a global pandemic comes along, which causes an unprecedented and mandatory cessation in economic activity, what would you want the Federal Reserve to do? From a generalized shareholder’s perspective, you would want them to do precisely what they did; come in with bazookas blazing and necessarily remove the consequence of near-term corporate bankruptcy with unlimited liquidity. And do this, they certainly did, and in a timely and stylish manner too! Kudos to Jay Powell. However, when the Fed does exactly what you want, and you’re used to valuing stocks solely on earnings and estimates (which are interrupted), then you start to understand the conundrum of the ancient Chinese ‘blessings’. This is especially so if you put a bunch of short positions on the most heavily affected sectors expecting an easy payoff too late in the decline. If you have no idea what we’re talking about, then that’s OK too. Who Is FS Insight For? You could be a relatively new investor looking to roll over some of your recent gains on Robinhood into quality companies that have an actual positive cashflow. Stocks are an excellent long-term store of value historically, and we believe they will continue to be. Maybe you’re a well-established investor who got rightfully spooked, went to cash, and missed out on the fastest rally in history, as parabolic and unexpected as it was (except not by us). Now you don’t know what to do. Maybe you simply wasted too much capital on downside protection and are looking at how to get long wisely in uncertain times. We love to help recovering bears. Nothing gets you more attentive to the stock market, like watching people you judge to be your inferiors getting rich in it. Maybe you saw Davey Day Trader lambasting Warren Buffet’s investment prowess and just needed to get grounded and back to some basics (we’re pretty sure he was joking). Maybe you want a fresh, data-driven voice in your resources to provide a contra-argument to the stale (and repeatedly wrong) investment advice that is entirely dependent on earnings guidance (which has virtually ceased to exist). Hopefully, you saw that we have been telling investors as loud as we can to pick the top-performing sectors since the heat of the March crash when there was blood in the streets so-to-speak. Whatever your reason for visiting, we’re happy to have you, and we’d like to share some thoughts with you briefly that we hope will help you grasp some of the fundamental concepts and key terms in today’s financial discourse. While we hope you’ll consider joining our FS Insight Family, we wish all investors and their families good health and prosperity during this unprecedented time of uncertainty and tragedy. We are grateful that you look us to for counsel in your financial affairs, and we are honored and humbled to hold that trust. FS Insight was started to give individual investors access to the same research, albeit distilled for accessibility, that we provide to top institutional clients like hedge funds and investment banks. That is why our team put together this article; we want to explain some confusing aspects of the post-pandemic stock market that may seem counterintuitive, or even plain crazy to most people. However, when you take the time and effort to inform yourself on a deeper level than most investors are operating at, the most controversial of all bell-weathers may begin to make a lot more sense. When all is said and done, the stock market speaks in the language of price. Get Out Of The Bear Trap Wait, why does the Fed have a bazooka? Why and how does the Fed buying corporate bonds affect stocks? U Shaped? V-Shaped? Who Shaped? What Shaped? The financial discourse moves fast, and markets move even faster. For even the most seasoned investors, it can be a chore to keep up with all the comings and goings of international stock markets during a global pandemic. That’s why we want to describe the basics in the context of what’s happening. We believe it offers a fresh and advantageous perspective. We have written this for all skill levels, so bear with us, a refresher never hurts! Since the beginning of the coronavirus crisis and the subsequent rapid market crash, apocalyptic prognostications about our financial future have been copious and prominently displayed. The market has been ‘just on the verge’ of retesting the lows according to some bear every single day since March 23rd. While some may misunderstand our view as being ‘blanket’ bullish, it is not. We aim to delve into the details of the data to gain insights that the broader market is missing and then turn those insights into actionable investment advice. Despite our non-consensus view, we also provide excellent tips for managing market volatility and downswings when they inevitably arrive. On June 25th, our Senior Editor is hosting a webinar on how to use Covered Calls to capitalize on volatility. Here are some of the main prevailing bearish arguments and our general responses to them. Wall Street Has Never Been So Disconnected From Main Street This is true, and while it may seem heartless, one of the main benefits the market provides is an entirely unbiased view of the sum of millions of unrelated decisions. This impartiality is one of the things that makes the market so powerful and compelling, although it can seem cold. The market does not have emotions. Wall Street is not Main Street. It has never been. If you have two bags of umbrellas, one which had been certified by someone to have all intact umbrellas with no holes, and one bag which was not certified and which may hold faulty umbrellas in it and it started raining, then what would happen to the relative value of the certified bag? It would go up, wouldn’t it? The companies that trade publicly on the US stock market are akin to the certified umbrellas. Logically, when you have a group of better and more survivable companies than one, it is natural that their general attractiveness compared to others, as investments would go up. Some bears may say ‘the stock market dropped 50% in 2008 and only 33% now and the effect on the economy is far worse’. To this, we would point out that since the 2008 financial crisis, the US government reformed markets and mandated much higher capital at US banks. Also, the primary cause of credit losses in that crisis, OTC derivatives, are no longer permitted. Derivatives have actually mitigated risk this time around at large financial institutions. US banks recently saw the most significant influx of deposits in their history, about $2 trillion. The financial system in 2008 caused and exacerbated the situation. In this crisis, the financial system has been a source of strength and support for the rest of the economy. Loans are flowing out of US banks to main street, and the Federal Reserve will even begin lending to everyday businesses. Yeah, we’d say that’s worth about 20% on the averages, if not more. The Economic Data Will Cause Market Panic There is no question that we are seeing torrents of the worse economic data in our lifetimes, and probably 3 or 4 others as well. However, recently we’ve been seeing positive surprises in the economic data. We think this will continue. The rapid drop in the market reflected the unprecedented cessation of economic activity, and everyone has assumed the data will be worse than estimates. Since the depth of the crisis in March, we have been saying that the general level of fear and pessimism creates a higher probability that economic data will surprise to the upside more often than to the downside. We call it the ‘glass half full.’ So far, recent developments have proven us correct. Jobs numbers, retail sales, bank deposits, consumer confidence, and cash in peoples’ hands have been better than expected. This suggests that demand may be more intact than the Wall Street consensus suggests. Earnings Will Be Depressed For Years, And So PE Ratios Will Have To Significantly Drop Logically, this does make sense at one level. How can companies come back from such an enormous shock quickly? Well, not all companies will. Those that do will come back stronger. How can you be saying there will be a ‘V’ Shaped Recovery? Firstly, all the comparable stock market drops in recent history to March’s panicked selling have been followed by a ‘V’ shape recovery. So, historical trends support this conclusion. The other thing is that companies are in survival mode, and to survive, many are going to have to undergo the most aggressive cost-cutting in history. We believe that this will create a set of scrappy and robust businesses that will be able to outperform their overly negative earnings expectations. We believe the best companies amongst the hardest hit sectors will provide considerable upside, and that effected industries will come back quicker and stronger than predicted by the consensus view. If what we just experienced was a sucker’s ‘bear market rally’ then it was the largest in history. Coronavirus Cases Continue to Rise, So Another Lockdown Is Inevitable Coronavirus cases are rising. They are increasing in The United States and elsewhere. However, let’s remember why the lockdowns were necessary in the first place because the government was trying to prevent the healthcare system from becoming overwhelmed. Despite the consistent uptick in cases (which we believe is not due to reopening), there has also been a steady downward trend in deaths and hospitalizations. Even in Germany, which has seen a recent and dramatic rise in certain areas, the authorities do not consider re-implementing a lockdown immediately. Instead, they are erring toward ‘more targeted’ measures. This is positive for the reopening thesis, and despite prevailing sentiments, we think the prospect of a new lockdown in the near term is very low. We Are In A Speculative Bubble That Will Crash Soon This is, in our opinion, one of the more ridiculous assertions. While we all witnessed how an unanticipated exogenous shock can roil markets (and one certainly could again), we believe that this line of logic is fundamentally wrong. How many past bubbles were burst when 78% of fund managers thought stocks were overvalued? It is almost oxymoronic to call the recent market gains a mania when the overwhelming sentiment on the street is bearish. This means that there is a lot of downside protection. So, when there are downside moves, the profits from those moves to those holding protection are swift. Those profits are often re-invested in long positions, which softens moves downward and helps the market hold key levels. When you have the entire market spring-loaded to benefit off a massive crash, it ironically makes it much more difficult for one to occur since people are not typically overleveraged, certainly not by macro indicators. The general risk/reward profile of stocks has significantly improved. The Nasdaq recently outperformed the 10-year treasury bond. The positively changing alpha will continue to attract capital away from investment-grade debt and toward equities. There is trillions and trillions of investment capital on the sidelines (much of it governed by predictable covenants) that will begin seeking the rewards the stock market has been providing to those taking risk. We believe that the trillions in dry powder sitting on the sideline (much of which will be required to start moving to equities by existing covenant) has only just begun to get behind this rally. We think it will drive prices higher and generally make equities more attractive in the medium to long term. Why The Fed Trumps All, Even Trump The rate of interest on ordinary loan amounts, and, if a creditor receives security, to only 2 and one-half percent. Therefore even the wealthiest men are forced to buy stocks, and there are people who do not sell them when the prices have fallen in order to avoid a loss. But they do not sell at rising prices either, because they do not know a more secure investment for their capital. Moreover in this kind of investment, their funds can be recovered in the quickest way Confusion of Confusions, Joseph de le Vega, 1688 Joseph de le Vega said it in 1688, not us. There are a lot of forces aligned, including the US status as global reserve currency that we believe puts a lot of firepower ready to purchase US stocks. We understand all the talk of ‘don’t fight the fed’ simultaneously with wild assertions that the Fed has ‘destroyed price discovery’ can be very, very confusing. We personally think much of these discussions would be left better to philosophers (not shareholders), we want to focus on what the immediate effect of the Fed’s actions are for markets today and next week, not the generational discussion about the role of the state in the economy that will be accelerated and refined by this crisis. The financial eco-system has entities (companies) that abide by certain rules and laws. When you are purchasing stock, you are purchasing a claim on current and future profits. So, of course, profitability and solvency are the key metrics by which any business is judged, and the same with the value of its stock. If the prospect of insolvency due to the virus is removed or substantially mitigated, the value of every publicly traded stock should go up (which it has), barring other developments. The Federal Reserve has exceeded the scope of any central bank by effectively stating that companies not failing because of poor management and solely because of a government-mandated shutdown should not lose the market’s confidence. Essentially, what the Fed is doing is the exact opposite of the Financial Repression of the 1970s that occurred in other countries. The Fed is promoting financial disinhibition, and urging investors to take more risk than the prevailing situation would typically make them inclined to take. It does this responsibly by removing the prospect of one of the virus’s main risks for business, near-term insolvency. This, coupled with Fiscal authorities’ ability and willingness to make meaningful efforts to plug the demand-hole caused by the virus, makes the US governments response the most effective and powerful state intervention in the economy in modern history. So why does the Fed’s action trump pretty much all other news? Because for the corporate world, it is like having death suspended. The funding runs and dash for liquidity that usually causes most of the downward price movement during panics (as investors indiscriminately liquidate) have been arrested forcefully. The Fed preventing that panic from spiraling out of control also gave informed market participants plenty of time to de-lever and get defensive. The Fed got debt markets functioning again quickly, and that is good for stocks. It prevented corporate debt from becoming the catalyst for a financial crisis on top of the health crisis. This has, for the time being, significantly mitigated downside risk in our estimation and will continue to be a positive for stocks. The Stock Market Is Like A Beauty Contest And… Have you ever had to judge a beauty contest? Sounds pretty easy, right? Just pick the prettiest girl and be on your way. If stock investing were this easy, then many professionals would be out of the job, and even more would be wildly wealthy. Let’s add one more variable and see how the complexity of your task exponentially increases: now don’t pick who you think is the prettiest girl, pick who you think all the others judging the contest will pick. This is Keynes’s beauty contest, and it is a way to demonstrate the difficulty in pricing stocks. How much do you know about those judging the competition with you and their perceptions of beauty? How similar are they to you? Do they even like girls? There are quite a few factors that could influence that and make the correct answer very difficult to ascertain. It would seem then, that to correctly guess which contestant would win, you would have to know quite a lot about the other judges and their aesthetic proclivities. In fact, that information is just as important as, if not more important then, the faces of the actual contestants themselves. John Maynard Keynes devised this analogy to explain how investors value and pick stocks to buy. If it were as easy as simply choosing the companies with the best 10-K filings, then stock selection would be effortless indeed. The problem is, investors must evaluate the inherent value of a stock and the willingness of the investing public to purchase it at a given price. Try as we may to use pure rationality to value financial assets, human emotion and passion have been part of financial markets since their inception. Despite many efforts to purify the market of this element, it has been a perennial driver of boom and bust. It’s not a case of choosing those which, to the best of one’s judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest… We devote our intelligences to anticipating what average opinion expects the average opinion to be -John Maynard Keynes A Guessing Game…. and Let’s take the same principle to a quantitative contest to illustrate just how difficult the extra variable of competition with other rational players that have access to the same information as you can become. Rather than judging a beauty contest, let’s have you guess a number correctly. Behavioral economist Richard Thaler ran the following ‘game’ or experiment to illustrate what Keynes was talking about in the Financial Times in 1997: Readers pick a number between zero and 100. The winner is the contestant with the number closest to 2/3 of the average of all numbers entered in the contest Let’s put our thinking caps on. Since the number has to be 2/3 of the number selected, we can deduce that it is lower than 67 since if everyone picked 100, unlikely as it may be, any number above 67 does not meet the criteria for a winning number. Since you know the other participants in the study are rational and have the same information and task as you, you could also assume that they likely would not pick 67 since it is the highest permissible number and 2/3 of 67 (which a lot of people might choose) is about 45. Oh! Wait! Then maybe the extra smart people will pick 45, which would mean the winning number would be 30, but how smart is my competition? How smart do they think I am? This is the issue when the extra variable is added. This is why it is so hard to determine the true value of stocks. If you follow this iterative logic, extrapolating the logic of your competition to get the perfect guess, then you would eventually come to the answer zero. However, while this iterative logic can be a useful exercise or analytical tool, it does not reflect the real answer in the experiment or the real world. The average of the numbers was 19, and the winning number was 13. In a nutshell, what we are offering at FS Insight is helping you get to 13. We know the market participants, and we have the data and analytical firepower to give you an edge. Yes, The Stock Market Is Like Gambling, Just Not The Kind You Think You may have heard people deride the stock market as nothing but a rigged casino. While there may be some superficial similarities, we think this is an unfortunate metaphor. That is not to say that the stock market is not like gambling. It is, a different kind of gambling. In horse racing, unlike casinos, there is no house with an inherent advantage. Same with the stock market. Players play against each other, and each horse will have ‘odds’ of winning. Those horses with poorer odds will pay off better if they win. Those horses with the best odds are expected to win, so when they do, the payoff is not nearly as high as if a ‘dark horse’ who was underrated came from behind and won. This is why there is a lot of similarity between a winning strategy in horse racing and a winning strategy in stock picking. You certainly don’t want to have all ‘dark horses’ because your odds of winning anything will be severely diminished. However, you also don’t want only the horses with the best odds, as your risk-adjusted return will not be as high as if you included a healthy mix of both! Diversification, along diverse metrics is always a good strategy in picking stocks. Oh, diversifying by narrative doesn’t hurt either. We can help you with that. Breaking Rocks In The Hot Sun, You Fought The Fed and The Fed Won Fed got you down? Don’t be down while the market is going up! It looks bad on you! Stocks are attractive, and we firmly believe that the end of the world is NOT at hand. Have you been margin called? Are you in the ‘dog house’ with your investors for missing the biggest rally ever? Are you an individual investor who is just starting to understand the complexities of the market? Whatever your situation give us a try. Come for the Skepticism, Stay For The Growth. Get Long With Tom! Try 1 month free!