A key strength of good investors is being able to handle disappointment and failure. In fact, no matter how intelligent, experienced and skilled you are at investing, mistakes are a cast-iron certainty. That’s because even the best investors cannot consistently and accurately anticipate all challenges that a company will eventually face and, while the risk/reward ratio may have huge appeal at the time of purchase, things always change in the business world.

The problem, though, is deciding exactly what to do with the shares that turn out to be disappointing. Clearly, they can fall into any number of categories, with examples being stocks that have plummeted to be worth a small percentage of their original value all the way through to companies that may be in positive return territory, but which have lagged their industry group or the wider index.

…..continue reading HERE

“a once in a decade opportunity”

By late 2002, the national currency of Brazil (known as the “real”) was practically in free fall.

In barely six weeks the real had lost nearly a quarter of its value, and in mid-October 2002, the real hit its weakest level in history at 4 per US dollar.

Thing is, the weakness in the Brazilian currency thirteen years ago wasn’t based on any rational, objective data.

It’s not like the Brazilian government had accumulated $18 trillion in debt, or another $42 trillion in unfunded liabilities.

In fact Brazil’s debt to GDP ratio was less than 50% at the time (compared to over 200% for, say, Italy).

Most of the ‘crisis’ was simply an emotional reaction to what was happening next door in Argentina, which had recently defaulted on its debt.

Foreign investors lumped all of Latin America together and started dumping everything– stocks, bonds, currency.

Many well-heeled Brazilians panicked.

And, believing that the real was on a one-way street to total destruction, they moved their money into the ‘safety and security’ of US dollars.

This turned out to be the wrong move.

Over the several years, the panic quieted and investors realized that none of their fears were backed up by any actual data.

Growth returned. And by August 2008, the real hit an all-time high of 1.55 per US dollar.

Investors who thought they were ‘smart’ by selling the real at its all-time low and buying the US dollar at its all-time high had managed to lose over 60% of their wealth in six years.

This highlights a rather strange sentiment of human psychology: investors seem to prefer buying assets when they’re expensive, and selling them when they’re cheap.

It has to do with a deep flaw in our ability to properly assess risk.

In any situation, there’s always the PERCEIVED risk and the ACTUAL risk.

Perceived risk is based on feeling and emotion. Actual risk is based on data. You can probably guess which one is more accurate.

We can see signs of this in nature; when small animals feel threatened, they’ll often puff themselves up and make intimidating growls, all in an attempt to increase their predator’s perception that a fight would be risky.

The western banking system is another example.

The US government is broke. The US Federal Reserve is nearly bankrupt. The US banking system is pitifully illiquid.

And the FDIC’s insurance fund fails to meet the minimum level of capitalization as required by its own regulation.

This is a system where the ACTUAL risk is quite high. Yet the PERCEIVED risk is shocking low since the public believes that everything in the banking system is OK.

That’s generally the time to be selling… or at least heading toward the exit– when the actual risk is much higher than the perceived risk.

Conversely, when the actual risk is much LOWER than the perceived risk, it’s time to buy.

That’s the case today in developing markets. Especially here in Latin America.

Two obvious examples are Chile and Colombia.

Colombia is still tainted with a reputation of cocaine and kidnapping, even though the country moved on from that long ago. Still, the perceived risk is very high.

Chile generally stays out of the news, and thus it is hard for ignorant investors to distinguish the country from its neighbors.

Both economies are commodity exporters.

And given the weakness in commodity prices, the market perceives the risk for all commodity exporters to be high.

But this is feeling. Emotion. Not fact.

The data show that both countries are among the most reliable and fastest growing in the region with rapidly expanding middle classes and solid public finances.

Chile, for instance, has zero net debt, a solvent pension system, and a banking system with strong levels of capital and liquidity.

Both have robust and growing domestic economies as well.

There’s certainly an economic slowdown right now. But looking at the currency markets, both the Chilean peso and the Colombian peso have lost roughly 40% of their value over the last few years.

That strikes me as absurd.

Are these economies 40% weaker? Is their long-term potential 40% worse?

Doubtful. The fundamental growth trends are still very much intact.

The only difference is that for anyone with incredibly overvalued US dollars to spend, assets in these places are dirt cheap– whether it’s real estate, or shares of well-managed productive companies.

On a related note, I was recently reading an analyst report about mining giant BHP Billiton, in which the analyst lamented the usual risks that weak commodities will hurt the company’s earnings…

… but in the end he admitted that the company had a great balance sheet, management team, and business model.

Right now BHP is trading nearly at the value of its net tangible assets and paying a 7% dividend yield.

And the analyst concluded, almost begrudgingly, that this was a once in a generation (if not once in a lifetime) opportunity to buy into a great company at such a cheap valuation.

I won’t be cliché and say that Latin America (particularly Chile and Colombia) is now a once in a lifetime opportunity. Or even once in a generation.

But given the historical data, it’s pretty clear that this is at least a once in a decade opportunity.

Until tomorrow, 
 
Simon Black 
Founder, SovereignMan.com

It’s been a tough couple of weeks.

I keep a mostly hedged book, long and short, so it’s rare that I get my head caved in on every position at the same time. But that’s pretty much what has happened. My shorts haven’t worked because they’re either rate-sensitive or Canadian banks. Meanwhile the longs, which include a lot of emerging markets—well, you know what has happened with those.

Nothing has changed with the long-term thesis. Nothing. But the mark-to-market is no fun, and any time you’re facing negative P&L, you have to do some soul searching and think about whether you still like these trades or they are permanently broken.

Anyway, you can read more about this discussion either in Bull’s Eye Investor or my newsletter for sophisticated investors, The Daily Dirtnap.

Fight or Flight?

What I really want to focus on today is the psychology of losing. I don’t care who you are, or how smart or confident you sound on Twitter, everyone in this business gets to feel pain at one time or another. You do your best to minimize it and mitigate it, but everyone will get hammered eventually. It happens to the best of us.

So what do you do about it?

This is where I get all Dicky Fox on you and start dispensing the motivational quotes. Like, it is human nature not to log on and look at the losses. Or the 1995 equivalent, throwing away the brokerage statement. People hide. They go into shutdown mode.

That is the worst thing you can do.

Hopefully the losses will motivate you to take some action. Most of the time, that means cutting the losses, but in rare, high-conviction cases, you may decide you want more risk. But sitting still and getting bludgeoned is not going to help. I assure you, it will get worse before it gets better. If it ever gets better. That is the nature of trends. And you are on the wrong side of one.

This is the reality of it: The financial markets are like a fight. You have to get up, ready to fight, every day. You don’t get to take a break from the fight, unless you just sell everything and take your ball and go home. Which is okay. You can run away, live to fight another day. Running is often preferable to fighting. I run all the time.

This time, I’m going to fight.

Endowment Effect

Here is thing number two. Have you ever heard of something called “endowment effect?” That’s the phenomenon where people get emotionally attached to things. Like the coffee mug you got in college. You wouldn’t sell it for $50, even though it’s only worth $5.

People get emotionally attached to stocks too. Which is weird because nobody has certificates anymore; it’s just a ticker in a web browser. But people are very protective of their ideas. It’s their idea, and nobody wants to admit that they are wrong and abandon this idea that could one day make them lots of money.

So you have two options. You can admit you’re wrong and sell it and go do something else, or you can try to wait out the market.

It can be very hard to wait out the market.

Inevitably, what happens to people who wait out the market is that they wait and wait and wait until they get to the point of maximum pain, and then puke the stock—on the lows.

That’s Wall Street.

If you have a number in your mind of how low something can go, your estimate is probably off. Like, if you’re long XYZ at $20, and it’s down from $25, and you think you can hang on until $15, it’s probably going to $5. People lack imagination about how bad the losses can get. They literally cannot conceive of things going horribly wrong. After doing this for 16 years, and seeing things go horribly wrong a bunch of times, I know.

All of my positions could easily get cut in half from here. Easily.

And then people start talking about the concept of “intrinsic value.” Like, this stock has $10 in cash on the balance sheet, there is no way that it can go to $10. And then it goes to $5. Seen it happen. Many times.

That goes for commodities, too. There is no reason why we can’t have $2 corn, or $20 oil, or $200 gold. All of these scenarios are unlikely, but there is no rule that corn or oil or gold can’t drop below a certain price.

If there is such a thing as fair value, the stock will go below it, for sure.

Loser

But more broadly, when people start getting hit, they get demoralized, which is bad because that’s the worst time to get demoralized. When the market is volatile, there are more opportunities (especially in options, where implied volatility is high).

I’ve written a lot of very stern comments here about not having discipline, but I should point out that the horrible bear markets of 2001 and 2008 gave rise to an entire generation of permabears. But the 2000s are not a good sample. For most of the history of the stock market, people are rewarded when they add to long positions on corrections of 10-20%.

You can find lots of reasons to buy stocks (valuation, strong USD, emerging markets, whatever), but there are always reasons not to buy stocks. There were reasons not to buy stocks in March of 2009. You can talk yourself out of a lot of opportunities if you only listen to the negative.

I don’t have perfect knowledge of how this is going to turn out. I don’t. But it doesn’t seem like a generational bear market to me. More likely than not, a year from now stocks will be higher. That’s as good of a prediction as I can offer.

Jared Dillian
Editor, The 10th Man

Jared’s premium investment service, Bull’s Eye Investor, is available now. Click here for our introductory offer. For Jared, no asset class or type of investment is off limits. From an iconic sports outfitter to a particularly liquid frontier-market ETF—Jared picks the best vehicles for his subscribers to profit from tomorrow’s trends today. Put Jared’s ingenious mix of market analysis and trader’s intuition to work in your portfolio today. Follow Jared on Twitter at @dailydirtnap.

I believe in putting my money where my mouth is, so this week I am sharing with you my own personal productivity tips: the actions that have helped me stay on top of my game, manage my business, wealth, family and life in general.

I developed these three ideas as the result of countless iterations, experiments and improvements I have made over my 25+ years in business.  They represent the best systems I have discovered to keep me focused, productive and fully engaged in those critical few activities that create value, while avoiding the trivial many that distract and deplete my precious resources.

Tip 1 – My Goals:  I have one long-term, overarching lifetime goal for each of the following areas of my life: Health, Family and Wealth.  Each year I break each of those long-term goals into an annual goal which supports its achievement.  Each day I set up a single action, in each of those three areas, that will help me achieve my annual goals and then schedule it into my day.  These are the “must hit” actions for the day and everything else is subordinated to them.  Big goals produce big actions which produce big results.

Tip 2 – My Schedule:  I live by my schedule and use it to rule my day.  If it’s not on the schedule, it gets ignored!   I use a paper based, week-at-a-glance planning diary called the Quo Vadis Trinote (7″ x 93/8″).  I know it sounds strange in a digital world, but I love the convenience of seeing my entire week laid out in front of me, and the ease of being able to quickly modify appointments or update actions.  In addition, I write my top three goals into a box at the top of each day, and then my minor to-do items into space below the day.  At the end of each day, I write down my biggest accomplishments for that day, in order to reinforce my own work ethic and traction.

Tip 3 – My Week In Review: 100% of the credit for this idea goes to David Allen’s great book, “Getting Things Done”.  Buy a copy today.  Each week (Friday mornings 8 – 10 am) I review and organize my entire week just past, and prepare for the week coming up.  I review every goal, project, and update all my actions.  I file every scrap of paper (even empty receipts from my wallet weekly) and they are actioned, filed or thrown away.  I review all email, VM and correspondence for follow up (scheduled) and periodically review what worked, and what did not.  I can then finish the week well organized and set to go for the following week.  I keep a file for everything.

My key point is to take productivity seriously, by having a system that is simple and works for you. I hope you enjoyed this note and if you have any questions, let me know.

By Eamonn Percy

More articles HERE

The single most important thing for investors to understand here is how current market conditions differ from those that existed through the majority of the market advance of recent years. The difference isn’t valuations. On measures that are best correlated with actual subsequent 10-year S&P 500 total returns, the market has advanced from strenuous, to extreme, to obscene overvaluation, largely without consequence.

The difference is that investor risk-preferences have shifted from risk-seeking to risk-aversion. That may not be obvious, but in market cycles across history, the best measure of investor risk preferences is the behavior of market internals, as measured by the uniformity or divergence of market action across a wide range of individual stocks, industries, sectors, and security types, including debt securities of varying creditworthiness.

Our observations on that are not new at all. Extreme overvaluation coupled with deterioration in market internals was the same set of features that allowed us to avoid the 2000-2002 and 2007-2009 market collapses. Given our success in prior cycles, why did we stumble in the advancing half of this one? The fact is that in 2009, I insisted on stress-testing our methods of classifying market return/risk profiles against Depression-era data, setting off a sequence of inadvertent but related challenges in the recent cycle, which we fully addressed last year. I’ve detailed the central lessons in nearly every weekly comment since mid-2014. The full narrative is detailed in our 2015 Annual Report. As I observed in the accompanying letter:

If there is a single lesson to be learned from the period since 2009, it is not a lesson about the irrelevance of valuations, nor about the omnipotence of the Federal Reserve. Rather, it is a lesson about the importance of investor attitudes toward risk, and the effectiveness of measuring those preferences directly through the broad uniformity or divergence of individual stocks, industries, sectors, and security types. In prior market cycles, the emergence of extremely overvalued, overbought, overbullish conditions was typically accompanied or closely followed by deterioration in market internals. In the face of Fed induced yield-seeking speculation, one needed to wait until market internals deteriorated explicitly. When rich valuations are coupled with deterioration in market internals, overvaluation that previously seemed irrelevant has often transformed into sudden and vertical market losses.

If you review my concerns in recent years, prior to mid-2014, you’ll notice that they focused on the extreme nature of the “overvalued, overbought, overbullish syndrome” that had emerged. Examining these syndromes across history, these overextended conditions were typically accompanied or quickly followed by deterioration in market internals, and then by vertical air-pockets, panics or crashes. Because of that regularity (which was picked up by the methods that emerged from our stress-testing efforts), we shifted immediately to a defensive outlook when those overvalued, overbought, overbullish syndromes emerged. The problem, in this cycle, was that the Fed aggressively andintentionallyencouraged persistent yield-seeking speculation regardless of valuation extremes. One needed to wait until market internals deteriorated explicitly before taking a hard-negative outlook on the market – a requirement (“overlay”) that we imposed on our methods last year.

It may not be obvious that investor risk-preferences have shifted toward risk aversion. It’s certainly not evident in the enthusiastic talk about a 10% correction being “out of the way,” or the confident assertions that a “V-bottom” is behind us. But a century of history demonstrates that market internals speak louder than anything else – even where the Federal Reserve is concerned.

Why did stocks lose half their value in 2000-2002 and 2007-2009 despite aggressive and persistent monetary easing? The answer is that monetary easing doesn’t reliably support speculation when investors have turned toward risk aversion, as indicated by the state of market internals. Why was I admittedly wrong in having such a defensive outlook during much of the advance in recent years? Because regardless of obscene overvaluation and historically offensive extremes in sentiment and overbought conditions, market internals suggested that investors and speculators were buying every shred of the risk-seeking recklessness that the Fed was selling. Why has the market become much more vulnerable to vertical losses since last summer? Because market internals have turned negative, indicating that investors have subtly become more risk averse, removing the primary support that has held back the consequences of obscene overvaluation. If the Fed is going to launch QE4 and QE5 and QE6, or if zero interest rate conditions are going to support speculation as far as the eye can see, those policies will only have their effect on stocks by shifting investors back toward risk-seeking, and the best measure of that shift will be through the observable behavior of market internals. We don’t expect that sort of shift at these valuations, but we can’t rule it out, and in any event we’ll respond to the evidence as it emerges. Given continued extremes in valuation, our own response would likely be to shift our outlook to something that could be described as “constructive with a safety net.” For now, our outlook remains hard-negative.

If you need to reduce risk, do it now

It’s important to recognize that the S&P 500 is down only about 6% from its record high, while the most historically reliable valuation measures are double their historical norms; a level that we still associate with expected 10-year S&P 500 nominal total returns of approximately zero. We fully expect a 40-55% market loss over the completion of the present market cycle. Such a loss would only bring valuations to levels that have been historically run-of-the-mill. Investors need not expect, but should absolutely allow for, a market loss of that magnitude. If your investment portfolio is well-aligned with your actual risk tolerance and the horizon over which you expect to spend the funds, do nothing. Otherwise, use this moment as an opportunity to set it right. Whatever you’re going to do, do it. You may not get another opportunity, and if you’re taking more equity risk than you wish to carry over the completion of this cycle, you still have the opportunity to adjust at stock prices that are close to the highest levels in history.

The chart below offers a good idea of how little conditions have changed in response to the recent market pullback. The blue line shows the ratio of nonfinancial market capitalization to corporate gross value added, on an inverted log scale (so that equal movements represent the same percentage change). The slight uptick at the very right hand edge of the chart is barely discernable. That’s the recent market selloff. Current valuations remain consistent with expectations of zero nominal total returns for the S&P 500 over the coming decade.

A final note on the impact of interest rates on expected and actual subsequent market returns, also from our Annual Report:

“It is important to recognize that while depressed interest rates may encourage investors to drive risky securities to extreme valuations, the relationship between reliable valuation measures and subsequent investment returns is largely independent of interest rates. To understand this, suppose that an expected payment of $100 a decade from today can be purchased at a current price of $82. One can quickly calculate that the expected return on that investment is 2% annually. If the current price is given, no knowledge of prevailing interest rates is required to calculate that expected return. Rather, interest rates are important only to address the question of whether that 2% expected return is sufficient. If interest rates are zero, and an investor believes that a zero return on other investments is also appropriate, the investor is free to pay $100 today in return for the expected payment of $100 a decade from today. The investor may believe that such a trade reflects ‘fair value,’ but this does not change the fact that the investor should now expect zero return on the investment as a result of the high price that has been paid. Once extreme valuations are set, poor subsequent returns are baked in the cake.”

Be careful to understand that argument correctly. Yes, low interest rates may encourage investors to drive stocks to extremely high valuations that are associated with low prospective equity returns. We certainly believe that as long asinvestor preferences are risk-seeking (as we infer from market internals), monetary easing and QE can encourage yield-seeking speculation that drives equities to recklessly extreme valuations. The point is that once valuations are driven to those obscene levels, low interest rates do nothing to prevent actual subsequent market returns from being dismal in the longer term. The low subsequent returns are baked in the cake.

One might like to think that, well, maybe interest rates will be just as low a decade from now too, so valuations can remain high indefinitely. The problem is that there is a very strong correlation between the interest rates at the end of any 10-year period and nominal economic growth over that same period. So even if low rates a decade from now might support higher valuation multiples, interest rates will remain this low only if economic growth turns out to be dismal (our total return estimates generally assume nominal growth of 6% annually – see Ockham’s Razor and the Market Cycle for details on that arithmetic). Because those two effects tend to cancel out, it turns out that the relationship between reliable valuation measures and actual subsequent returns is highly insensitive to the level of interest rates. Again, yes – low interest rates may encourage higher valuations. But once those rich valuations are established, thenearly direct correspondence between valuation levels and actual subsequent market returns is largely unaffected by the level of interest rates.

The following chart from May is a reminder of two things. First, the relationship between interest rates and valuations is much weaker than many observers seem to assume; and second, the close relationship between valuations andactual subsequent market returns is largely unaffected by the level of interest rates.

The upshot is this. Current valuations continue to imply approximately zero nominal total returns for the S&P 500 over the coming decade, coupled with the risk of a 40-55% market loss over the completion of the present market cycle – a loss that would only bring valuations to run-of-the-mill historical norms. An improvement in market internals would suggest a shift back to risk-seeking speculation among investors, and would defer the immediacy of our concerns. In the absence of that improvement, we continue to view the market as vulnerable to steep losses. As I noted early this year (see A Better Lesson than “This Time Is Different”), market crashes “have tended to unfold after the market has already lost 10-14% and the recovery from that low fails.” Prior pre-crash bounces have generally been in the 6-7% range, which is what we observed last week, so I certainly don’t see that bounce as having removed any of our concerns. We remain extremely alert to the prospect for much more extended market losses. Our outlook will change as the evidence does.

Again, if your portfolio is well aligned with your risk-tolerance and investment horizon, given a realistic understanding of the extent of the market losses that have emerged over past market cycles, and may emerge over the completion of this cycle, then it’s fine to do nothing. Otherwise, use this opportunity to set things right. If you’re taking more equity risk than you can actually tolerate if the market goes south, setting your portfolio right isn’t a market call – it’s just sound financial planning. It’s only fun to be reckless if you also turn out to be lucky. Market conditions are now more hostile than at any time since the 2007 peak. If you want to be speculating, and you can tolerate the outcome, then you’re not taking too much equity risk in the first place. But it’s one or the other. Can you tolerate a 40-55% market loss over the next 18 months or so? If not, take this opportunity to set things right. That’s not the worst-case scenario under present conditions; it’s actually the run-of-the-mill historical expectation.

The foregoing comments represent the general investment analysis and economic views of the Advisor, and are provided solely for the purpose of information, instruction and discourse. Please see periodic remarks on the Fund Notes and Commentary page for discussion relating specifically to the Hussman Funds and the investment positions of the Funds.

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Prospectuses for the Hussman Strategic Growth Fund, the Hussman Strategic Total Return Fund, the Hussman Strategic International Fund, and the Hussman Strategic Dividend Value Fund, as well as Fund reports and other information, are available by clicking “The Funds” menu button from any page of this website.

Estimates of prospective return and risk for equities, bonds, and other financial markets are forward-looking statements based the analysis and reasonable beliefs of Hussman Strategic Advisors. They are not a guarantee of future performance, and are not indicative of the prospective returns of any of the Hussman Funds. Actual returns may differ substantially from the estimates provided. Estimates of prospective long-term returns for the S&P 500 reflect our standard valuation methodology, focusing on the relationship between current market prices and earnings, dividends and other fundamentals, adjusted for variability over the economic cycle (see for example Investment, Speculation, Valuation, and Tinker Bell, The Likely Range of Market Returns in the Coming Decade and Valuing the S&P 500 Using Forward Operating Earnings ).

(c) Hussman Funds