Sunday, October 22, 2017

Risk and Risk Management and much more


I know how to read an annual report. I know the concepts of value investing and how growing earnings per share ultimately results into a higher stock price. But I am not a stock analyst.  I don’t peer over corporate balance sheets and try to forecast earnings for the next quarter nor the next decade. Yes, sometimes I look at how earnings grew and how much debt a company has on-line in Globe Investor or in Yahoo-Finance.  But if you consider how often and by how much all those highly-paid analysts miss the next quarterly earnings results, then this is obviously not all that there is to successful investing.

Yes, I do run an Annual Property Operating Data statement to estimate a property’s economics and I know that I want a cap-rate of at least 3% before I consider buying real estate. But there is a lot more than an APOD involved and often it turns out different than what was expected based on the APOD. If it was just about the balance sheet and profits, then how do we explain Amazon or Tesla? 

One can only look at the numbers so much! Investing is not about how many dollars you have in the bank account. Currencies and cash are just ways to temporarily store income and other proceeds from your assets. You also need cash, whether it is in the form of dollars in you bank account or other currencies in other accounts or gold or money market funds. It is all the same. For longer term cash, I start more and more to lean towards gold. With government debts; consumer debt and student debt and even subprime auto loans very high, there could, as by many dooms-day-sayers have predicted, another big crash.  In what does Venezuela differ from the U.S.? Or from Canada for that matter? Politicians spend and borrow like crazy. To a lesser degree Consumers do the same.  Corporate debt is apparently not far behind.

No, I do not invest in dollars, I invest in assets, often income producing assets, in various asset classes. Because really, I do not know which ones will work out. Owning assets gives you options. If there is a stock market crash you may say: Oh… I lost 30%. But so did your neighbor!  Relatively, you will still be just as well off as before the crash. Exception may be the person who didn’t own anything because 30% of nothing (whether up or down) is still nothing. The real question is what would be better a portfolio of collapsed stocks or a real estate portfolio?  What would be better a gold portfolio or a portfolio in bonds? Often though, if the stock market crashes, real estate is not far behind. During the depths of the 2008-2009 crisis, even gold was down. So even in the total portfolio, net worth goes up and down. However, compared to other investors you may not have become a lot richer or poorer. It also depends whether your assets are priced in gold or U.S. dollars of course. And, as Warren says, when the tides rises it lifts all boats (except the ones that sunk during bad weather – that is me).  So that is where the real risk lies: the boats that were sold at the bottom of the market or that went entirely broke.  That is why we tell our readers: ‘Don’t sell in a down market; just sit it out and wait until prices have recovered or have done even better’ or never sell (except commodities).

Investing is about the assets you own – not their current valuation. That latter is temporary but should go up over the long term. He or she who owns assets has options and as long as you see cash as a temporary means for exchanging assets you don’t have to worry about valuation too much. Of course, it is much better to buy ‘cheap’ than expensive. Buy at depressed prices and sell high.   But if you wait for things going on sale; you may have missed a lot of the interest or dividends that are produced by these assets. Sometimes the income generated from an asset contributes 50% or more to your final profits. There is a balance and consequently don’t be overly obsessed by asset value and appreciation.

The asset classes themselves do not guarantee always the best return. If the stock market is down big time due to a government collapse induced by high debt, rental income and dividends are likely to fall as well. On the other hand, gold might be high in demand as a stable and reliable currency. Gold may allow you to buy food and new assets that are cheap.  As to how do you prepare for the ‘End of America’?  Have gold, some cash and have a lot in various assets such as a diversified stock portfolio combined with real assets such as real estate; maybe bare land; art, a business, own physical commodities, whatever but be diversified so that one asset type may do poorly while the other is just fine or maybe even boom.

The main thing is, do you have access to enough cash so that there are no forced sales at the bottom of a market and for the duration of the downturn.  Also, assets that were closest related to the cause of the collapse are often the ones that recover slowest. For example, U.S. banks were at the center of 2008-2009 and still are dirt cheap.  If during the next collapse, national debt and subprime-autos are the focus of the collapse don’t expect a large-scale recovery there. My feeling is that like the Nifty-fifty stocks were the at the center of the 1972 collapse, so will be the FANG stocks at the center of the next collapse. First though the FANG may shoot to the sky - to absurd valuations.  Real estate should be away from ground zero, but governments and banks may once again take large hits. Also avoid the automotive industry.  Commodities may prove interesting as well as they are already in a downturn.  Toronto may be hard hit because of topsy real estate and being the center of finance. Gold may go down initially but rise like a phoenix from the ashes of a collapsed fiat monetary system. Not sure about crypto-currencies as they are so speculative, but blockchain technology may be taking over from the traditional banks just like Amazon affected traditional retail (that again may change soon though).  Above all, diversify and hold physical assets and have your own business or start one. 

Personally, I think we may go into a completely new world with a different financial system; reduced nationalism; people being and taking more personal responsibility and the days of income-redistributing governments over. In the near and intermediate future, tensions are growing in Asia where Japan starts to rebuild its army; with North Korea and a more militant China that wants to spread its ideology throughout the world. The west is still in the grip of self-accusation and recrimination over things they cannot really change. If we don’t watch out, we may have a crisis of confidence, become paralyzed and get overrun by the ‘Hun’ who does not have that much of a guild-complex. There are lots of tensions and conflicting interests in this world. Let’s hope we get through this with minimal violence. I can see the perpetual fighting in the Middle East escalating; China, North Korea at Japan’s and South Korea’s throat. India and Pakistan going at it.  Europe may be ‘too old’ and tired to get involved but what will Russia do? Die of old age or blow itself up? Strangely enough, North and South America may stay out a lot of the fighting but are paralyzed by self recrimination and isolationism. A nuclear missile from Asia may wake us up like Pearl Harbor did. Africa will be Africa – I hope it doesn’t completely fall of the cart.  I see a world full of promise but also one that may after 70 years of 'peace' approach a violent breaking point. Let’s hope that Humpty-Dumpty can be put together again when it is all over. One thing is for sure; we won’t recognize our world half a century from now, when I reach the ripe age of 114 with more ripening ahead. Keep accumulating a wide range of assets some will carry you to an even better time.

Wouldn't that be something? Me still blogging 50 years from now. Can you imagine all the posts full of nonsense you would have to read?

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