When I speak at financial seminars and conferences around the country, I feel a tension – a palpable fear – that didn’t exist in the past.
Investors aren’t just nervous or uncertain. They’re scared. And who can blame them?
The economy is sputtering. The Eurozone threatens to come apart at the seams. And the stock market is gyrating wildly.
In response to all this, some stock market pundits are pounding the table, insisting that this is an historic buying opportunity. Others, however, are infected with anxiety themselves. And a few are actively fear mongering.
Who should you believe, the raging bulls or the rampaging bears?
The answer is neither.
As historian David McCullough often reminds his audiences, there’s no such thing as the foreseeable future. None of these gurus has a crystal ball.
And that’s okay. Because financial independence is not about following the right predictions.
It’s about following the right principles.
Fortunately, the principles of successful investing are well understood.
Why don’t most people follow them? One reason is ignorance. There’s no shame in this. It’s a big, complicated world out there and we’re all ignorant of different things.
However, it’s unfortunate that most kids graduate from high school without a modicum of financial literacy. It’s tough to get a quick start in this world if you don’t understand compound interest, 401(k)s, adjustable-rate mortgages, or why we have a stock market.
So what are the great principles of investing?
It’s tough to cover them all in a short column like this. (Although I cover the bases in my first book, The Gone Fishin’ Portfolio.)
But here are the nuts and bolts everyone should know:
For starters, few people get rich by founding a computer company in their garage, recording a platinum record, or playing third base for the Yankees. Most people with a net worth of a million dollars or more became financially independent the old fashioned way. They maximize their income, minimize their outgo, and religiously save and invest the difference.
As my friend Rick Rule likes to say, when your outgo exceeds your income, your upkeep becomes your downfall.
Ok, let’s assume you’ve done what many people are either unable or too undisciplined to do: You’ve saved some money. Now what?
The next step is to understand that there are six factors that will determine what your investment portfolio is worth in the future:
Note that there’s nothing here about forecasting the economy, timing the stock market, or figuring out how the European debt crisis will end. You cannot know the answer to those questions.
And that’s okay, too, because they will have little bearing on what your investment portfolio is worth five, 10, or 15 years from now.
If you’re investing to become financially independent, think long-term and forget about the day-to-day trivia that dominates the headlines and pays the salaries of so-called experts.
Focus instead on following proven investment principles. In other words:
The principles are not complicated. Spend less money than you earn. Save.
Put your savings into a diverse portfolio of uncorrelated assets. Diversify to prevent big losses. Live below your means, and let compound interest do the heavy lifting.
Want to learn more about becoming financially independent?
Our free white paper, How to Build Wealth, covers asset allocation, position sizing, tax management, and other sound investment principles in detail.
Did I mention that it’s free?
Until next time, heed the advice of Thomas Jefferson:
“In matters of style, swim with current; in matters of principle, stand like a rock.”
Growing up, when I got into an argument with my mother, she would sometimes resort to the nuclear option, her tried-and-true conversation stopper.
Putting her hands on her hips and using the worst faux Southern accent imaginable, she’d say, “Well if you’re so damn smart, why aren’t you rich?”
I never knew how to respond to this. Of course, I was 12 at the time and the deadbeats on my paper route kept margins low. Still, it ingrained in me the notion that the rich must have a little something extra going on upstairs, otherwise we’d all be rolling in it. Right?
There is, in fact, some evidence to support this. According to a recent report from the U.S. Census Bureau, there is a strong positive correlation between income and education. Over an adult’s working life, on average…
But here’s the rub. Studies show that those who earn the most aren’t necessarily the richest…
To determine real wealth, you need to look at a balance sheet – assets minus liabilities – not an income statement. Just ask Dr. Thomas J. Stanley, the bestselling author of The Millionaire Next Door and perhaps the country’s foremost authority on the habits and characteristics of America’s wealthy. Many of his findings are just the opposite of what you’d expect.
For example, we generally envision millionaires as Bentley-driving, mansion-owning, Tiffany-shopping members of exclusive country clubs. And, indeed, Stanley’s research reveals that the “glittering rich” – those with a net worth of $10 million or more – often meet this description.
But most millionaires – individuals with a net worth of $1 million or more – live an entirely different lifestyle. Stanley found that the vast majority:
This is certainly not the traditional image of millionaires. And it makes you wonder, who the heck is buying all those Mercedes convertibles, Louis Vuitton purses and $60-bottles of Grey Goose vodka? The answer, according to Dr. Stanley, is “aspirationals,” people who act rich, want to be rich, but really aren’t rich.
Many are good people, well-educated and perhaps earning a six-figure income. But they aren’t balance-sheet rich because it’s almost impossible for most workers – even those who are well paid – to hyper-spend on consumer goods and save a lot of money. (And saving is the key prerequisite for investing.)
This notion shocks many Americans. Dr. Stanley recalls an appearance on Oprah when a member of the audience asked the question, one he’s heard hundreds of times before:
“What good does it do to have all this money if you don’t spend it?”
She was angry, indignant even. “These people couldn’t possibly be happy.”
Like so many others, this woman genuinely believed that the more you spend, the better life is. Understand, we’re not talking about people who live below the poverty line. (Clearly, their lives would be better if they were able to spend more.) We’re talking about middle-class consumers and up, those who often live beyond their means and then find themselves under enormous pressure, especially in a weak economy.
Some were overly optimistic about their earning prospects. Others didn’t realize that they are up against an army of the best and most creative marketers in the world, whose job it is to convince you that “you are what you buy,” that you need to outspend – to out-display – others. The unspoken message behind the constant barrage of TV and billboard ads featuring all those impossibly good-looking men and women is that you are special, you are deserving, and you need to look and act successful now.
According to Dr. Stanley, “The pseudo-affluent are insecure about how they rank among the Joneses and the Smiths. Often their self-esteem rests on quicksand. In their minds, it is closely tied to how long they can continue to purchase the trappings of wealth. They strongly believe all economically successful people display their success through prestige products. The flip side of this has them believing that people who do not own prestige brands are not successful.”
Yet “everyday” millionaires see things differently. Most of them achieved their wealth not by hitting the lottery or gaining an inheritance, but by patiently and persistently maximizing their income, minimizing their outgoing and religiously saving and investing the difference.
They aren’t big spenders. They just recognize that real pleasure and satisfaction don’t come from the car you drive or the watch you wear, but time spent in activities with family, friends and associates.
They aren’t misers however, especially when it comes to educating their children and grandchildren – or donating to worthy causes. Although they are disciplined savers, the affluent are among the most generous Americans in charitable giving.
Just how prevalent are American millionaires? According to the Spectrum Group, there were 6.7 million U.S. households with a net worth of at least $1 million at the end of 2009. Very few of them won a Grammy, played in the NBA, or started a computer company in their garage. Clearly, thrift and modesty – however unfashionable – are still alive in some parts of the country.
So while millions of consumers chase a blinkered image of success – busting their humps for stuff that ends up in landfills, yard sales and thrift shops – disciplined savers and investors are enjoying the freedom, satisfaction and peace of mind that comes from living beneath their means.
These folks are turned on not by consumerism but by personal achievement, industry awards, and recognition. They know that success is not about flaunting your wealth. It’s about a sense of accomplishment… and the independence that comes with it. They are able to do what they want, where they want, with whom they want.
They may not be smarter than you, but they do know something priceless: It is how we spend ourselves – not our money – that makes us rich.
Editor’s Note: This column was excerpted from Beyond Wealth: The Road Map to a Rich Life, by Investment U and Oxford Club Investment Director Alexander Green.
The book – endorsed by Pulitzer Prize-winner Daniel Walker Howe and Whole Foods Founder and CEO John Mackey – is a fascinating exploration of the intersection between money, personal fulfillment and successful living. Beyond Wealth is available at bookstores nationwide. Or you pick up a copy from Amazon here.
There are a number of signals that bode well for price appreciation with individual stocks: growing market share, rising sales, strong earnings growth and improving margins…
But you shouldn’t overlook another excellent indicator: share buybacks.
According to Standard & Poor’s, U.S. public companies spent at least $437 billion last year buying their own shares back. That was 46% more than in 2010.
Is this a good thing? Absolutely…
Regardless of whether you’re an individual or a corporation, sitting on cash isn’t terribly rewarding these days with the average money market fund paying five one-hundredths of 1%. And if the outlook is uncertain, a business owner doesn’t want to commit to building new facilities or taking on employees that aren’t needed. Nor is it necessarily in the best interest of shareholders to distribute this cash in the form of taxable dividends.
So buying back shares often makes good sense. Why? Because when you divide net income into a smaller number of shares outstanding, you get greater growth in earnings per share. And, ultimately, that’s what drives share prices higher.
Of course, stock buybacks boost earnings per share only if they’re larger than stock issuance. Historically, that hasn’t always been the case. (Much executive compensation today comes in the form of stock options that have a dilutive effect on existing shareholders.)
But in recent quarters, the supply of shares outstanding has been shrinking. And, according to analyst Howard Silverblatt at Standard & Poor’s, during the current earnings season, 97 of the S&P 500 enjoyed a boost to earnings per share of at least 4% from repurchases alone.
Expect to see more of these buyback announcements in the weeks ahead. Why? Because U.S. corporations are sitting on more than $2 trillion in cash. That’s enough to buy all of ExxonMobil (NYSE: XOM), Microsoft (Nasdaq: MSFT) and IBM (NYSE: IBM).
There are some caveats, however. Some companies announce their intention to buy back shares and then don’t follow through. If business conditions change, interest rates rise, or cash flow decreases, a repurchase program may never get completed.
The other thing to watch is the exercise of stock options, as mentioned above. If a company is only buying back enough shares to offset the dilution that occurs when executives exercise stock options, you won’t see the buyback boost earnings per share.
But, generally speaking, share repurchase programs are a decided positive. And right now, with money cheap and corporate earnings strong, buybacks are occurring at record levels. Cash-rich companies in the midst of major share buybacks right now include Smithfield Foods (NYSE: SFD) and Juniper Networks (NYSE: JNPR).
Of course, some analysts would rather see corporate executives buying shares with their own money rather than the company’s money. And I don’t disagree…
But sometimes you can have your cake and eat it, too. In a recent study, stocks that were subject to repurchases but not insider buying beat other stocks by nearly nine percentage points over four years. But stocks that were the subject of both repurchases and insider buying beat others by a whopping 29 points over four years.
Which companies have enjoyed share buybacks and insider buying recently? Two of them are CACI International (NYSE: CACI) and Crawford and Company (NYSE: CRD-A).
These are the kind of companies that should handily outperform the market in the months ahead.
Why You Shouldn’t Be Afraid to Buy Stocks Now, Part II
by Alexander Green, Investment U Chief Investment Strategist
Monday, June 18, 2012: Issue #1797
On Friday I made the case that everyone who is interested in achieving great wealth or protecting what they have should invest in stocks.
Not because stocks have generated a certain return over a certain period of time. Not because the outlook for the economy is fabulous. (It’s not.) And not because I have any inkling what the stock market is going to do next. (I don’t … and neither does anyone else.)
You should own stocks because great fortunes are usually the result of business ownership. (And the fortunes generated in real estate often involved massive amounts of leverage that seemed safe only when investors believed real estate appreciation is a one-way street. Not many do anymore.)
The simplest way to gain a piece of a great business is not to found one but to take an ownership stake through the stock market.
It’s not only easy… it’s fair. If I buy shares of Microsoft (Nasdaq: MSFT), for example, my return will be the same as the world’s richest man, Bill Gates. Sure, he may own a few more shares than I do, but our annual percentage gains will be the same.
Every stock market investor needs to be smart about it, however. In particular, you need to follow three proven principles that form the foundation of Investment U and The Oxford Club’s investment strategies:
Let’s take a quick look at each.
Asset Allocation is a phrase that makes the average investor’s eyes glaze over. Yet it is your single most important investment decision. It refers to how you divide your portfolio up among non-correlated assets: stocks, bonds, cash, metals, inflation-adjusted Treasuries and so on. Diversifying a portion of your risk capital outside of equities reduces your portfolio risk and volatility. History shows that businesses (stocks) outperform everything else over the long haul, but few people have the stomach to stay fully invested in prolonged bear markets. Benjamin Graham, Warren Buffett’s mentor, said no one should ever have more than 75% of his portfolio or less than 25% in stocks. It’s a good rule of thumb.
Trailing Stops. Anyone can plunk for a few shares. But the secret of investing is knowing when to get out. Unfortunately, no one rings a bell at the stop. But running a 25% trailing stop behind your individual stock positions allows you to both protect your principal and your profits. We’ve written on this topic frequently. For more information, click here.
Position-Sizing. You should not invest more than 4% of your stock portfolio in any one stock, at least initially. If it climbs, it may eventually become a much bigger portion of your portfolio but that’s ok. After all, you’re going to be running a 25% trailing stop to protect your profits, too. But look at the other side. If a stock goes against you and you take the maximum loss (25%) in the maximum position size (4%), your stock portfolio is going to be worth just one percent less. And if stocks are only, say, 60% of your asset allocation (as The Oxford Club recommends), the maximum loss in your maximum position size in your maximum stock allocation means your portfolio is only down six-tenths of one percent.
Many investors need the high returns that only stock can provide but can’t handle the risk. The solution? Asset allocate properly, run trailing stops and watch your position sizes.
It sure beats the heck out of sitting on the sidelines… and wishing you were earning higher returns.
Editor’s Note: This article is the finale in a two-part essay from Alex. To read the first part of his essay and find out why you should look at stocks more as ownership and investment in quality businesses, click here.
Why You Shouldn’t Be Afraid to Buy Stocks Now, Part I
by Alexander Green, Investment U Chief Investment Strategist
Friday, June 15, 2012: Issue #1796
The headlines these days are filled with gloom…
The economy is sputtering. Consumer confidence is down. Unemployment is up. The Eurozone is coming apart at the seams. To top it off, federal, state and local government spending are sending us down the road to ruin. Who can buy stocks in this type of environment?
You can. And you’d be unwise to let anyone counsel you otherwise, even if stocks go lower before they go higher.
Owning great companies is a smart move. (Notice I said great companies not small, unproven, or unprofitable companies.)
Most wealthy Americans achieved their affluence not by inheritance or real estate speculation but by starting and owning profitable businesses. And these folks can be thankful they weren’t deterred at the outset by naysayers and know-it-alls who tried to convince them the economy wasn’t right or their timing was wrong or whatever.
Of course, most of us don’t have the time, the investment capital, or the experience necessary to found and run a successful business. But we can buy shares of the greatest businesses in the world through the stock market.
And it’s easy. A click of the mouse – and a seven-dollar commission – and you’re in.
Another click – and another seven bucks – and you’re out. (Compare that to your typical real estate closing.) And if you buy publicly traded companies, as opposed to running your own private one, you don’t have to apply for loans, hire employees, grapple with an avalanche of federal regulations, pay expensive accountants and attorneys, or even show up for work. What’s not to like?
Of course, businesses can experience tough times. But they are adaptable. When sales take a downturn, they’ll cut expenses to the bone and lay off unnecessary personnel. They’ll refinance their debt at lower rates. They’ll tighten up the ship any and every way they can to make the business as lean as possible. And then when even slightly higher sales start to materialize, it will translate into a big jump in earnings. Those who are still trying to understand how the companies that make up the S&P 500 reported all-time record profits in each of the last 11 quarters might want to read this paragraph again.
Once you start thinking in terms of owning businesses – as opposed to predicting elections, economies, interest rates, currencies, commodities and equity markets – it’s clear how you should grow and protect your wealth. In fact, it’s more than a little ironic that the very people I hear telling investors not to buy stocks are – overwhelmingly – business owners themselves. Their business is advising other people not to buy businesses.
Seems odd, but I guess there’s good money in it.
Of course, even if you follow the basic principles of stock market investment – sticking to quality, diversifying widely and buying at reasonable prices – you can still experience losses. That’s normal. It shouldn’t come as a surprise and it shouldn’t deter you from investing in stocks.
Indeed, there are three ironclad strategies that every investor should follow to maximize his stock market profits while keeping any losses strictly limited. And those are exactly the subject of Monday’s column…
Editor’s Note: One of Alex’s favorite shortcuts to finding great businesses is finding CEOs and directors who are investing their own money back into the company in the form of stock purchases. And that’s exactly what’s been happening with today’s Investment U Plus pick.
And since we first mentioned the company back on May 14, its stock has steadily ticked higher – not to mention it sports a robust 8% yield. For more information on how you can receive this and our other daily recommendations along with your Investment U issues for pennies a day, click here.
More than a few investors are feeling a little gun-shy right now. Weak economic indicators – including soft employment and low consumer confidence – and ongoing problems in the Eurozone have put many on the defensive.
That’s not necessarily a bad thing. When the market starts to wobble, there is often more downside ahead.
But there’s a big difference between investing defensively and not investing at all. Successful investing is about managing risk – not running from it.
That’s why even investors with little appetite for stocks should be looking at one dirt-cheap sector: large-cap value.
Brandes Institute recently sliced U.S. stocks into 10 deciles by value characteristics and found that value hasn’t just done better. From 1980 to 2010, the cheapest stocks outperformed the most expensive by 575%.
Why does this happen? As a former money manager, I know that investing in value requires patience. That’s something most retail investors – and many small institutions – simply don’t have. They’ll hold a stock or a stock fund a couple quarters and if nothing is happening – especially if growth stocks are doing well – they’ll grouse that they’re sitting on “dead money” and roll into something else, often at precisely the wrong time.
The great global value investor John Templeton used to hold his stock positions an average of seven and a half years. Yet many investors would describe this approach as “From Here to Eternity.”
That’s why value investing is often referred to as “time arbitrage.” It often takes several months (or years) for value investing to work its magic.
Yet now is likely an excellent time to get started. Credit Suisse data reveals that the cheapest stocks in the S&P 500 index based on five metrics, including the price-to-earnings and price-to-sales ratios, have lagged the most expensive ones by 9% this year. And, according to Russell Investment, the last time a value index ranked on top and a growth index on bottom was the disastrous year of 2008.
Every seasoned investor knows that various asset classes go through cycles of outperformance and underperformance. Value has lagged for a very long time – and now offers plenty of upside potential without the neck-snapping volatility of go-go growth stocks.
How to play it? You can research and buy individual value stocks. Or you can take the simple, diversified approach and just buy a fund or ETF. If you prefer the latter route, a good candidate is the Vanguard Value ETF (NYSE: VTV).
VTV tracks the performance of a large-cap, value benchmark: the MSCI US Prime Market Value Index. The fund remains fully invested and uses a passive management strategy (no active trading), so it is relatively tax efficient. The expense ratio here is the lowest in the industry – just 0.12%. And the fund’s 10 largest holdings – which make up almost a third of the portfolio – are companies you know well: Exxon Mobil (NYSE: XOM), Chevron (NYSE: CVX), General Electric (NYSE: GE), AT&T (NYSE: T), Procter & Gamble (NYSE: PG), Johnson & Johnson (NYSE: JNJ), JP Morgan Chase (NYSE: JPM), Pfizer (NYSE: PFE), Wells Fargo (NYSE: WFC) and Intel (Nasdaq: INTC).
In short, the recent sell-off has made value stocks a bargain right now. It’s a great opportunity… if you have the patience for it.
Historically, natural gas has been 10 times cheaper than crude oil. As I write, it is approximately 35 times cheaper. Don’t miss out on this contrarian investment.
Many investors like to believe they are contrarians, investing against the crowd at key (and highly profitable) turning points. Yet in my experience, few actually do.
Here’s a simple test. Did you view the run-up in internet stocks in the nineties as absurd? Did you avoid speculating in real estate during the housing bubble? Did you buy high-quality stocks during the 2008 financial meltdown? Did you pick up gold back when it was under $300 an ounce? How about oil stocks when crude was less than $25 a barrel?
If you answered “yes” to any of these questions, you’re probably already looking at natural gas.
In mid-2008, natural gas traded above $10 per futures contract. Since then, prices have collapsed. Every day, the U.S. natural-gas market is flooded with an average of three billion cubic feet more than the nation consumes. Shares of most companies have taken a drubbing over the past year, even as the broad market has risen.
In sum, the news about natural gas has been almost uniformly awful. And that’s a good thing. As renowned investor Jeremy Grantham recently wrote, “Everyone who has a brain should be thinking of how to make money on this in the longer term.”
The shale gas revolution has cut the price of natural gas about 45% over the last year alone. New discoveries and innovative drilling techniques, along with recent mild weather, have led to a vast oversupply. According to the U.S. Energy Information Administration (EIA), national inventories have risen 56% over the past year.
The market is so awash in natural gas, by this fall there could be no space left to store the stuff in the entire United States unless demand surges or producers seal their wells. We may be creating a surplus that is beyond our capacity to store.
Needless to say, that has put heavy pressure on prices. Historically, natural gas has been 10 times cheaper than crude oil. As I write, it is approximately 35 times cheaper.
Given this scenario, why would anyone in his right mind invest in natural gas right now? Because this discount is not just enormous, it’s unsustainable. Natural gas is preferable to coal and other fossil fuels because it is clean burning, easily transportable, and much more affordable. Over the next few years, the free market will turn natural gas into the answer for our country’s energy problems.
It’s already happening. Electrical utilities and trucking companies, among others, are already switching from coal or diesel to natural gas.
Waste Management says 80% of the trucks it purchases during the next five years will be fueled by natural gas. Navistar (NYSE: NAV), Cummins (NYSE: CMI) and General Motors (NYSE: GM) are all courting the market with new natural-gas powered trucks or engines. Navistar’s goal is to expand to a full range of products using natural gas in the next 18 months. The company says that within two years, one in three Navistar trucks sold will burn natural gas.
And we are only at the tip of the tip of the tip of the iceberg here. Less than one-tenth of 1% of vehicles on U.S. roads burn the fuel today. Clearly, this is going to be a big area of future growth.
But what’s the best way to play it?
Not by buying Chesapeake Energy (NYSE: CHK), despite all the ink that’s been spilled. Yes, the company has wonderful gas assets. But it also has a boatload of problems that could sink your investment.
There has been a number of revelations about Chesapeake CEO Aubrey McClendon over the last few weeks and few of them are good. Among other things, Chesapeake saddled itself with about $1.4 billion of previously unreported liabilities through off-balance-sheet finance deals.
Yes, things could get better at Chesapeake, but they could also get a lot worse. It would be a shame to recognize the great opportunity that currently exists in natural gas and buy the wrong stock.
A much better investment, in my view, is a company that controls 1.1 million acres in the Marcellus Shale Play, a particularly attractive target for energy development in the Appalachian Basin. It also has hundreds of thousands of acres in low-cost, low-risk areas in West Texas, New Mexico, Oklahoma, Mississippi and Kansas.
Over the last decade, this firm worked tirelessly to lower its cost structure, strengthen its balance sheet and upgrade its inventory. As a result, the company now finds itself in the best position in its history.
Even with falling natural gas prices, it achieved record operating results in 2011. Proven reserves increased 14%. Production grew by 12%. Yet reserve replacement was 849%. It was the company’s sixth consecutive year of double-digit growth in both production and reserves.
Yet the best is still ahead. Results over the next several years will substantially exceed those of prior years. Liquids production will increase by 40% this year alone. I estimate earnings will jump sharply this year and then triple in 2013. That’s if natural gas prices remain depressed. If they rise, earnings will really skyrocket. And so should the stock.
That’s why this stock is the newest addition to our Oxford Trading Portfolio. And in fairness to existing members, I cannot reveal the company’s name here.
However, I do invite you to join us and become an Oxford Club Member and benefit from our many services, including our award-winning recommendations. To learn more, feel free to click here.
Francois Hollande and the Flight of French Capital
by Alexander Green, Investment U Chief Investment Strategist
Monday, May 7, 2012: Issue #1767
Francois Hollande’s answer to this budget crisis? Still more spending and a proposed 75% tax rate on job creators.
Winston Churchill famously said “You can always count on Americans to do the right thing – after they’ve tried everything else.” Now we can say the same about the European Union.
Global financial markets are down sharply this morning in response to election results over the weekend. In France, French Socialist candidate Francois Hollande narrowly squeezed out President Nicolas Sarkozy and his unpopular austerity measures.
Yet Hollande insists his campaign was not about the incumbent. “My real enemy,” said the President-elect, “is the world of Finance.”
He has chosen the wrong antagonist.
Governments can control fiscal policy. They can control monetary policy. But they cannot control financial markets. French voters have voiced their opinion about Hollande. And now financial markets will voice their opinion of him.
He’s not going to like it.
We’ve all the heard the nattering between economists about Europe’s choice between austerity or growth. Stronger countries, like Germany, want southern members of the Eurozone to demonstrate fiscal responsibility and cut out-of-control spending. But the citizens of these countries – especially Spain with its unemployment rate of 25% – want jobs. They want growth.
Fortunately, austerity and growth are not incompatible. Unless you believe it’s achieved through still more reckless spending and painful taxes on risk takers.
Recognize that France already has one of the highest overall tax burdens, yet it continues to bleed red ink. Debt is 90% of GDP. Trillions in unfunded pension and retiree health-care obligations loom in the not-too-distant future.
Hollande’s answer to this budget crisis? Still more spending and a proposed 75% tax rate on job creators.
To be sure, this has populist appeal among some voters, especially those who believe national governments are giant candy stores funded by millionaires and billionaires.
Let’s set aside the obvious folly of piling new debt on top of old in the midst of a fiscal crisis. Entrepreneurs and other business owners – being rationally self-interested like the rest of us – will take every step imaginable to avoid a punitive 75% tax rate. Many, in fact, will choose to take their money out of the country – or not invest it at all.
A businessman or businesswoman under a high-tax regime always does a simple back-of-the-envelope calculation. It goes like this: If I start or expand my business, I will face the risk of substantial losses for which I will be solely responsible. But if through hard work, enterprise and a bit of luck I beat the odds and succeed, the government will take up to three-quarters of what I make.
Many will choose to punt. Their businesses will not be expanded. The unemployed will not be hired. Tax revenue will not be raised. Economic growth will not expand. And neither will corporate profits. That bodes ill for Europe’s equity markets.
And it gives us a foretaste of what lies ahead in the United States if our so-called leaders in Congress don’t get their act together. Politicians on both sides of the aisle don’t want to confront the reality of our unsustainable budget deficits. Yet, ultimately, financial markets will force them to. As you can see today, the purple thunderheads are gathering.
It’s funny how words and expressions enter and leave the language. A few years ago, for instance, no one had heard the phrases “Great Recession,” “the one percent,” or “the Arab Spring.”
Want to know my prediction? You’ve already heard the last U.S. economist or politician say he favors “the European model.”
Contrarian Investing in 2012: How to Buy Great Global Assets Really Cheap
by Alexander Green, Investment U Chief Investment Strategist
Monday, June 4, 2012: Issue #1787
iShares Japan (NYSE: EWJ) hit a 52-week low Friday. Could this be the greatest contrarian investment of the year?
Japanese companies have a problem. Several of them, in fact.
Their nation’s fiscal situation, in many ways, is worse than that of Greece or Spain. (Debt as a percentage of GDP, for example, is more than 225%.) The Japanese economy is growing at an anemic 1% – and has been for decades. To top things off, the country’s population is not just aging, but dying off. That means less demand for everything from sushi to golf clubs to industrial equipment.
So what are Japanese companies doing about it? They’re diversifying outside their national border, buying up companies at fire-sale prices around the globe. And that’s creating an opportunity for investors like you.
For example, last week Japanese trading house Marubeni Corp. agreed to buy U.S. grain handles Gavilon Group LLC in a deal worth about $5.6 billion. Japan Tobacco Inc. offered to buy Belgian tobacco maker Gryson NV for $600 million. And Takeda Pharmaceutical said it would acquire a Brazilian drug maker for $246 million.
These aren’t isolated examples. With more than $34 billion in foreign investment this year, Japan is likely to exceed last year’s record $84 billion, a total that propelled the country to the number three spot in global deal rankings.
What’s going on here? After decades of frugality and debt-slashing following the 1980s asset bubble, Japanese firms are flush with cash, more than $2.6 trillion. That’s even more than U.S. corporations’ record $2.2 trillion in cash.
But aside from this treasure chest, the Japanese have a surging yen that gives them increased purchasing power around the world. With limited opportunities for growth at home, tons of cash and an appreciated currency, Japanese companies are in the midst of the biggest boom in overseas investment the country has ever seen.
But hold on… didn’t this end badly for the Japanese in the 1980s when they bought up trophy properties like Universal Studios, Rockefeller Center and the Pebble Beach Golf Course? Indeed, it did. Many of those purchases were both too rich and ill timed. But recent deals are taking place against a starkly different backdrop.
In previous mergers and acquisitions, Japanese companies often failed to do thorough due diligence or bargain hard enough. But not any more. M&A specialists routinely report that Japanese firms are executing deals quickly, efficiently and effectively. Unlike before, they aren’t reluctant to bargain hunt at auctions or make a hostile bid if friendly takeover offers are rebuffed.
Japanese firms are busy buying gas, oil and mining projects around the globe as global corporations struggle to lock up natural resources and get more control over operations. Japanese retailers are buying foreign firms to capture new markets. For example, toy maker Tomy Co. paid $640 million last year to buy the U.S. maker of Thomas the Tank Engine railroad sets. (They didn’t have much choice with birth rates went down sharply in Japan.) And Japanese drug maker Astellas recently paid $4 billion for OSI Pharmaceuticals in the United States.
What does this mean for you as an investor? Plenty. You now have the opportunity to buy dirt-cheap, cash-rich Japanese companies that are, in turn, buying up depressed and undervalued assets around the globe.
The easiest and most liquid way to play this is to invest in iShares Japan (NYSE: EWJ), a broad index of Japan’s leading companies.
Only contrarians need apply, however. Japan is cheap because the market is almost completely out of favor. The fund hit a 52-week low Friday.
How to Make Money in the Stock Market Weighing Machine
by Alexander Green, Investment U Chief Investment Strategist
Friday, June 1, 2012: Issue #1786
These companies are likely to thrive – and deliver exceptional returns – to investors who are able to take the broader view, learn from the past and act unemotionally.
During a radio interview last week, I was asked by the host to explain how Europe’s fiscal problems will play out and the likely impact on the U.S. stock market.
This question is a fine example of why I don’t do many media interviews and why it’s largely a waste of your time to listen to most of the pundits who grant them.
The Eurozone is a mess. That much is clear. But as I told the audience, no one knows how the weak sisters in Europe will resolve their fiscal problems. (Although it’s bound to be instructive for everyone watching.) No one knows what the ultimate fate of the euro will be. No one knows what the fallout will be in world financial markets. And to the extent that someone is confident that they do know, history shows they are very likely to be wrong. Billionaire Ken Fisher doesn’t call the stock market “The Great Humiliator” for nothing.
Europe’s banking and public debt troubles – and their negative ramifications – have dominated world headlines for months. Only a rank novice (or a perpetual gloom-and-doomer, of which there are many) can believe these developments aren’t currently discounted in global stock and bond prices. That doesn’t mean financial markets won’t go lower. They might. And perhaps they will.
But they can also rally from here. Those who say they can’t imagine how are admittedly suffering from a poverty of the imagination – and I’ll bet took no advantage of fire-sale prices during the recent financial crisis (or even the mini-meltdown last fall).
I’ve said it before but it bears saying again. Economies and world stock markets are affected by the complex interplay of government policies, geopolitical tensions (and war), economic growth, interest rates, inflation, commodity prices, currency values, human psychology (particularly fear and greed), consumer confidence, capital flows, pending elections and potential legislation governing everything from tax rates to corporate regulations.
If you really believe you have all these things figured out, you probably shouldn’t be investing your own money.
But here’s something you can take to the bank: Share prices follow earnings. I challenge you to look back through history and pinpoint even a single public company that increased its profits quarter after quarter, year after year, and the stock didn’t tag along.
As Warren Buffett’s mentor Benjamin Graham famously said, “In the short term, the market is a voting machine, but in the long term it is a weighing machine.” What it weighs, of course, is corporate profits. A company’s true value will in the long run be reflected in its stock price. Bank on it.
If you understand this, you recognize that the current market is handing you a boatload of opportunities. It may not feel that way, but that’s how it always works. You pay a premium to invest in stocks when the outlook is rosy and investors are complacent. The real bargains appear only when there is trouble on the horizon and skepticism is high. (It’s too bad that millions recognize this only in hindsight.)
Right now you should be searching for solid, recession-resistant companies with double-digit sales growth, sustainable profit margins, high returns on equity, and quarterly profits that are likely to surprise on the upside in the weeks ahead.
These companies are likely to thrive – and deliver exceptional returns – to investors who are able to take the broader view, learn from the past and act unemotionally.