China has a highly unusual business environment- the government is currently holding 2 Canadians hostage to benefit a private company (Huawei). Those with the right connections regularly use government resources for their own benefit. As far as investing in Chinese stocks go, it is a trap for foreign capital:
- Massive fraud.
- The CCP encourages mainlanders to be racist, nationalist, and xenophobic.
- Because of state-sponsored racism and xenophobia, there are far fewer (or no) consequences when somebody cheats a foreigner versus an ethnic Han Chinese citizen.
- The CCP often exploits foreign capital and sponsors the theft of intellectual property.
- Relations between the CCP and most developed countries will deteriorate because the CCP has been increasingly antagonistic towards other countries. The resulting trade wars will hurt China’s economy and make the environment sketchier for foreign capital.
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COVID-19 is going to be awful. Society will have plenty of assets (e.g. cruise ships) and unemployed people that will be fairly unproductive in the next few years. But, while I’m extremely scared of what COVID-19 will do to most stocks, I think that now is the time to invest in stocks (*that won’t get killed by COVID-19). What worked in the past will likely continue to work in the future:
- Buying high quality businesses…
- …at reasonable prices…
- …that aren’t in shrinking industries.
COVID-19 has dramatically changed #2 and #3. Many industries that were previously stable or booming may see a wave of bankruptcies. But that’s ok. I don’t have to own those stocks. Nobody is holding a gun to my head forcing me to own airlines, movie theatres, department stores, etc. There is still a small universe of stocks with low COVID-19 risk that I will concentrate my portfolio in.
Here are the excesses that I see in the lending markets:
- When investors put money into securitizations, they don’t pay attention to the underwriting quality of the loans that they own a piece of. They allow charlatans to unload low-quality loans into securitizations. Investors are ultimately buying into a pile of loans with inflated values. Unfortunately, yield-chasing investors gravitate towards assets that they don’t understand. This may be a desirable feature for the yield chasers- they will look smarter if others also don’t understand what the yield chasers own.
- Certain instruments such as Credit Risk Transfers (CRTs) and the lower tranches of CMBS have a significant chance of being completely wiped out. While the riskiest tranches of CRTs and CMBS have seen their prices drop 30%+, it doesn’t seem like investors are sufficiently scared about the senior CRT tranches in a COVID-19 environment.
- The system of yield-chasing mortgage REITs financing themselves almost entirely with short-term debt does not work. There are currently liquidity issues because lenders do not want to continue providing short-term debt (via repos / repurchase agreements) and the lenders also don’t want to sell the collateral. A key reason why problems exist is because the banks accepted highly leveraged investments as collateral.
I don’t think that the mortgage REIT stocks are very interesting because (A) none of them are good longs and (B) it’s not a good use of time to research them as shorts.
It has been difficult for me to accept that I should be buying stocks with high P/E ratios, high P/B ratios, and mediocre management teams. Quality rarely comes cheap and without warts. But, I’ve been trying to move away from deep value investing dogma because I want to figure out what actually works. As part of that, I’ve been keeping a model portfolio of 30-35 large cap stocks since October 2017 that you can view in real-time here. It has outperformed the S&P 500 by ~5% annually since October 2017 (!). This is a surprising amount of outperformance for large cap stocks (e.g. large cap mutual funds would be incredibly happy with 2% outperformance).
While it is possible that I am confusing luck with good stock picking, I have to live with imperfect information. I would prefer the feedback from a 30+ stock portfolio than the feedback from a focused portfolio with <10 stocks. Going forward, you should expect me to be heavily biased towards quality companies.
Our brain will automatically leap into action when it senses danger. If we are in physical danger, it will trigger our ‘flight or fight’ response. If we are in social or emotional danger, it will message us through feelings such as anxiety so that we avoid that situation. Unfortunately, this system doesn’t always act perfectly and can cause us to behave irrationally. For example, we may feel a sense of dread when faced with an unpleasant task. This leads to procrastination, an irrational behaviour that many of us wish we didn’t have.
This post will look at:
- How our brains nudge us towards irrational behaviours.
- How we can get rid of those irrational behaviours.
- How we can use it to understand narcissists and how to deal with them.
I’ve started an experiment where I’m keeping a public portfolio of large cap stocks via the Motley Fool CAPS system- you can view it here. I would like to see if I can generate value on the long side… something that I find much, much more difficult than shorting.
My criteria are:
- Pick only the quality businesses in a particular sector. For example, Dollarama is the clear leader among discounters.
- Not overpriced. For that reason, Amazon and Netflix don’t make the cut (just look at what happened to Amazon during the Dot-Com Bubble).
- I avoid industries where there are no clear industry superstars. Oil and mining stocks simply don’t make the cut as none of them are quality businesses.
- Lastly, I avoid dying or shrinking industries. Profits ultimately don’t grow in dying industries and therefore those stocks almost never do well.
Human beings are wired to hold self-serving beliefs about the world regardless of the accuracy of those views. While it is easy to see these tendencies in other people (e.g. flat earthers, Donald Trump’s anti-vaccination views, conspiracy theories), all human beings are wired to have blindspots when it comes to the inaccuracy of their own views. Why? Ideologies are often arbitrary but they serve social and political purposes. Nelson Mandela was once on US terrorism watchlists; nowadays, he is celebrated as a freedom fighter and human rights activist. Clearly, it’s not possible for Nelson Mandela to be both a terrorist and a hero. Yet, society conveniently ignores conflicting evidence when it distorts history to fit a particular political agenda. My theory is this: human beings participate in the mainstream ideology when it benefits them. When it doesn’t, social outcasts and misfits band together to form their own alternative ideology that benefits them. In both scenarios, the ability to ignore, downplay, and dismiss conflicting evidence lessens the mental burden of upholding a particular ideology.
The most disappointing thing that I’ve learned about short selling is that identifying frauds and scams is not as consistently profitable as it “should” be. Identifying frauds actually isn’t the hard part. The real issue is that fraud isn’t symmetrical. While fraud reduces returns on the long side, actually making money by betting against fraud is much harder than it seems. Here are some reasons:
- The wealth isn’t exactly transferred from the longs to the shorts. Short sellers have to pay money to borrow shares. Much of the profit from short selling ends up in the hands of brokers, who earn large fees from lending shares to short sellers.
- Short positions tend to be correlated because of the way they are marketed. The parties lending out shares tend to be institutional investors who fall prey to the marketing tactics of small investment banks. Being unable to ride out market conditions can cause short sellers to lose money.
- Worthless companies often get taken over. There is always some rich person or misguided CEO that will throw money at a fraud.
I’m aware that there’s information on mining stocks from guys like Angry Geologist, Exploration Insights (Brent Cook and Joe Mazumdar) and investment bank analysts with mining degrees (P.Geo, P.Eng, etc.). The danger is this: just because they CAN perform due diligence doesn’t mean that they ACTUALLY perform due diligence. I don’t mean to be disrespectful to these people. (*I do understand that I am attacking their credibility.) However, they often come to conclusions without having access to key technical data. For example, Simon Dominy and Strathcona have unique views on Pretium’s Valley of Kings deposit. They had access to all of the sample tower data, including the sample tower data on the Cleo vein. Strathcona had access to the drill core so they could make their own interpretations about the lithology (Wikipedia) of the rocks and therefore the appropriate geological controls. If you don’t have access to accurate lithological information (e.g. pictures of all of the drillcore), then you cannot build a reasonable resource model. Insiders have this information. The investing public doesn’t. When mining professionals make conclusions without access to key technical data, you should take their opinion with a grain of salt.
Secondly, one should question an analyst’s optimism about deposits. With the benefit of hindsight, we can figure out that mineral exploration has been a disaster since 2000. Past optimism about exploration stocks seems quite dubious with the benefit of 20/20 hindsight.