Taste of the Friday File: What if You’re Wrong?

Some big picture thoughts from before the current "panic"

By Travis Johnson, Stock Gumshoe, February 9, 2018

Now that we’re facing the first bout of stock market volatility in years, I thought I’d share some of my general thoughts from a few months ago with everyone — this originally appeared as part of a Friday File for the Irregulars back before the tax cuts were passed, about a week before Thanksgiving last year.

The regular Friday File for current Irregulars will be out later today, and will include some more big-picture blatheration as well as a continuation of my Annual Review of the Real Money Portfolio… but I do have lots of people asking me “what should I do?!” … and I don’t have an answer for that other than, don’t be sure you know what’s happening, but here, at least are some big picture thoughts that I can share which still make sense to me today.

And if you’ve thought about joining the Irregulars, our group of paid members who keep Stock Gumshoe going and get some extra jibber-jabber from me in return, well, this is the kind of thinking you’ll probably get overdosed with if you do — so consider yourself warned.

From 11/17/17

I often get asked what my biggest worry is… and that’s probably inflation, if only because the Fed has been trying to manufacture it for soooo long now. I worry about inflation sneaking in, causing interest rates to rise faster, and destroying over-levered sectors of the economy like real estate.

But there’s really no sign of that actually happening in the US, and everything seems quite copacetic with the slow pace of interest rate increases and the flattening yield curve… the bigger risk immediately, I suppose, is that China might again try to slow its overheated and debt-fueled real estate market — they didn’t do anything super-restrictive heading into the Party Congress, because that’s the time when they want to emphasize sunshine and rainbows, but now that Xi is essentially set as “beloved ruler for life” if he so chooses, they could start to poke some holes in the debt-fueled excess. That would be good for the economy in the long run, I expect, but bad for the global markets in the near term — you can sometimes see a pretty good reflection of those shifting sentiments about “what’s China gonna do next?” in the copper price, and thats been pretty bouncy of late but I have absolutely no idea which direction it will turn.

As I wrote this week, Marin Katusa’s betting big on copper — I haven’t been tempted to go big into any primary copper producers yet personally, but I do note that the counter-cyclical investors in my portfolio have also gone into copper over the past couple years in anticipation of this recovery… primarily Altius Minerals (ALS.TO, ATUSF), which now gets more royalty revenue from copper than from any other commodity.

Altius made its largest copper royalty deal, with Yamana’s large, low cost and well-established Chapada Mine, back in March of 2016 when copper prices were around $2 a pound… when the deal was signed for roughly C$60 million, it made sense given the projected C$8-9 million in EBITDA that Altius expected from the mine for at least 17 years (and likely 30+, given the mine’s continuing expansion potential). As of the last quarter, with prices only averaging $2.70 or so, that was already up to what would be an annualized royalty of something like C$14 million.

So a year and a half in, we already see the benefits of being a counter-cyclical investor — commit money to projects when they are not popular, and reap the rewards for perhaps decades if the cycle turns (as they almost always have, at least over the past 15 years or so). That certainly doesn’t always work — the Alberta coal royalties Altius bought, for example, experienced a big writedown because those mines won’t produce for as long as anticipated thanks to new regulatory restrictions (though that royalty acquisition will likely still pay for itself eventually, particularly because of the 100+ year mine life of some of the included potash royalties, the regulatory crackdown means Altius significantly overpaid). That’s a risk I’m willing to take with these folks, which is why I keep adding small bits to my Altius position every now and then, and why I like it as my portfolio’s lower-risk exposure to base metals and other less glamorous commodities — copper, potash, iron ore, and whatever else they find with their prospect generation businesses. If China’s industrialization surges and copper and iron ore recover, Altius will be a huge beneficiary over a long period of time… if not, they won’t go out of business (but they might well trail the market, as they’ve done for several years running).

Will a bear market sneak up on us as we head into the end of the year? I’m not crazy enough to try to predict when the good times will stop rolling… but generally, when we’re going into the final six weeks of the year, the sensible investor lets that seasonally strong period work for him. Look for some tax losses you might want to take, look for any possible bargains that might appear because other people are taking tax losses and selling indiscriminately, but let that November and December optimism and that tendency to have a “Santa Claus rally” and a big influx of new cash into the market in January work for you.

So I keep telling myself, “don’t sell just to sell” … even though I’m feeling (as you probably are) that the market is too richly valued and is a little “stretched.” Try to hold on to things even if it’s a little scary — we all know things seem expensive, but they’ve seemed expensive for several years… and this is certainly not an egregious and unsustainable or unjustifiable bubble like we saw with tech stocks in 2000… if the averages work out at all, odds are that you’ll do better if you wait for things to fall apart a little bit before you get aggressive about protecting yourself.

That’s not to say that you should go “all in” and buy with both fists here — I have no idea what you should do, I don’t know whether you need more money to help your kids pay for college in a couple years, or if you’ve been retired for 20 years and need to be more conservative, or whether you’re living large in your 30s and seeing your salary go up 20% a year and delight in taking risks. For me, a getting-dang-close-to-50 guy with kids and a family and plenty of earning years left in my quiver (I hope), I’m staying almost fully invested… and have levered up on some growth names, particularly with options to limit my capital exposure, but am also keeping that 6-7% or so cash cushion because I keep hoping to see some bargains come my way if the market takes that 20% hit that seems so long overdue.

It is important to try to plan and visualize what you will do if the market behaves completely opposite of your expectation, and to have a strategy for buying in a downturn (like a “wish list”) or selling at stop loss trigger points for some of your holdings… as I try to repeat every chance I get, beware the cool comfort of certainty.

If you feel certain that the market is going to fall by 50% next month, then sure, speculate on that a little with your gambling money… but you’re almost certainly going to be wrong. If you feel certain that Bitcoin will go to $100,000, sure, bet on it with the money you don’t tell your spouse about and cross your fingers… but you’ll probably be wrong, so don’t bet your retirement or your mortgage unless you love living on the edge and taking risks.

The world has been set up now to reflect only our own desires and fears back to us. It is ever more easy, despite the open and exciting world of free and instant communication, to go through life without truly seeing a perspective that’s opposed to yours… and even though most of us consider ourselves to be wise and open-minded (and above average in all other ways, of course), if we see only things we agree with (thanks, Facebook and balkanized politics!), then it is frighteningly easy to slowly and quietly become certain about things that aren’t really true (or rational, or supported by evidence).

That goes for politics, most obviously, but it goes for investing, too — if your eye gravitates only to the stories about financial and social collapse and to the predictions about a new gold standard, then you’ll keep getting more and more of those stories, and they’ll squeeze out other stories, and after a while the conspiracists and panic peddlers will seem like the normal ones, and it will make sense to you to sell your house and cash in your 401(k) and buy gold coins and go live on a farm in Iowa even though you love your home and your job and your neighbors in Queens.

Echo chambers make us all more foolish — so if you’re tempted to sell everything and buy gold coins and hide in the basement, go out of your way to read some articles about amazing growth companies and strong emerging consumer economies… and if you think Amazon’s going to $5,000 a share and you can’t go wrong by levering up on all the hot new tech and biotech names that catch your eye, spend a few minutes listening to the gold coin crowd. Just about everyone is right every once in a while, it behooves us all to be open to the idea that our basic perception of the likely trend for the world and the economy is wrong.

Disclosure: I do still own Altius Minerals, and, in fact, bought a bit more this morning following the recent dip. I also own shares of Amazon. I won’t trade in any covered stock for three days after publication (or re-publication, in this case), per Stock Gumshoe’s trading rules.