It should also be noted that you can get crushed by the S&P 500 Index return as well. It is basically an article of faith in the personal finance community that one ought to invest in index funds, perhaps particularly the S&P 500 index fund. There are a couple advantages to doing so. It’s easy. It’s cheap. You get the average result.
Most of my money is in index funds. That’s the case because most of my money is in a 401k type plan. Index funds are the only reasonable choice that I have from my plan sponsor. This is a good thing, I suggest you keep most of your money in an index fund. For example, here is the S&P 500 index return over the last 100 or so years
What the S&P 500 is
The S&P 500 is a collection of the 500 large companies selected by the S&P 500 committee to be representative of the US stock market. The major requirement is that the market capitalization (this is the combined value of all the shares of a company at the market price) is greater than $5.3 billion. The stocks in the index are then weighted by their market capitalization. This is convenient for index funds because they don’t have to buy or sell a little bit of a stock just because its price changes.
What the S&P 500 misses
In my view the S&P 500 leaves out two major types of company. Foreign companies (though 27 are currently included in the index), as well as small companies (in this case we’ll consider sub-billion dollar market caps to be small).
Large foreign companies can generally be invested in by choosing an international index fund like the Vanguard Total International Stock Index Fund.
To get exposure to smaller companies you could buy a small-cap index fund. You might want to do this because small capitalization stocks on average return more than larger capitalization stocks (about 3% more since 1930). Over long timescales that extra 3% really adds up. Think of it this way, if you expect to earn $700 after inflation from investing $10,000 in the S&P 500, you expect to earn $1000 from small cap stocks. Obviously returns are not that smooth, but that extra 3% is a very hefty amount.
The Problem With Small Cap Index Funds
My biggest gripe with small cap index funds is that they are still huge! The median market cap in the Vanguard small-cap index fund is $3.3 billion. There’s a lot of room below that. The problem is, if you get much smaller it’s very hard for an index fund to build a position. The bid-ask spread on tiny stocks can be very large, some days tiny stocks don’t even trade. If you manage an index fund and you have mandate to buy all of the stocks, how do you deal with this?
Often, you just don’t. You either hit the ask on these stocks and pay a huge spread, or simply do not invest in stocks with low liquidity. These frictional costs aren’t included in the expense ratio of the fund. These costs can be as much as 1% annually. Additionally, forced selling from these funds during market panics can push down the prices of illiquid stocks substantially.
How to beat these index funds
My investment philosophy is stems from a few simple ideas.
- The market is mostly efficient. Therefore most of the time buy and forgetting index funds is a great way to go.
- This efficiency comes from highly informed, highly skilled professionals who work against each other in the markets resulting in prices that very closely reflect true value.
- Areas of the market where highly informed, highly skilled professionals do not exist, or are severely constrained probably have significant mispricings.
- It is possible for an amateur to spend enough time and do enough research to identify these mispricings and exploit them for profit.
So I seek to invest in areas where professionals cannot or will not go. The most obvious area is nano-cap and micro-cap stocks. A mutual fund manager, no matter how intelligent generally just can’t invest in a company with a two million dollar market cap. If they manage $100,000,000, why are they going to spend years trying to build up a $100,000 position in a tiny illiquid company? The answer is that they simply will not attempt it.
This also means that they don’t bother trying to calculate the fair value of that company, and many companies like this can languish in obscurity for years with market prices far below fair value.
What if you’re wrong?
Now, to be fair, it could be that the market for nano-cap and micro-cap stocks is efficient. Maybe I can’t exploit mispricings for profit because maybe there are no mispricings. That could be true, but I would still argue that my practice of buying tiny stocks and sitting on them would still be a good strategy. There are a couple reasons for this:
- The small cap premium. Smaller capitalization companies are more risky, and therefore return more. As we saw earlier, this is about 3%. I would expect it to be higher for even smaller companies, if I’m wrong and the market is efficient. If two assets returned the same, but had different levels of risk, why would anyone invest in the riskier asset?
- Illiquidity premium. If your money is illiquid your investment is less useful to you. If two assets returned the same, but one was very liquid and the other you required you to sit with a limit order for 6 months to get your money out, why would you invest in the illiquid asset? Therefore, if the market is effecient there is some premium for investing in illiquid assets.
Heads I win, tails I win. I love situations were I can be totally incorrect and still win. Now, obviously investing in very small and illiquid companies comes with risk. It is totally inappropriate if you expect to need the money you’re investing at some point in the next 20 or 30 years. But if you’re investing for the long, long run I expect that analyzing tiny companies, buying good ones, and waiting until you’re very old will be more profitable than investing in the S&P 500.
I have no positions in any index funds mentioned. I wrote this article myself, and it expresses my own opinions. This is not a investment recommendation. I am not receiving compensation for it (other than from the owner of the blog District Media Corp). I have no business relationship with any company whose stock is mentioned in this article. Always do your own research before making any trade, buying or selling any stock mentioned.
Here’s the second part of the Sitestar story as promised. For those of you who missed it, here is part 1. Since our story left off a great deal has happened. First off, a group of shareholders sent a demand letter to the company. The demand letter basically says that the company needs to provide this shareholder group access to the books as well as the shareholder record. This was the warning shot in a fight that would eventually topple the CEO.
The Shareholder Group
The shareholder group at the beginning of this episode is comprised of an independent director on Sitestar’s board, Jeffery Moore, and two hedge funds, Arquitos Capital Partners, run by Steven Kiel, and the Aleisa Value Fund, run by Jeremy Gold and Christopher Olin.
The company at this time (2014) was run by Frank Erhartic, and the CFO is Daniel Judd. Frank Erhartic started essentially another dial-up company called “Lynchburg.net”, it was acquired by Sitestar back in 2000. He evidently worked his way up and became CEO in 2002. The company has largely been winding down since then. Interestingly, the salary that Mr. Erhartic was taking between 2010 and 2014 was actually quite small, less than $50,000 per year. Considering that at the time Mr. Erhartic was really running the whole show at the company, this actually seems like a relatively small salary. This wasn’t the only money that Mr. Erhartic made from the company however, there were many related party transactions over the years, and there is some question as to whether Erhartic used these to extract money from the company. That question is central to the drama that unfolded over then next two years.
Related Party Transactions
A related party transaction is basically when the company has a transaction with someone who has decision making power or the implication of decision making power related to the transaction within the company. For example, if the company rents office space from a major shareholder. In this case, Erhartic loaned the company a relatively small amount of money (about 50,000) at a 10% interest rate.
Formation of the shareholder group
As far as I can tell Mr. Moore (a board member of sitestar) became concerned when board meetings were not held, and his name was signed to SEC filings that he hadn’t seen. These SEC filings had all kinds of errors, for example adding 20-30 years to Mr. Moore’s age. Furthermore, Moore was concerned with the lack of progress in the company’s real-estate portfolio. Shut out of board meetings, he formed a shareholder group with two value funds hoping the agitate the company to be more transparent, and improve returns.
A proxy battle?
At this point the shareholder group initiates a proxy battle in order to force management to start holding an annual meeting, turn over the books, and improve operations. A proxy battle reminds me of an old fashioned circa 1800’s US election. Two groups (parties) are trying to get a hold of the company (country) so they print their own ballots (yeah, that was totally a thing) and mail them to shareholders (hand them out to voters), along with advertising material explaining why their group is really the best for the company (country). This is serious business for management, as often proxy-battles can result in management losing their jobs. A problem with small companies is that this process can often take long enough that management can sometimes drain the money from the company before the outside shareholders can obtain control. Often the threat of a proxy battle can convince management to accommodate the outside shareholder, assuming that the shareholder isn’t simply out to get rid of management.
Fortunately for both sides, management and the shareholders were able to come to an agreement, the shareholder group withdrew its proxy. Basically the deal was that Sitestar increase the number of people on the board from 3 to 6 and that 3 members should come from the shareholder group and 3 members were appointed by management. In the event of a deadlocked board the president (Erhartic) was allowed the tie-breaking vote. This allowed management to retain control of the company, barely. In addition the shareholder group got basically everything it wanted, regular board meetings, reimbursement for its proxy battle, and an agreement to more closely look at the way the real-estate was being handled. If you’re interested you can read about the settlement in detail here.
As a quick aside, the reason board seats are important is because the board members are the representatives of the shareholders (always remember, the shareholders are the people that own the place, it is for their benefit that the company exists). The board basically acts as the boss of the CEO, and it is they that the CEO ultimately needs to answer to.
A Blogger and An Audit
On December 3rd 2015 a blogger, Inelegant Investor, posted information about the $50,000 loan from a related-party transaction. He was told that CEO Erhartic’s mother, had loaned the company $50,000 at a 10% interest rate. This seemed odd because the company didn’t seem to have any need for the money at that time, and On the same day, apparently Sitestar’s board was informed by Sitestar’s auditor that there were several related-party transactions for which the auditor had requested more documentation. Evidently the auditor did not receive this documentation.
At this point Erhartic, who masterminded the strategy for Sitestar’s transition to real-estate, resigned from the board, and then was summarily fired by a majority of the board. At this point the shareholder group of Moore, Kiel, Gold, and Olin had effectively taken over the company. Moore replaced Erhartic as chairman of the board and Kiel ended up replacing Erhartic as CEO of the company. The company investigated Erhartic’s transactions and later sent a demand letter for restitution based on the results of that investigation.
Looking Toward the Future
Sitestar’s future at this point is a little uncertain. There haven’t been any financials released since the change of control, and the financials are quite late at this point. That could mean any number of things. Many reasonable investors do not invest in any company with late financials, figuring that no one waits to release good news. Also, the company has issued a statement of non-reliance on previous financials. These related party transactions apparently cost the company money in ways that weren’t captured in previous financials. Quite frankly it is hypothetically possible that the amount of money the company has is substantially less that they previously claimed. Personally, I think its reasonable that they haven’t released financials yet, and I think when financials are released the news will be basically neutral, so I don’t worry very much about this.
Another important thing to keep in mind is that Erhartic was simply not charging very much for his services, $50,000 per year isn’t very much for a CEO. The book value of Sitestar is roughly 5 million dollars based on previous financials (which the company has stated cannot be relied upon). If Sitestar can earn a 10% return on equity (a dubious prospect), then we’re looking at a company earning $500,000 per year. If the CEO’s salary goes from $50,000 to $150,000 (the median CEO pay), that would represent a very significant portion of sitestar’s earnings. If the board members start to get even token compensation for their work (which would probably be reasonable) it would eat even further into the profit available to shareholders.
There are two updates that one should be aware of as well. First, I mentioned in the previous article that there was roughly a million dollar liability on the books that the company contended that it would not have to pay. This has been settled for about $90,000, so at the very least we should see that go away on the next set of financials. Second, the company has formed an HVAC investment company and seeded it with $1,000,000. This is a good news, bad news.
The good news is that the company had a million dollars, Frank Erhartic didn’t run off with all of the cash. I’m not terribly surprised as he never really struck me as the sort of person who would. The improprieties going on here look a lot more to me like someone being lazy about documentation, and trying to avoid some payroll tax, (essentially compensating himself with company expenses, like rent/loans, rather than through salary, when he could have just had a larger salary) rather than any sort of serious thievery.
The bad news is, what does Steven Kiel know about running HVAC companies? Presumably whatever HVAC company they acquired would come with its own management team, but I don’t really get the point here. I still have limit orders open in the 4.x cent range and I wouldn’t be surprised if they get filled at some point in the next month. I do check on the company regularly however as any bit of news could certainly mean a big move for the stock in either direction. I’d hate to fill my limit order because terrible news came out the night before and the company traded down to a penny.
Disclaimer: I have no positions in any stocks mentioned, but may initiate a long position in SYTE over the next 72 hours. I have open limit orders between 4 and 5 cents per share. I wrote this article myself, and it expresses my own opinions. This is not a recommendation to buy or sell any stock. I am not receiving compensation for it (other than from the owner of the blog District Media Corp). I have no business relationship with any company whose stock is mentioned in this article. Always do your own research before making any trade, buying or selling any stock mentioned.
Outside of index funds in my 401k I do most of my investing in small microcaps. I’d like to profile one of them today. It’s got a little bit of an interesting story to it, and might be one of the strangest stocks I’ve seen. So strap in.
A word of warning
This stock is traded over-the-counter. It trades for a few cents. It is extremely illiquid. Your BS alarms should be running really loudly right now. This is exactly the type of stock people would use in a pump and dump scam. It is missing one important component for a pump and dump scam however, it just isn’t exciting.
What does Sitestar (OTCBB: SYTE) do?
Welcome to the exciting and fast-paced business that is dial-up internet. You might be like me and be somewhat surprised that anyone still uses dial-up internet. Some of you might be too young to know what dial up internet is.
Basically the idea is that you have a phone for your home, called a land-line. It’s one line for the whole family, though often there are a few phone in the house that connect to this one line. The idea of dial up internet is that you can use this land-line to send data instead of your voice. Unfortunately, because of the way this works only one computer in the house can connect to the internet at a time. Also, if someone is connected to the internet no one can use the phone.
So turns out people actually still pay for this, $10 to $20 per month in fact. At this point Sitestar isn’t expanding their dial up service. They just collect a toll on their existing network.
So why do we care? This is a dial-up company. Might as well invest in a buggy-whip business. Obviously the dial-up portion of the business will eventually be with zero. Why would you invest in a company that’s gonna be worth zero?
Well there is only one reason you invest in a company that’s going to be worth zero, you think that you will get more money out of the company than you paid for it, before it goes to zero. An example of this might be Outerwall (OUTR), they are the owners of Redbox (the dvd rental kiosks). Obviously in 2025 (maybe earlier!) Redbox will be worth zero. Investors are now betting that they will get more in dividends from Outerwall than they paid for the stock before it is worth zero.
Well, Sitestar has never paid a dividend. That’s odd considering that between 2008 and 2014 they took in about 9 million in cash while spending only about 2 million reinvesting in the dial up business.
So where did the rest of the money go?
Well, about a million went to repurchasing shares, reducing the total number of shares outstanding from 91 million to 74 million. Another 3 million went to paying off the debt and other liabilities sitestar had. The last 3 million went to buying real estate.
Real estate, you ask? Yes! During the great recession the CEO Frank Erhartic went on a buying spree, snapping up residential properties that had become substantially discounted due to the bursting of the housing bubble.
So what’s it worth?
Well, the company has about 3.7 million in real estate, and virtually no liabilities to speak of. (Well, there is about a million dollar debt the company has to a former employee that the company contends is not actually owed. It should be eliminated from the books at some point in the future.) That real-estate is held at cost. I figure the company has to be worth at least that much. So, what’s a single share worth? Well, 3.7 million divided by 74 million shares outstanding works out to be 5 cents per share. Sitestar last traded at 5.86 cents per share. (Don’t get that confused with $5.86.) Since January Sitestar has traded between 5 cents per share and 6 cents per share. Sitestar still makes some money from its dial-up operations and these are probably worth another hay-penny to penny per share (I’m just so excited I finally got to use hay-penny in a sentence.) I am a buyer between 4.5 cents and 5 cents.
It’s important to understand that Sitestar is extremely illiquid. What does it mean when a stock is illiquid? In this case, it means most days $SYTE doesn’t trade. It means, that if you put in a market order for Sitestar it might not get filled, or worse it might get filled at a ridiculous price.
Well, up until recently I thought, basically Sitestar was going to be somewhat more than the carrying value of the real-estate and if you wanted exposure to some real estate on the east coast, this seemed like a cheap way of getting it. Naturally, the situation has changed a bunch in the last year or so and tomorrow we’ll go over what these changes are and what difference they make to the stock.
I have no positions in any stocks mentioned, but may initiate a long position in SYTE over the next 72 hours. I have open limit orders between 4 and 5 cents per share. I wrote this article myself, and it expresses my own opinions. This is not a investment recommendation. I am not receiving compensation for it (other than from the owner of the blog District Media Corp). I have no business relationship with any company whose stock is mentioned in this article. Always do your own research before making any trade, buying or selling any stock mentioned.
Every time I have a discussion with someone about an upcoming trip to Europe they ask whether it is better to buy their Euros in advance or to wait. Fortunately this is a question with a very simple answer.
I have no idea.
Neither do you.
Neither does your brother-in-law, or your hairdresser’s friend. Except in some rare situation where you’re friends with a Swiss central banker and he tells you in advance that he is going to surprise the markets with a new policy, you have no idea.
This Isn’t Useless
Turns out that knowing you have no idea and that no one else does either turns out to be a great opportunity. Just because you are ignorant doesn’t mean you can’t create a good strategy.
This strategy is two pronged, minimize fees and reduce volatility!
This is simple. Don’t bring a credit card that charges foreign transaction fees. There are plenty of choices here. Discover, certain American Express cards like the Starwoods Rewards Card, basically all of the Visa cards with the word “travel” in their name, and same for Mastercards.
It is important to bring a few cards. Frankly, I’d bring one of each. Sometimes american credit cards fail for funny reasons.
For cash, never pay at some sort of cash exchange place. Also, probably don’t exchange cash at your bank window. Some banks will allow you to place an order for Euros online, you’ll get a better rate this way.
The absolute best deal I’ve found is to get a high-interest checking account, they will often reimburse your ATM fees.
What you don’t want to do is exchange a big chunk of money at once. Currency markets are sometimes volatile. This means that you could end up paying either a few percent more than average or a few percent less than average if you exchange all of your money at once. This could be worse than any fee you’d pay. Might as well get the average result instead.
In order to get the average result, I suggest paying as you go. If you have to make any especially large cash purchases you might want to get the total sum in pieces (if your fees are zero). If you pay a flat fee for each withdrawal, for example if you don’t get your ATM fees reimbursed, then you’ll want to minimize the total amount of fees you pay and try to get as much as possible with each withdrawal.
Don’t Get Fooled
There are any number of people out there who are willing to tell you that they know what the currency markets are going to do. They’re selling. If someone tells you that Euros will definitely go up in the summer or definitely go down the question you need to ask them is, “What percentage of your net worth are you currently betting on that?”
The bare minimum you can check is that anyone who claims to know what’s happening in currency markets at least has skin in the game. If they’re asking you to risk your money that they might be right, make sure they’re actually risking a much larger percentage of theirs as well.
That all being said, if you can predict the future prices of currencies reliably in a way that people could take advantage of, then you’re probably in the wrong industry. That sort of ability is worth way more money than saving a few hundred dollars in exchange fees.
In fact that’s exactly the way to explain all of this.
Maybe it is possible to predict future foreign exchange values, but you’d have to have a skill worth hundreds of millions of dollars, and if you have that skill, why the heck are you worrying about any of this?
Well, I suppose that might be a little strong, but it’s the idea behind their new “Stock Up” plan. Personally I use Google’s Project Fi service, but this idea is strange enough that I couldn’t let it pass without comment.
Basically if you refer a friend to t-mobile you and the friend get a share of t-mobile stock once they start service. Additionally, if you switch to What’s that worth? Well, it currently trades at $43 per share, so by the metric of refer a friend promotions, this isn’t crazy good. The interesting part, in my view, is that it aligns the interests of the customers of T-Mobile with the owners of T-Mobile.
What is T-Mobile’s Stock worth?
Well, that’s a good question. Generally when people own telecom stocks like AT&T or Verizon they own them in order to enjoy the dividend the stocks pay. A dividend is a share of the profits that the company pays to the owners (shareholders) of the company. T-Mobile doesn’t pay a dividend. The company has decided to retain earnings in order to continue to expand. They do this so that in the future they will be able to pay more money to their owners than they would if they paid out that money today. This makes the company kind of an odd-duck in the telecom world, and might make it hard for people who ordinarily buy telecom stock to decide, what is this thing worth?
The Efficient Market Hypothesis basically states that the company is worth whatever the last trade was, so roughly $43. There is, however, another method of determining what a stock is worth. This might be called the value investing approach.
In the value investing approach you start by trying to determine the worth of a business to a private buyer. Imagine if you were to own all of T-Mobile. It earned $733 million last year. It also has grown from $24 billion in sales to $32 billion in the last two years. What is that company worth to you? (If this is a hard question, don’t worry there is a method for figuring out the answer.) Suppose for a moment that we have an answer. Suppose that the answer was $80 billion dollars.
So how does this tell us what a share of T-Mobile stock is worth? Well, the company is owned entirely by the shareholders. If you add up the value of all of their shares you should get that $80 billion number. This means that all we have to do to determine the worth of a single share is to divide $80 billion by the number of shares outstanding. You can look up the number of shares outstanding (822 million), as well as other important and useful information about the company on a finance portal. Personally, I’m partial to finance.yahoo.com. Long story short this gives us a value of about $96 per share. Well, if that were the case this t-mobile promotion would look a lot more interesting.
Is that the case?
No. The $80 billion figure I used was a random guess. In order to determine what the value of the company ought to be, you really need to determine what all the money it will ever make is worth today. If that sounds hard, that’s because it is. Generally the way people try to determine it is to simply look at how much money the company made in the past, and then try to determine if those past profits are stable and will continue into the future. Can we do that with T-Mobile?
How much does T-Mobile make?
If you average over the last three years, T-Mobile has made roughly 1 billion dollars. The trouble with telecoms is that they require huge capital investments to keep the company going and customers happy. This can sometimes mean that the official income numbers don’t really reflect reality. A telecom could have a huge income, but if it has aging equipment it might end up spending even more doing replacement and maintenance. This can also mean that income will be suppressed in the near future as depreciation charges will be larger.
T-Mobile looks okay on this count. For the past 3 years they’ve spent about as much on capital expenditures as they’ve taken in depreciation charges. This generally means that they’re treading water on the investment front.
If T-Mobile can continue to grow sales at the rate it has been over the last few years (big if), I estimate that the next 3 years will make T-Mobile about $7.5 billion (1.5 in the first, 2.5 in the second, and 3.5 in the third). From there on I assume that T-Mobile will stop growing and continue to make about $3.5 billion per year. Now all we need to do is add up those future earnings to get the present value of T-Mobile.
Unfortunately we can’t just add the numbers up, because $2.5 billion dollars is worth more to you today than it is 100 years from now (even without counting inflation). This is because you could invest the money if you got it today and then end up with more money 100 years from now. This means that future payments need to be discounted by an interest rate to determine their present value. This rate is called the discount rate.
You’ll notice that I can get just about any answer I like for the value of T-Mobile by adjusting the discount rate. I’m going to use a discount rate of 8%. There is a formula for doing this, but with some mathematical trickery we can reduce the problem to 1.5 / 1.08 + 2.5 / 1.08^2 + 3.5 / 1.08^3 + 43.75 / 1.08^4. This works out to a present value of T-mobile equal to $38.5 billion dollars. We then divide that by the number of shares outstanding (still 822 million), and figure that the value of a share of T-Mobile stock is $46.
Basically that means if everything continues to go right for T-Mobile the stock is worth, about what its worth right now. To me that indicates that there’s a bunch of risk in T-Mobile, I wouldn’t buy their stock.
Since we’re getting the stock free from their Stock Up plan, I probably wouldn’t worry about it. I’d just sit on the share, or shares, figuring that it’s a very small portion of my net worth, and I should be invested in the companies that I spend money on.
Nuts and Bolts
In order for you to actually claim your share of T-Mobile stock you’ll need to sign up with the Loyal3 brokerage. Here’s our review of Loyal3.
Looks like the UK has voted to leave the European Union. Financial markets are reacting horribly to the news, with Europe down 8%, UK down 9%. So what’s a Brexit? Why are financial markets reacting so bad? Is it time to panic? Why don’t we knock these questions down one at a time, then my favorite security for riding out the situation.
Explain Like I’m 5, Brexit
So Britain has never quite been of one mind about the European Union. For one they’ve always refused to participate in the Euro. The sticking point seems to be anti-immigration sentiment. EU rules mean that there is free movement of people throughout the EU. So, anyone from anywhere in Europe could go and live in the European Union. In the United States, we’ve had this for centuries. If you’re born in a poor state like Mississippi you can move into a wealthy state like California, no one worries about it. To get an idea of the sentiment in Britain, maybe it’d be easier to imagine if NAFTA had a legislature rather than just being a trade agreement.
Further imagine that this legislature had decided that there should be free movement of people as well as goods in North America, so that someone from central america could move to Oregon with no visa or other documentation. Basically all current illegal immigration in the US would be legal, and there would probably be more. While I think that would be a good thing, you can understand how there would be a great deal of opposition and calls to leave NAFTA.
When thought of that way it’s actually quite amazing that the vote to leave the European Union was as close as it was, 52% in favor of leaving versus 48% in favor of staying in the EU. This brings us to our next question…
Why markets are crashing
While free trade and immigration remain unpopular with populists the fact of the matter is that they are great for the economy. Iregui in 2005 <link> found that the cost of immigration restrictions to world GDP as somewhere between $11.5 trillion and $158 trillion (in 1990 dollars). Yes, that’s a huge range, but no study I’m aware of has found that free immigration wouldn’t be a massive economic benefit to the world. The reason for this is obvious. If Einstein is born, but gets stuck in Kenya the whole world suffers. Further, as we move more toward a knowledge economy the variance of productivity from any one person has increased substantially. When all anyone does is farm, it really doesn’t matter where you’re born, you still produce about the same amount. But when some people are capable of building companies worth hundreds of billions of dollars, the world misses out on vast wealth by locking them out of, say Silicon Valley, for example.
So, in my view, the markets see future restrictions in freedom of movement as bad. Further, I think there is some expectation of a trade war between the UK and the EU. Trade wars are bad for the same reason immigration restrictions are bad, and can have similar costs.
Even so normally, the market doesn’t react this badly to crappy news, I can’t think of the last time I’ve seen the UK’s stock market (the FTSE) sell off 9%! This is probably because the market wasn’t expecting the British to vote to leave the European Union. Normally, votes like this the market has time to build in the drop over months as it becomes more obvious that the British will stay, or leave, or whatever. This time the market got it wrong, betting markets said that the UK would probably stay in the European Union. It seems that bad weather in pro-stay areas might have been a significant factor. The market, unfortunately, doesn’t have a preternatural ability to predict the weather, and so it got blindsided. The result is that all of the downside of the UK leaving the EU has to get baked into stock prices at once.
If you have money in the European stock exchanges, as I do, you might be wondering, is it time to panic? In a word, no. In financial markets panic is never the correct solution. Any time you let your emotions get control of your decision making in your finances you might as well set money on fire. I keep a shoebox of dollar bills to burn so that I can achieve catharsis without making more expensive decisions.
In fact, I suggest that you instead just assume that you can’t sell any financial instrument you buy. At some point I’m going to have to go back through my brokerage statements and figure out if I’d be better off if I never sold any of the stocks that I ended up selling. I’m pretty sure I’d be better off.
My favorite panic security
When the rest of the world panics, I want to sell them safety. I should note at the beginning here, selling safety is very risky! I have 0.2% of my investable assets in it. Today I will probably lose half of what I have invested in it. If that doesn’t sound like the stock for you, don’t touch it with a ten foot pole.
The “stock” is the exchange traded fund XIV. The VIX is the so-called fear index. It measures volatility in the market. As of this writing the VIX is up about 36%. Some people like to use it as a hedge by buying funds that track the VIX, so that when volatility goes up and they lose money in other parts of their portfolio the VIX going up makes up for it. In order to get this protection owners of these funds expect to lose money on average over time. Essentially, by buying XIV we accept the risk that owners of VIX that are trying to get rid of, in exchange for the expectation of making money over time. That risk means that XIV crashes by 75% occasionally. On average you outperform the S&P 500.
Maybe you’ve seen a nice graph of risk versus returns. Cash is low risk low return, short term bonds are more risk and more return, long term bonds give more risk and more returns, then all the way on the riskiest end you have something like small-cap stocks giving the most risk and the most return. XIV is the dire half-dragon version of this. You’d have to be crazy to think you could successfully trade this, I simply keep it under 0.5% of my portfolio by selling when it’s above that, and I buy more when it gets below 0.15% of my portfolio.
What’s the conclusion here? I think Britain made a mistake, but there is a silver lining. Stocks are on sale, and I’m loading up.