How past setbacks equip you for success in this market downturn

Friday, 24 June 2022 — Burradoo, Australia

[7 min read]

Dear Reader,

We are clearly on track to enter a global bear market, coupled with a potentially withering recession amidst high inflation.

In short, it looks like the financial system is quite screwed — as well as many businesses and households.

I could have sugar-coated it. But let’s call a spade a spade.

Why is that?

Because recognising that there’s a problem will allow you to get in the right mindset and come up with the right solutions.

Now, I’m not here to revel in doom and gloom. Rather, I want to help steer your mindset so you can increase your chances of winning and avoid making the wrong decisions that many certainly will because emotions get the better of them.

I’m pretty sure you’ve heard from family and friends about how they have lost a lot in their investment portfolio — stocks, derivatives, and cryptos. And some of them are probably lamenting that they didn’t sell when they were ahead.

Those who had made much larger gains on paper, especially with cryptos, are likely to be more inconsolable. My bet is that a good number of these people cut their teeth for the first time in 2018, after that massive crash in Bitcoin [BTC] that brought it down from US$20,000 to around US$3,500.

This is what I want to talk about today.

Market downturns make the best teachers and offer a suitable training ground for successful investors.

Big successes don’t come without setbacks. This is because asset prices can run wild and oftentimes the biggest returns don’t come without prices crashing down to ridiculous levels.

The exception is when you’re dealing with a start-up investment that blazes the trail in its field and hence becomes a unicorn. That is rare, like scoring a hole in one.

So how do you set yourself up to succeed as the markets come crashing down right now?

Understand the drivers of value

In the current markets, everyone is scared of being the last one out. Many sell down without considering the company’s value. In such cases, you could end up buying at a bargain price.

But how do you tell what’s a bargain? You need to know what the company’s value is.

Value comes from the company’s assets — cash, inventory, property/plant/equipment, land, and various projects that are expected to deliver future revenue.

Past profits may give you some indicators of how efficiently the business runs. Economic conditions could change and cause the future profits to vary. Therefore, you may need to look at what are the key economic drivers that affects the way they do business.

While market downturns invariably mean that companies see their business volume and profitability decrease, a well-run company may end up gaining market share as its competitors crumble under the pressure.

And it may be the usual suspects that manage to get ahead in their industry.

Exercising resilience by refusing to join the herd in a panic

The well-known saying that ‘a loss is only on paper until you actually sell’ has stood the test of time.

I know that there are many instances of people losing their shirt by wrongly applying this statement. And this goes back to what I said above. It only applies when you know the key drivers of value and stick with companies that pass the test.

Holding onto a company as its price plummets well below what you paid for is painful. It makes you second-guess yourself as to whether you have made a bad purchase.

In a market downturn when everything is falling, it may not mean you own a bad company. It’s just that people are dumping. You should only start worrying if the company announces some bad news that may affect the company’s longer-term prospects. Otherwise, it may be a great opportunity to accumulate a quality company at a discount to your initial purchases.

Some of your best buys are made when everyone is dumping because the recovery hands you even better returns.

Stacking the odds to your favour now!

It’s important in such markets to focus on what you’re good at and build up your holdings.

Many financial pundits will talk about diversification, but I think this is where you shouldn’t follow their advice.

Remember that in a market crash, everything comes down. This means there are lots of gems selling as if they’re lumps of coal. You should be able to focus your portfolio on these and accumulate.

For me, I prefer gold stocks. It’s done me well for the last decade. This would be the third gold stock bull market for me when it comes around.

And why gold stocks?

They’ve been falling longer than the rest of the market. You can have a look at the ASX Gold Index [ASX:XGD] since 2019 in the figure below:

Australian gold stocks have experienced no less than four false rallies since 2021. It’s been disappointing, but I believe that those who held on are more emotionally resilient to handle the coming months than those who invest in other assets.

Unbeknownst to the market, gold stocks are setting up for seriously good returns in the future when the conditions are right. I’ve tracked the relative price of gold in Australian dollars against the ASX Gold Index. Here’s a figure showing the ratio between the two since January 2013, just before that withering gold bear market that led to a massive bull market in 2015–16:

Since September 2020, you can see that gold has been retaining its value better than gold stocks, which is why the ratio is rising. Gold stocks did make a few recoveries but were beaten down and are now trading at increasingly depressed levels. Here’s the relative performance of the ASX Gold Index and four of the largest gold producers since the start of 2021:

As you can see, even the biggest companies are trading 20–50% lower than 18 months ago.

Will gold stocks retreat even more relative to gold such that it is at levels we saw in 2013–14?

I hope not. But if so, that would be a wonderful setup for once-in-a-lifetime gains.

Seizing the golden opportunity

Right now, I see that the central banks are aggressively raising rates and trying to bring down inflation, and the entire financial system.

However, the world is now watching them. There’s no global pandemic nor a war to blame it on something else.

The wizards behind the curtain that is the World Economic Forum, and the central banks are now seen for what they are. It appears they’re behind the geopolitical tension, the push to shift the world to clean energy before the infrastructure is ready, and the corporate wokeism that is dividing the Western world.

They want you to ‘own nothing and be happy’.

They do that by buying low and selling high.

I plan to do the same. The difference is that they can pull the levers to move the markets.

Regardless, I am positioning myself to succeed. Join me on this journey here.

Those who like to trade frequently may also want to augment their successes with our latest offer here.

God bless,

Brian Chu,
Editor, The Daily Reckoning Australia

Dear Reader,

It was the longest day of the year. The sun rose here at 5:11am. It set at 9:55pm. It was a glorious, stretched-out midsummer day…the solstice…with flowers in bloom…birds singing in the trees…and a warm breeze off the Atlantic brought the temperature here up to a delightful 68 degrees.

In the morning, before US markets opened, we drove a friend back to the airport in Shannon, admiring the hills, valleys, and towns along the way. We were cutting through Tipperary, with its lush fields, fat cows, and antique stones.

‘They’re trying to get Irish farmers to stop raising beef’, says a neighbour.

‘The idea is to reduce greenhouse gasses. But the Germans don’t stop eating beef. They just buy it from South America instead. They chop down the rainforest…and then send the beef 4,000 miles in a refrigerated ship. How does that make sense?’

We stopped to fill up the tank. It’s a large tank. Still, the cost — 197 euros (US$206) — was a shock. But we’re getting used to big price increases. We saw them coming years ago. Now they’re here. So are big price decreases — for cryptos, techs, junk bonds, and stocks in general. And today’s cogitation is, broadly, about when all this price commotion will settle down.

Not anytime soon, is our guess. And to give you a peak at what lies ahead…

Decision of the century

…now taking matters into his own hands, Mr Market is deflating the price of assets, correcting mistakes made by Yellen, Powell et al. As the corrections go deeper, pressure on the Fed to ‘do something about it’ will increase. Then cometh The Decision of the Century, when the Fed will have to either let Mr Market finish his house cleaning…or burn the house down completely with more money printing.

We think we know which way it will go…but we don’t want to spoil the story. So let’s read on…

And here comes POTUS, doing his part to whip inflation now. According to our sources (Bloomberg), today, the president will announce a suspension of federal taxes on gasoline:

‘President Joe Biden will call on Congress to enact a gasoline tax holiday, a person familiar with the plans says, as he looks to cool soaring pump prices heading into summer.

‘Biden will make a statement Wednesday calling on Congress to enact the pause, the person said, speaking on condition of anonymity ahead of an announcement.’

Gasoline taxes are the best kind of taxes. They tax drivers to get the money to maintain highways. Cancelling the tax doesn’t make the expense go away. It just shifts it to other people — including those who don’t drive.

And since the feds have no extra tax revenue lying around, the money will have to be borrowed…adding further pressure to interest rates and/or on the Fed to print more money.

So, this is just another jackass political move, shifting the cost of highway maintenance from a user tax to an inflation tax.

But yesterday, investors seemed confident; they seemed to think that the Powell-Yellen team would win the battle with inflation…without ever having to draw blood. Big talk. Small rate hikes. Letting their bonds ‘run off’ without renewing them. Piece of cake, right?

Dow 33,000?

Then, the Fed could go back to doing what it does best — making Wall Street richer while destroying the Main Street economy. When prices settle down, in other words, it can ‘bring back the punchbowl’ and let the good times roll again.

By the close of business, the Dow had gained 641 points.

Does this mark the crest of the inflation wave…and the beginning of a rebound in the stock market? The old-timers say that if a market can bounce back and recover 50% of its loss, it is a sign of a recovery. If the bounce fails to reach the 50% market — which would be Dow 33,000 or so — the bear market will probably continue.

You can take that for what it is worth — which is not much.

But remember, Mr Market is in control now. He’s doing what he always does at the end of a bubble — bringing prices back down to Earth. And like a cat, he plays with his food before he devours it.

So far, he has whacked asset prices. But just as asset price inflation produces a ‘wealth effect’, asset price deflation engenders a ‘poverty effect’. People have less to spend. Sales, profits, wages, tax revenues — everything goes down.

From assets to consumer prices, deflation seeps into everything. And the main source of leakage is housing. The fall in stocks and bonds leaves most people high and dry. But when the housing market takes on water, almost everyone gets drenched. Households drown as mortgage payments rise.

And now, says Bloomberg, the leakage has begun:

‘We’re already seeing the stock market selloff spin into the housing market.’

Yes, dear reader, left alone, inflation will take care of itself. Mr Market will get the job done. The economy will go into recession. People will have less to spend. Businesses will make less money. Prices will fall.

But will the Fed have the courage not to act?

We’re as curious as you are.

Regards,

Bill Bonner,
For The Daily Reckoning Australia