Wednesday, October 12, 2011

China – Shmina! It’s all bull!

We have been told for decades China is the waking dragon whose economic emergence will somehow fuel the world’s economy into prosperity. But, not according to Jim Chanos’ article in the September 26 edition of Bloomberg Bussinessweek. He points out that local governments in China have racked up $1.6 trillion in debts they can never pay back. Makes the Greek Euro-crisis look like a flea on a tiger’s back. He also points out how Chinese accounting is different from Western accounting. “The further down you drill on China, the more bearish you get…” His article concludes that American investors should sell short certain Chinese stocks and Chinese currency. Selling short is a technique where you make a profit when the stock goes down. Those Canadians who owned shares of Canadian/Chinese company, Sino-Forest know just what Chanos means. Sino-Forest stock dropped from $19.40 to $1.29 in June 2011 as certain accounting problems came to light.
In my investing book, Beyond the Bull, I point out how important it is to know about the concept of deceit in the investment world. Deceit is part of our modern commercial world. In the old days smoking cigarettes was OK. In late 2007 the world’s bankers were told that US mortgage-backed paper was a sound investment. In May 2008, just before the crash, we were told that we should buy resource stocks so that we would own “assets in the ground” to protect our portfolios against possible problems in the banking system. In a world dominated by politicians and financial salesmen, we know that economic reality is never as rosy as they say.
How can we survive in such a world? How can we thrive?
They key is in our focus. If we focus on the words of the politicians and financial salesmen, we know what to expect: more deceit. The key is to focus on our own personal financial world. What’s in our own portfolio? Is it going up? If it’s not going up, why are we invested in it? Our focus should be the price of our investments over time. If those investments are going up, we are succeeding. And, when the price trend of our investments turns down, we simply sell them. It’s a very simple plan, but it works.
A case in point would be the Canadian stock market. At the very top in the year 2000, the TSX composite hit 11,423. On October 4, 2011, it traded at 11,250. Holding a portfolio of Canadian stocks for the long term has not been a profitable way to invest. Gold, on the other hand, traded at $294 in the year 2000. Today it’s $1650. Gold is in a long term up trend, stocks are not. Financial planners will tell you that gold in speculative and stock mutual funds are not. That’s the deceit. Reality is gold has been going up for 11 years and stocks have been going up AND down. That’s reality.
A similar case can be made for the bond market: in early 2000, long term Canada bonds yielded 6.25%. Now the yield is under 3.25%. In the bond market, bond prices rise when interest rates fall. Those who bought long term bonds in 2000 and are still holding them have received 6.25% interest each year and racked up a sizeable capital gain. Financial planners told us that the stock market has outperformed the bond market over long periods of time: but that has not been true for the past 11 years.
Financial planners are usually mutual funds salesmen trying to persuade us to buy their product. It’s the “persuasive” element of this situation that gives rise to the deceit. The truth lies in the mathematics of your portfolio. Your investments are either in up trends or they’re not.
The key is our focus: if investors and financial planners had focused more on bonds and gold – and less on the stock market, they would have been much more successful during these past 11 years.
Beyond the Bull Accounting. Check in on your portfolio: is its focus correct? Does it contain only investments that are in up trends? At what price did you buy? What is the price now? Is your portfolio like a Chinese stock? – the story sounds good, but it doesn’t add up. The remedy? Sell your losers.

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