Buy food, buy oil and buy a gun.
Former banker Satyajit Das made that suggestion at the Port Phillip Publishing conference After America in Sydney. The reason is someone asked him what they should do – after he’d shown everyone in the room that the global financial system was a basket case.
His other suggestion (serious this time) was a model on how to invest in markets that are characterized by volatility. As he said at the time:
‘What’s my first priority – capital preservation. Second priority is income. Third priority is capital gains. Whereas for most of the last 20 years I’ve seen the inversion of that. You have most of your assets in high quality, capital preserved, income-producing assets and you create what I call tail exposure. You have a U-shaped portfolio.’
Part of that strategy involves taking advantage of big rallies (like we’ve seen recently) without forgetting the first job of investing (especially now) is to not lose money.
But the conference was almost a year ago, so does the advice still stand?
We’ll explore that question in today’s Money Weekend…
The Same, But Different
A year isn’t supposed to be that long in investing. But news sure moves fast. In early 2012 it was Greece and the wider European sovereign debt crisis dominating headlines.
Now it’s Japan.
Prime Minister Shinzo Abe wants 2% inflation. He’s urging the Bank of Japan into printing huge sums of money to get it.
Since then the Nikkei index has rallied and the yen has fallen. According to the Wall Street Journal, since November the Nikkei is up 32% while the yen is down 14% against the US dollar.
Everything is going to Shinzo’s plan then…except the rally in the stock market can’t obscure the motherlode of debt the Japanese economy has hanging over it. The logic given for the rally is that Japanese corporations will increase their earnings via higher sales with a cheaper currency. Maybe they can for a while.
There are plenty of people who are still prepared to short sell Japan. Hedge fund guru Kyle Bass says buying Japanese stocks is like picking up dimes in front of a bulldozer. This is because Japanese government debt is over 200% of GDP and interest payments already consume 25% of tax revenue at very low interes rates.
His position is that this cannot last much longer, and that significant trouble in the Japanese bond market would kill the Nikkei rally.
Interestingly, at the same After America conference Dan Denning said the current (at that time) fixation on Europe was a misdirection. Investors should watch Japan. And they should watch for trouble.
The fact is Japan can’t print its way to prosperity. And neither can the United Sates. Even so, stocks are up in both countries, as the debt crisis is pushed to the sidelines.
As Dan Denning said in the Daily Reckoning yesterday, ‘We’re either headed higher in an inflationary melt-up driven by currency depreciation, or we’re over-bought already and on the verge of a hard fall. Line up. Take your bets.’
But the fundamentals haven’t changed. There’s a lot of debt in the system that won’t generate the income to pay it off.
Government deficits are rising, pension obligations stretch into billions, but financial returns are shrinking as governments lock in financial repression by holding down interest rates.
That means After America might as well have been yesterday. You’re still investing in the same world, it’s only the headlines that look different.
On that basis, you’d think the odds stay tilted toward lower economic growth. That was the scenario Satyajit Das described at the conference. That brings us to Das’s U-shaped portfolio…
Outlying Bets for Tail Exposure
There seems to be no change in the financial markets and economic outlook from a year ago. That means the strategy stays the same. You’ll get big melt-ups and big melt-downs as governments around the world juice-up the market on financial steroids while markets correct what’s not sustainable.
That means you should expect volatile markets. And that’s why Das’ position was that your first priority should be capital preservation, followed by income, then lastly capital gains.
We know Kris Sayce, editor of Money Morning and Australian Small-Cap Investigator, suggests a similar approach, looking for dividend producing stocks that can grow their cash flow over time. Lower share prices are an invitation to buy more shares in that cash flow.
But the U in the portfolio is to go after exposure at either end of the bell curve. Kris says one way is to buy deep out-of-the money options. These are outlying bets both ways: you can gain from the big run up in stocks, and the big slides. The premium is fixed but the gains aren’t.
Options aren’t for everyone. But Kris says you can use smaller portions of your capital to try and catch the volatile swings with products like ETF’s (exchange traded funds).
As an example, he likes the Japan ETF that trades on the ASX under the ticker IJP. Look at its strong rally since the market began pricing in Shinzo Abe’s power transition.
Kris says riding moves like this is another way to try and benefit from the volatility, but it takes active investing and never taking your eye off the exit point. He says these type of plays are not ‘stocks for the long run’.
As Das said at After America, ‘You’re going to have to have a plan to survive and just be very careful about your risk.’
Callum Newman
Editor, Money Weekend
Ed Note: Attendees at the Port Phillip Publishing conference After America voted Satyajit Das best speaker. We’ve nearly run down our final inventory of the six disc DVD set. But there are some copies left if you want to grab your copy now.
From the Port Phillip Publishing Library
Special Report: The Big Money Secret of Ironstone Mountain
Daily Reckoning: Japan’s Spring Offensive Against the Yen
Money Morning: Two Questions to Ask Before You Buy Another Stock
Pursuit of Happiness: Exchange Traded Options: A Way to Boost Your Retirement Income
