What is the Best Stock Valuation Ratio?

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Value investors use a number of ratios to assess whether a stock is cheap.  Everyone has their favorite.  Everyone debates the merits of one versus the other.  I backtested some of the popular ratios to see how they would perform if you simply split the market up into deciles and compared the cheapest to the most expensive deciles.  The population I used for this analysis was the S&P 1500.  In this case, we are comparing the most expensive 150 stocks to the cheapest 150 stocks.  These are the total returns since 1999, with the 150 stocks re-balanced annually, because re-balancing monthly is impractical.

Below is a list of the ratios that I tested:

EBIT/Enterprise Value – This is the ratio identified by Joel Greenblatt in The Little Book that Beats the Market.  EBIT is “earnings before interest and taxes”.  Tobias Carlisle refers to this as the “Acquirer’s Multiple” in Deep Value

The Enterprise Value is the total cost of the firm to an acquirer.  Enterprise values are the total cost of the firm to an acquirer at the current market price.  In other words, if you were to buy this company in its entirety, you wouldn’t simply pay the market price.  You would also assume all of its debt obligations and would inherit all of its cash on hand.  It is the cost to acquire the entire company.  EV gives you a good idea of the true size of the business.  The calculation for Enteprise Value is:

EV = market value of common stock + market value of preferred equity + market value of debt + minority interest – cash and investments.

Price/Cash Flow – The price per share divided by the total trailing twelve month cash flow for the last calendar year.  In other words, how much total cash is the stock generating for what you are paying?

Price/Sales – The price per share divided by the total revenue per share.  This ratio was popularized by Kenneth Fisher in his 1984 book Super Stocks.

Price/Free Cash Flow – Free cash flow is the company’s operating income minus its capital expenditures.  Free cash flow strips away the company’s other financial performance variables and looks simply at how the core business is doing.  This ratio looks at how much free cash flow is being generated per share relative to the price of the stock.

Free Cash Flow/Enterprise Value – This is the same thing as price/free cash flow, but instead compares free cash flow to the total size of the business.

Price/Book Value – Book value is the total balance sheet value of the company.  It’s the simple equation Assets – Liabilities = Shareholder Equity.  The goal of many asset-based value investors is to buy company’s that are trading at or below book value.

Price/Earnings – This is the most basic and common valuation metric.  It takes the per share price of the stock and divides it by the earnings per share.

Price/Tangible Book Value – The same thing as price/book value, with a twist.  When calculating shareholder equity, intangible assets are taken out of total assets.  The goal here is to look at what assets can actually be sold and turned into cash.

The results are below:

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I think it is best to look at the effectiveness of the ratio based on the difference in return between the cheapest and most expensive decile, rather than looking at its total return for the cheapest decile.  A ratio that is effective in identifying cheap stocks should be equally effective in identifying expensive stocks.  Based on the backtesting, the acquirer’s multiple popularized by Tobias Carlisle is the most effective.  Tobias maintains a nice screener here.

Here is a visualization of the value premium in chart form:

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The important takeaway is that no matter which ratio you prefer, they all work to some extent and buying expensive stocks is a risky bet.  Value investors can debate about which ratio works best, but they all work!  No matter how you slice it, cheap beats expensive.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Bruce Greenwald on Globalization

This is a fascinating and thought provoking video with Bruce Greenwald on globalization and the future of the economy.

PLEASE NOTE: The information provided on this site is not financial advice and I am not a financial professional. I am an amateur and the purpose of this site is to simply monitor my successes and failures.

 

Greenbrier (GBX)

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Greenbrier, one of my holdings, is poised to benefit from a recovery in oil prices.  Greenbrier manufactures, leases and repairs rail cars.

Greenbrier was a beneficiary of the fracking boom and was negatively impacted by the bust in the last two years.  Much of the oil that is being drilled throughout the US must to be transported via rail.  Greenbrier’s stock peaked at $75 a share in mid 2014 around the same time that oil prices peaked above $100 and then began its decline to $50.

GBX’s Performance

Meanwhile, amid the decline in oil prices, Greenbrier has been humming along and generating profits while the stock has been disconnected from the actual performance of the company and slid to the current $41.85 price level.  Take a look at the operating income for the last few fiscal years:

2016: $408 million

2015: $386 million

2014: $239 million

They have also been paying down debt.  Long term debt has been reduced from $445 million to $303 million.

Saudi Arabia & Oil Prices

With that said, it appears that oil prices are bottoming.  Saudi Arabia engineered the decline in oil prices to kill their competition.  Their mission is now accomplished and they want to see oil prices go back up.  They are now organizing OPEC to cut production and raise oil prices again.

I suspect Saudi engineered higher oil prices will simply mean that US production will increase in response, which will benefit the train industry and companies like Greenbrier.  The only way that it wouldn’t benefit would be if the US invests in oil pipelines.  It appears unlikely that any pipelines will be built.  In addition to the environmentalists, there is a strong resistance from NIMBY citizens.  Any struggle to get these pipelines built will probably be akin to the Bush administration’s efforts to drill in ANWR, efforts that were abandoned because they were deemed to be too much of a political pain.

Personally, I don’t see how transporting all of this oil via train and truck is any better for the environment than putting it in a pipeline, but I don’t think it is good investing to think in terms of what should happen.  Even if the new administration fights the political pressure and gets a pipeline built, it will be years before it actually happens.  In the meantime, we will need a way to transport all of this oil and rail will benefit.

Margin of Safety

Greenbrier presents an excellent margin of safety at the current price.  Even without higher oil prices, Greenbrier has been performing well while the stock price has fallen amid speculation that ignores the fundamentals of the business.  My guess is that betting against rail while oil goes down has been fashionable on Wall Street, thereby creating attractive prices.  It is a great value even if my prediction about oil prices doesn’t come true.  I feel the same way about Valero, another stock I own as a play for an oil resurgence.

That’s the idea behind the margin of safety — even if I am wrong, the stock was purchased at a wide enough margin of safety that I should still do ok.  I can bet on higher oil prices in a safe way, as opposed to buying a leveraged ETF or oil futures.

PLEASE NOTE: The information provided on this site is not financial advice and I am not a financial professional. I am an amateur and the purpose of this site is to simply monitor my successes and failures.

Don’t Try This At Home! DIY investing is not for everyone.

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I post a disclaimer on every post that this site is not financial advice and I don’t recommend people simply copy my strategy. Buying individual stocks carries significant risk that most people aren’t cognizant off. 90% of investors have no business buying individual stocks. I often tell people that if they can’t withstand a 50% loss of the amount invested, then they have no business investing in stocks. 50% losses (or worse) are going to occur roughly once a decade and most people behaviorally can’t handle them. With that said, many people wonder if they should try buying individual stocks for themselves.  My advice would be: for most people, absolutely not.

But . . . if you are insistent on buying individual stocks, I recommend that you first get your financial house in order and make sure that you have sound investing knowledge.  There are some great personal financial blogs out there chronicling how to pull this off.  Mr. Money Mustache is one of my favorites.  Dave Ramsey gives great advice as well.

So, before you open a brokerage account and start buying individual stocks, I would say that the below items should be taken care of first:

  1. Get out of debt.  Seriously, if you have debt, especially high interest rate credit card debt, your #1 priority in life right now should be getting out of it.  You should treat it as if you are on fire and need to stop, drop and roll.  Compound interest is a mesmerizing thing when it works in your favor as it does for stock investors.  For credit card debtors, compound interest can ruin your life.  As someone who made a number of stupid financial decisions in my 20’s, I speak from experience.  The same goes for other kinds of debt: student loans, car payments, etc.  Get that stuff paid off before you start even thinking of messing around with buying individual stocks.  Start coupon clipping.  Start cutting your expenses.  Get a side hustle.  Whatever you need to do, do it!  Get out of debt as soon as possible!  Life isn’t meant to be lived in chains.
  2. Set up an emergency fund.  Stock market investing only works over long stretches of time.  In other words, you have to lock the money up for years before you even think of using it.  If you’re constantly withdrawing money from your brokerage account, then compound interest will never have a chance to work its magic.  To be prepared for life’s hiccups and keep you from dipping into your brokerage account, you need to have a savings account covering at least 6 months worth of expenses set aside.  Be prepared for life’s unexpected emergencies, otherwise you’re going to dip into your investments and no strategy will work.
  3. Buy a house.  Rent is throwing your money away.  For what you’re throwing away in rent, you could have a mortgage.  With a mortgage, you build equity in a home and get tax deductions for the interest you pay.  Homes really are a great investment over long stretches of time.  Don’t buy dumb, ridiculously expensive homes that you can’t afford and don’t need.  Don’t try to keep up with the Joneses.  Do find a house with a mortgage payment that you can easily afford and is beneath your means.
  4. Invest in mutual/index funds.  You should have money already invested in the stock market via your company 401(k) or set up in mutual funds.  Vanguard has some great options. The IRA account I am tracking on this blog does not constitute my full net worth or investments. I invest in index funds and any stock investor should devote some of their equity investments to this approach.
  5. Read and learn about investing.  An entire section of this website is devoted to books about value investing.  You should read them all before you decide to buy an individual stock.  If you refuse my advice and only read one book about investing, then my choice would be The Intelligent Investor in its entirety before you even think about opening a brokerage account.
  6. Develop your own philosophy about investing.  Value investing isn’t for you?  That’s fine!  However, pick a philosophy.  You must have  an intellectual foundation.  One of the worst mistake that investors make is shifting between philosophies of investing and chasing recent returns with no real commitment to one philosophy over another.  This is a mistake because all styles go in and out of vogue at different times.  After one style has a nice run, that’s probably the worst time to pile in.  The key to winning in the market is finding a style that makes sense to you and sticking with it.  Consistency is key.  You’re not going to be able to stick with it unless you believe in it and it makes logical sense to you.  There will be times when you are losing money and you will want to throw in the towel.  You’ll be less likely to throw in the towel if you can look at your portfolio and remember why you made your decisions.  If you believe in your philosophy, you can weather the storm.  The mind is the true source of investment gains and folly.  Figure out a philosophy that you can believe in and stay committed to it when times get tough.

A good example of consistency being critical is Peter Lynch’s Magellan Fund.  Peter Lynch is one of the greatest money managers of all time.  From 1977 to 1990, he achieved an astounding 29% rate of return for his investors.  However, most investors lost money because they piled into the fund when it was hot and sold when it was cold.  They had no patience and the lack of patience made them lose money even though they were in one of the greatest performing mutual funds of all time.

With that said, once your financial house is in order and you have a sound knowledge and philosophy about investing, then you can feel free to roll up your sleeves and attempt do-it-yourself investing in individual stocks.

Should you do what I’m doing?  No.  

Do your own homework and choose a style that you are comfortable with. Don’t just buy something because someone else is buying it. Think independently.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Are Markets Efficient?

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My high school interest in the stock market led me to major in Finance in college.  Hoping to learn juicy insights into beating the stock market, I was instead taught the efficient market hypothesis, or EMH.  The efficient market hypothesis states that markets are largely efficient at assessing risk and dishing out returns.  Over time, equities perform better than other asset classes because equities are riskier than other asset classes.  Returns are a compensation for risk.  Basically, business students pay a lot of money to learn that they don’t have a chance against an index fund.  Fortunately, I went to a state college for this advice.

Eugene Fama and Kenneth French, the architects of EMH, performed research which showed that value investing delivers higher rates of return but attributed this to the increased riskiness of value investing.  Value investors disagree and contend that their approach actually reduces risk because they demand a margin of safety from their investments.

I don’t have  PhD.  I don’t have a Nobel Prize. I’m just a working stiff with a blog and a brokerage account.  My analysis is lacking in sophisticated mathematical modeling, but I agree with the value crowd based on common sense.  Just look at the price ranges from the last year of a few large and stable American companies:

Apple: $118.69 to $89.47 – 24.62% difference

American Express: $75.74 to $50.27 – 33.63% difference

Caterpillar Inc: $56.36 to $97.40 – 43.47% difference

I find it difficult to believe that the underlying value of these business experienced such a wild fluctuation in the last calendar year.

One could also look to the entire market as a whole.  Look at the performance of the S&P 500 over the last 26 years:

1990 – 2000: Up 318.42%

2000-2003: Down 27.66%

2003-2007: Up 47.26%

2008-2010: Down 19.88%

2010-2016: Up 90.43%

Did the actual underlying economic output of the United States experience such wild swings over that time period, as the markets seemed to believe?

Here is the total economic output of the United States since 1990:

U.S. Bureau of Economic Analysis, Gross Domestic Product [GDP], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/GDP, December 31, 2016.

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It certainly doesn’t look like the actual economy of the United States experienced anywhere near the wild volatility that the United States markets experienced from 1990 to 2016.

I don’t believe that the markets are efficient.  It seems to me that Ben Graham’s characterization of Mr. Market, the crazy manic depressive shouting prices for businesses based on his mood, is closer to reality than the efficient market popularized by EMH.

I believe that astute investors can find mispriced stocks.  Fortunately, most of the investing community believes in EMH because this is what is written in Finance textbooks.  This a good thing.  The more people that believe that markets are efficient, the less competition there will be for value investors.

PLEASE NOTE: The information provided on this site is not financial advice and I am not a financial professional. I am an amateur and the purpose of this site is to simply monitor my successes and failures.

 

 

Is Retail Dead?

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Value investing requires one to defy conventional thinking.  It requires independent thought.

Right now, the conventional wisdom is: brick and mortar retail is going to be dead soon.  Most physical retailers are going the way of Blockbuster Video and Borders books.  People are going to buy everything online.

You can see this conventional wisdom in the valuations that the market assigns to the following stocks:

Wal-Mart: 14.98 times earnings

Dillard’s: 11.38 times earnings (a stock I own)

Gamestop: 6.79 times earnings (a stock I own)

Amazon: 171.87 times earnings (!)

Clearly, investors are wildly optimistic on the prospects of Amazon and downbeat on the future of more conventional retail operations.  Like most things, I think that the market is getting ahead of itself.  They have taken a trend (the rise of online retail) and are getting carried away with it.  The amazing innovations that Amazon churns out definitely fuel the optimistic forecast.

For Gamestop, the logic is a bit more easy to understand.  Consumers are going to buy more of their video games online directly to their console rather than shop in the store.  Maybe.  When I look at Gamestop’s actual operating income for the last four fiscal years, I see a much different story:

FY ending 2016: $648 million

2015: $618.30 million

2014: $573.50 million

2013: -44.90 million

In other words, Gamestop has been delivering consistently better results while the market has been losing faith in its prospects as a result of speculation.  I do not see a business that is dying.

The point of value investing is to ignore the speculation and focus on what is actually happening and what the company is actually earning.  At 6.78 times earnings, Gamestop presents a tremendous margin of safety regardless of its future.  In other words, 6.78 years of earnings can pay for the entire company’s market capitalization.

Amazon is the sexiest of growth stocks with amazing prospects for the future.  But the stock offers no margin of safety.  Gamestop does.  That’s why I am taking the unconventional route and owning brick and mortar stores like Dillard’s and Gamestop that the market hates (or is ambivalent to) and passing on incredible story stocks that the market loves.

Keep in mind that Amazon is up 332% in the last five years.  Those are tantalizing returns that attract attention and investors.  However, following the crowd and chasing returns is not investing.  It is speculation.  Investing is considering what you, as the owner of the company, are paying for what the company is earning.  The logic is that Amazon will continue to grow and continue to be an amazing company.  Perhaps it will.

“Perhaps” and “maybe” have no place in an investment operation.  Those words are for the track, not for investing.  When it comes to my investments, I demand a margin of safety.

PLEASE NOTE: The information provided on this site is not financial advice and I am not a financial professional. I am an amateur and the purpose of this site is to simply monitor my successes and failures.

Projecting Market Returns

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Market prognosticators frequently opine in the direction of the markets based on public policy, what Millennials are doing, whether Euro will do this and the Yen will do that, who won the Super Bowl, if it is an election year, etc.  They have no idea what they are talking about.

The more accurate forecast models take a hard look at value.

Shiller P/E

One method is the Shriller P/E.  It was designed by Yale economist Robert Shiller.

Looking at the market in terms of the current P/E can be misleading depending on where we are in the business cycle.  For instance, during a recession, earnings plummet and P/E ratios rise even though the market may be undervalued.   During a boom, earnings are temporarily inflated, which can cause the market to appear cheap when it may in fact be quite expensive.  Shiller accounted for this by comparing price to average earnings over the last 10 years, accounting for the impact of economic gyrations.

Gurufocus maintains a nice  tracker of the Shiller P/E here.

Market Capitalization as Percentage of GDP

A better method is looking at the market in terms of its value in relation to GDP.  Buffett popularized this method in a 1999 article in Fortune.  Buffett was able to use market valuation as a percent of GDP to assess market values.  He assessed the market correctly at the time and declared the market to be overvalued.

The methodology is easy to understand.  The market derives its value from earnings and US companies can only earn what the US economy can actually produce.

Gurufocus maintains a tracker for this metric here.

A Better Method

The GDP method is more accurate than the Shiller PE, but it is still an imprecise instrument.  For instance, the GDP model predicts a range of returns over the next 10 years of +4.6% to -8.2%.

Recently I came across a market valuation model that was even more compelling at the Philosophical Economics blog.  This model instead looks at the average equity allocation.  The idea is that during a bull market, valuations increase as investors move their money from other asset classes into stocks.  As the equity allocation increases, the market runs out of fuel for higher valuations and future returns are diminished.

The key reason this makes sense is the relationship between interest rates and returns.  As interest rates rise, it seems natural that investors would decrease their equity allocation and put more of their funds towards bonds.  If bonds are dishing out high rates of return for little risk, why take the risk of owning equities?  This is precisely what happened in the 1970s and early 1980s, when interest rates soared and equities were punished.  It also set the stage for an extraordinary period from 1982 to 2000, in which declining interest rates from historic highs fueled one of the greatest bull markets in history.

Interestingly, as Buffett pointed out in the earlier referenced 1999 article, earnings and economic growth were actually less in the 1980s and 1990s than they were in the 1960s and 1970s.  The only difference between the two periods is the direction of interest rates.

The model can actually be plugged into a simple equation:

Expected 10 year rate of return = (-.8 * Average Equity Allocation)+37.5

Looking at the most recent data, the current average equity allocation is 40%.  Plug this into the equation and we get the following result: (-.8 * 40) + 37.5 = 5.5% expected 10 year rate of return

The metric is tracked here and is updated quarterly.  If the equity allocation were to rise to 45%, that implies that the next ten years will deliver a paltry 1.5% return.  That would hardly seem sufficient compensation for the volatility risk in equities.

So What?

Generally I like to remain agnostic about the market and focus on bargain stocks.  However, my 401(k) plan is dedicated to index funds and I think it makes sense to look at market valuations.  An overvalued market combined with an overheating economy is certainly cause for concern and something investors should remain cognizant of.

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They heard that the average equity allocation went down in the most recent quarter

The model described in this post should reduce your fears when the market drops.  A market drop simply means that future returns are going to be higher.  Drops in the market are cause for celebration, as you can now buy stocks that will deliver a higher rate of return.  I would certainly buy more if the market were to plunge 50% tomorrow.  I’d also probably start scrounging whatever cash I had on hand and piling into the market.

PLEASE NOTE: The information provided on this site is not financial advice and I am not a financial professional. I am an amateur and the purpose of this site is to simply monitor my successes and failures.

Portfolio Stats

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Above are the characteristics of the portfolio.  As there are no companies trading below liquidation value, this year’s portfolio sticks to Graham’s recommended mix of safe balance sheets and earnings yields that double the current AAA bond yield, which is 3.71%.

Graham recommended a minimum earnings yield of 10% regardless of how low interest rates are.  After the most recent run-up in the markets, there were not many bargain stocks to choose from and I had to loosen the standards and try to simply double the current AAA corporate bond yield.  I certainly stretched both rules with Valero.  However, when you factor in Valero’s current 3.48% dividend yield, the logic makes a bit more sense, particularly when it appears that oil prices are bottoming.  Regardless, the average still remains 10.95%, which is above Graham’s recommendation.

The average debt/equity ratio of the portfolio is currently 14.845%, which is safe.  This average rate does not include MSGN, which has negative equity, a phenomenon common among spin offs because parent companies normally like to unload debt on these entities.  I am comfortable with this debt because 19 out of the 20 securities in the portfolio have safe balance sheets and I can afford to have 1 security representing 5% of my portfolio with a risky capital structure.  Additionally, I am comfortable with this debt because the risk of recession is low based on the current household debt service ratio explained in an earlier blog post.

For each of the stocks in my portfolio, there is a reason to either yawn or be repulsed, which is the point.  All of these companies have problems but they are all earning money and have safe capital structures, implying that their problems will not be fatal.  If the company were perfect, everyone would own it and the bargain would disappear.  Beautiful companies aren’t cheap.  The beautiful cheap company is about as common as a unicorn and takes a genius like Warren Buffett to spot.

I’m not anywhere near Warren Buffett’s level of intelligence, so I’ll settle the diversified portfolio of deep bargains.  Besides, with the small sums that I am investing, I can indulge in deeply discounted small cap companies that larger investors cannot invest large sums in.  Over long stretches of time I believe that I can beat the indexes with this approach.

PLEASE NOTE: The information provided on this site is not financial advice and I am not a financial professional. I am an amateur and the purpose of this site is to simply monitor my successes and failures.

Understanding the Economy

A few years ago, hedge fund manager Ray Dalio provided a very useful template for understanding the economy.  The video is above and I think it is incredibly useful as a template for understanding where we are in the economic cycle.  I encourage everyone to watch the video.  I think you will find it enlightening.

To sum up Ray’s thesis: debt drives the economic cycle.  Without debt, the economy can only grow as fast as productivity.  It is debt that drives booms and recessions.  Debt allows the economy to grow beyond the productivity rate, which hovers around 2% in the long run.  When debt levels become too high and begin to restrain cash flows, households and business restrict spending and this causes the economy to contract.

2008 and 2% Growth

The Dalio template explains what happened in 2008 and the aftermath.

In the short term (5-10 year) business cycle, borrowing increases.  As borrowing increases, cash flows because increasingly tightened.  When the cash flows tighten enough, a recession occurs.  The Federal Reserve responds by lowering borrowing costs, restoring borrowing and creating a new economic boom.  Throughout these booms and busts, debts continuously increase.  In 2008, we approached the end of a long term (80 year) debt cycle, in which debts became so high and interest rates were already so low that the conventional monetary tools no longer worked.  This was the beginning of a decade of deleveraging, in which businesses and households shied away from debt after such a tumultuous experience.  During such a time in which new debts cannot drive the economy, the best that the economy can do is grow at its productivity rate.

There has been a lot of head scratching in the last decade about why the economy can’t grow faster than 2%.  Dalio’s template explains it.  It has nothing to do with taxes, regulation, culture, etc. It is caused by the deleveraging. Without debt, the economy can’t grow faster than the productivity rate, which averages around 2%.

Deleveraging

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The data  supports the thesis that businesses and households are deleveraging.  The S&P 500 debt to equity ratio fell to its lowest level in 30 years.  Households went through a similar deleveraging process, as documented in the chart above.  Households now have the lowest debt payments as a percentage of disposable income that they have had since the early 1980s.  Incomes have increased, households cleaned up their debt levels and interest rates have died. Every business and every household that had a lot of debt in 2008 went through hell in the recession. The memory has not been lost. 0% interest rates and quantitative easing weren’t enough to spur borrowing, causing a lot of confusion among economists and policy makers. The cause ought to be obvious: no one wants to get burned again because the memories are fresh.

This has been bad for economic growth since the crisis, but I think it improves the long term prospects of the US economy.  Economist Hyman Minsky theorized that stability is destabilizing, because stable times encourage increasingly reckless lending and borrowing. We experienced this truth in 2008. If Minsky is right about stability, then the opposite must be true for instability. Instability is stabilizing.  Less debt means a lower likelihood of a 2008 economic shock. A more healthy attitude about debt and borrowing might prevent a wild economic boom, but the lack of such boom times also prevents catastrophic economic shocks.

We went through a similar experience in 1929, the last time we reached the end of a long term debt cycle. The difference between 1929 and 2008 was the response of the Federal Reserve. The Fed responded disastrously in 1929. The Fed turned an economic panic and recession triggered by a deleveraging into a Great Depression, as Milton Friedman proved. This time, it appears that in 2008 the Fed responded appropriately. That is why we have been able to go through a relatively tranquil deleveraging, in which debts decreased and the economy grew in a limited capacity at its productivity rate.

Turnings

I was fascinated by Dalio’s template of the long-term 80 year debt cycle because it matches perfectly with William Strauss and Neil Howe’s generational theory. The theory describes history in terms of 80-100 year cycles. The cycle of history also seems to match Dalio’s observations about the long-term debt cycle, in which debts continuously accumulate throughout the ups and downs of a long term cycle and then culminate in a period of deleveraging, lasting roughly a decade. Check out Strauss and Howe’s excellent book if you want to understand the debt cycle in a better historical context.

Strauss and Howe also discuss a high that follows a crisis (deleveraging). When the delveraging is over, a roughly 20 year period of financial tranquility follows. Yes, there are recessions and the normal stock market bull and bear markets, but nothing of the magnitude of a 1929 or 2008. Instability is stabilizing and everyone making the decisions has fresh memories of the deleveraging. This prevents corporate managers from acting like the reckless managers of the 1990s/2000s or the 1920s.

The last decade has usually been described as a slow growth period of malaise. I think this misses the mark. The seeds have been planted for a future sustainable economic boom because the paring down of debts and the memories of the crisis lowers the likelihood of an economic shock. The Fed’s actions – far from being reckless as is typically described – were exactly the monetary medicine that the economy needed. This was the medicine that Fed failed to deliver in the early 1930s. The deleveraging was inevitable in the 1930s, but we didn’t need to have a Depression. We could have had a period like the decade we just experienced.

So What?

How do I use this template to influence investment decisions?  Generally, I am agnostic when it comes to the macro economy. As long as I have a diversified portfolio of cheap stocks that are financially healthy, I should outperform the market over long stretches of time.  The market will rise over time as long as the economy continues to expand.  The slow and steady expansion of the economy is its natural impulse, as people are always looking for more productive ways to produce goods and services and the population will continuously expand.

With that said, I think it is important for investors to remain cognizant of our position in the debt cycle. For instance, if debt service ratios are approaching new highs, a recession is likely to happen soon. In that environment, it makes sense to steer clear of heavily leveraged firms or firms that are heavily cyclical. If debt levels are combined with high market valuations, avoidance of market indexes may be prudent.

I hope you find the Dalio template as insightful and useful as I do.

PLEASE NOTE: The information provided on this site is not financial advice and I am not a financial professional. I am an amateur and the purpose of this site is to simply monitor my successes and failures.

 

 

 

Final 2016 Purchase

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I purchased 144 shares of Steelcase Inc. (SCS) at a price of 17.9432 yesterday.  Steelcase has an earnings yield of 7.79%.  This makes my fund nearly 100% invested.

I will give the current portfolio investments a year to work out and re balance next December.

Additionally, this morning I received a $24.51 dividend on IDT.

PLEASE NOTE: The information provided on this site is not financial advice and I am not a financial professional. I am an amateur and the purpose of this site is to simply monitor my successes and failures.

I am a value investor. My outlook is inspired by the ideas of Benjamin Graham. This site is a real time chronicle of my portfolio and an outlet to share my ideas. I hope you enjoy.