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%.



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.


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


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.

MSGN: A Promising Spin Off

I purchased 119 shares of Madison Square Garden Networks today at 21.40.  MSGN currently has an earnings yield of 10.11%.

Spin Offs

I became aware of MSGN because it is a spin off.  Spin offs are when companies take divisions of their firm and spin them off to operate as a separate entity.  Companies do this for many reasons.  They may believe that the firm will receive a higher valuation if valued separately.  They may want to unload debt on the entity.  Regardless of the reason, spin offs are an attractive area to invest.  Spin offs have been proven as a group to beat the market.

The best explanation of a spin off strategy is detailed in Joel Greenblatt’s book You Can Be a Stock Market Genius.  It is a great book despite the ridiculous title.  In the book, Joel gives many real world examples of spin offs he purchased for his fund and details his rationale for doing so.  It also explains in depth the reasons that spin offs outperform better than I can.

As stated previously, spin offs outperform the market.  If you don’t feel like doing the homework involved in investigating spin offs individually, there are ETFs that specialize in owning these entities.

With this said, proceed with caution.  My belief is that the metric which best captures risk is not beta, but the debt-to-equity ratio.  As mentioned earlier, while spin offs outperform for many reasons, parent companies like to load up these entities with debt.  It’s like divorcing your significant other and then saddling them with all of your credit card balances.  I’m sure there is a more complex explanation in corporate jargon that makes this sound better.  In a downturn, this debt can become a dismal drag on performance.  One of the spin off ETFs (exchange traded fund), the Guggenheim Spin Off ETF (CSD), saw a 2/3 erosion in price during the recession in 2008.  Even despite that loss, the ETF has still outperformed the market.  While they outperform the market, spin offs will require a healthy supply of Pepto Bismol during recessions.

For those who want to investigate spin offs individually, a great list is maintained at this site.  I will frequently take a look at this list as a starting point to do research.  I’ll then do a search to read news articles about the deal and any other analysis that has been done to evaluate the opportunity.


MSGN is the cable network division of Madison Square Garden.  This was spun off from the main MSG entity about a year ago.  The primary owner of MSG is the Dolan family.

It looks like the Dolans, who sold Cablevision a year ago, wanted to hold onto the prime iconic piece of New York real estate that is Madison Square Garden but simultaneously realize that cable is a dying business and want to rid themselves of it.  Hence their sale of Cablevision.

By spinning off MSGN, they isolate the entity for a potential buyout from another firm while continuing to hold onto the property that they feel has a future.

Earlier this year, Starz was bought out for 20 times earnings.  Why wouldn’t someone pay a similar multiple for MSGN, which is at half that valuation?

Even if I am wrong, MSGN has an attractive earnings yield and I am comfortable with it in my portfolio.  The only downside is the debt load, but considering that every other company I own has a healthy balance sheet, I am comfortable with this risk.

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.

Monday Buys


I was able to find some quality bargains over the weekend and purchased the positions effective today.

FNHC.  Federated National Holding Company.  103 shares @ 18.5

DDS.  Dillard’s.  40 shares @ 63.80

FAF.  First American Financial.  68 shares @ 37.26

IESC.  IES Holdings. 129 shares @ 19.5

STS.  Supreme Industries.  160 shares @ 15.85

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.

Yesterday’s Purchases


I compromised a bit yesterday and took in some stocks with higher valuations than I would prefer, but I am comfortable with the overall valuation of the company vs. what I paid for it and its historical value.  Each pick also has a healthy balance sheet with little to no debt.

I hope that the Fed decision will prompt further selling through end of the month and I can find better bargains before year end.  Currently the fund is 65% invested and will likely stay that way until I can identify more quality bargains with appealing balance sheets.

American Eagle Outfitters (AEO) – 150 shares @ $17.065

Earnings Yield = 7.62%.

Sanderson Farms, Inc. (SAFM) – 29 shares @ $89.6

Earnings Yield = 6.98%

TopBuild Corp (BLD) – 67 shares @ $37.915

Earnings Yield = 7.8%


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.

Today’s Stocking Stuffers


Today’s purchases were all companies trading at attractive yields with healthy balance sheets and consistent earnings.  Benjamin Graham recommended an earnings yield at least double the typical investment grade corporate bond, which is now 3.77%.  Double that would be 7.54%.

I’m finding that it is much harder than in past years to find quality bargains after the run up in the markets.  It figures that as soon as I launch this site, the markets are uncooperative!  I may not be able to become fully invested before January 2017 due to the lack of attractive options, but that’s okay.  I’m sure Mr. Market will be in a different mood eventually.

My objective is to complete my purchases on an annual basis and give the stocks a year to work out with an annual re balancing every December so I can take advantage of the January effect.  If I cannot become fully invested by year end, I will likely purchase some short term treasury instruments.  At the moment, 49.56% of the fund is now invested.

37 shares of Valero (VLO) @ $67.58

Earnings Yield = 7%.  Dividend Yield = 3.57%.  The earnings yield is bit lower than I typically demand, but when combined with the dividend yield, share buybacks and the apparent bottoming of oil prices I think it is a good value.

337 shares of Manning & Nappier (MN) @ $7.51

Earnings Yield = 8.9%.  Dividend Yield = 8.48%

129 shares of IDT Corporation (IDT) @ $19.75

Earnings Yield = 9.31%.  Dividend Yield = 3.92%

81 shares of Cato Corp (CATO) @ $30.70

Earnings Yield = 8.60%.  Dividend Yield = 4.34%

171 shares of United Insurance Holdings (UIHC) @ $14.90

Earnings Yield = 9.23%.  Dividend Yield = 1.59%

65 shares of Cooper Tire & Rubber Company (CTB) @ $38.80

Earnings Yield = 10.96%.  Dividend Yield = 1.08%

61 shares of Greenbrier Companies (GBX) @ $41.75

Earnings Yield = 14.08%.  Dividend Yield = 2.07%.

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.



Today I purchased 98 shares of Gamestop (GME) at $26.06 per share, or $2,553.88.  I also purchased 113 shares of Kelly Services, Inc. (Kelly Services Inc.) at $22.40, or $2,531.20.

Gamestop (GME)

Gamestop currently has a P/E ratio of 7.06, or an “earnings yield” (1/PE Ratio) of 14.16%.  The market capitalization is currently $2.7 billion and total revenues are $9.3 billion. There is no long term debt and the company is producing stable earnings.  Gamestop has lagged the performance of the S&P 500, losing 11.93%.

Kelly Services Inc. (KELYA)

Kelly Services is a staffing agency boasting an earnings yield of 15.27%.  The market capitalization is $870 million and revenues are $5.5 billion.  Long term debt is minimal at $8.7 million with assets of $2 billion.  Like Gamestop, the stock produces consistent earnings.

I typically prefer stocks that are down for the year, but Kelly Services has been on a tear, up 47.81% in the last calendar year thanks to a tightening labor market.  Regardless, one can’t ignore how cheap the stock still is relative to its earnings.

Earnings Yield

I prefer to express P/E ratios in terms of earnings yield.  Rather than saying the stock trades at 10 times earnings, I think it makes more sense to refer to it as a 10% earnings yield.  It would be helpful if more investors thought in these terms and they would be less likely to buy crazy overpriced stock.  Think about that the next time you buy a stock at 50 times earnings, or a 2% earnings yield!

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.

The Account and my First Trade

Current Account Size

As of 12/11/16, the brokerage account that I will track on this blog currently has a balance of $51,121.23.  The broker I am using is TD Ameritrade.  I used Ameritrade in the past and enjoyed the service, plus their commissions are reasonable ($9.99 per trade).  My first trade occurred on Friday, 12/9.  I purchased 103 shares of NHTC, Natural Health Trends Corp.

NHTC – Trade #1

I goofed a bit on the trade, a mistake I would like to avoid in the future.  I originally placed a limit order for the 103 shares at 24.70.  I grew impatient that the order wasn’t being executed in time and switched to a market order.  This actually caused me to incur an additional brokerage fee of $9.99.

In any case, the order was filled with 5 shares at 24.7 and the remaining 98 shares at 24.7847.  The stock closed on Friday at 25.16.

Why did I select NHTC?  The stock boasts an impressive price/earnings ratio of 5.89.  It also has zero debt and has been consistently producing earnings each quarter.  A look at the stock chart is quite terrifying, as the stock is currently down 46.62% for the year.

Of course, that’s Mr. Market talking.  Whenever a stock is as cheap as this one, the chart is bound to look terrifying.  The opportunity for the value investor is to ignore that noise.  A diversified portfolio of stocks like these should beat the market averages over the long run, even though at an individual level they will look quite terrifying.

Defining Risk

In finance classes, risk is defined as beta.  Beta, simply defined, is the amount of volatility in the underlying stock.  How volatile is the price movement in the last year?  A beta of 1 implies that the stock perfectly matches the risk in the overall market.

NHTC’s beta is 2.27.

I don’t care about beta.  Risk is the likelihood that I will lose money.  While NHTC currently has a high beta, it is also making money and has no debt despite its problems.  In my opinion, the debt-to-equity ratio captures risk to a far more accurate degree than the movement of the price on the chart.

Why 103 shares?

A rule I would like to stick with in this portfolio is that I will not purchase a holding that exceeds 5% of my overall account balance.  My position in NHTC was purchased for $2,551.50, or 4.99% of my total portfolio.  When fully invested, this will help me have a portfolio of at least 20 stocks at any given time for an adequate level of diversification.  If I cannot find a sufficient quantity of bargains, I will then at least have a nice cushion of cash to deploy when the market falls and bargains become more plentiful.

Another rule I will stick with is that I will not deploy leverage of any kind.  I will not borrow money to purchase stocks.  Leverage is nothing but trouble.

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.

The Benjamin Graham Approach


Grahamian Value Investing

My investment approach is inspired by Benjamin Graham, so I think it is only appropriate that my first post describe Benjamin Graham’s philosophy and how I plan to apply it in my own portfolio.

Benjamin Graham is the father of value investing.  He was one of the first to advocate for fundamental analysis (trying to figure out what a company is worth based on financial statements), as opposed to technical analysis (analyzing chart patterns the way a fortune teller reads your palm).  The Benjamin Graham approach is to look at stocks as ownership shares in a company, rather than pieces of paper or dots on a stock chart.  His approach is simple to grasp: figure out what a company is worth and purchase shares in that company for less than they are worth.  On the particulars, value investors differ greatly in approach, but this basic outlook remains consistent throughout the value community.

Graham’s 1949 book, The Intelligent Investor, espoused his principles to a mass audience.  The key concept in the book was that investors should purchase stocks with a margin of safety.  The margin of safety is the extent to which you are buying the stock below its true intrinsic value.  He also described the market not as an all knowing master of the universe, but as a manic depressive called Mr. Market.  When Mr. Market is in a good mood (think 1999 at the height of the “New Economy” financial euphoria), he offers absurdly high prices for companies.  When Mr. Market is in a depressive mood (think the aftermath of the 2008-2009 financial meltdown), he pushes the prices of companies to absurdly low levels.  The goal of the intelligent investor is not to allow his investment decisions to be dictated by the moods of Mr. Market, but to instead seek to gain from Mr. Market’s erratic behavior.  In other words, buy from Mr. Market when he is depressed and sell when he is elated.

Influence on Warren Buffett

One of the readers of the 1949 edition of The Intelligent Investor was a 19 year old named Warren Buffett.  Buffett sought a coherent investment framework throughout his teens but was unable to find one that was intellectually convincing until he came across Graham’s book.  In fact, Warren Buffett later went on to say about the book: “It changed my life. If I hadn’t read that book in late 1949, I’d have had a different future.”

Buffett went on to enroll in Columbia primarily because Benjamin Graham taught an investing course at Columbia.  He later went on to work for Ben Graham in his investment partnership.  This is an excellent interview where Buffett describes his experience with Graham.

As everyone knows, Warren Buffett used Graham’s concepts to become the greatest investor of all time.  Graham recommended buying stocks when they were deeply depressed.  Buffett employed this method extensively in the 1950’s and 1960’s.  Eventually, however, he outgrew this approach.  Instead of buying stocks when they were deeply depressed and selling after a run up in price, Buffett sought to buy quality companies for the long term, still following Graham’s basic approach of waiting until the price was right but increasing his standards for quality and lowering his standards for price discounts.

This change in approach was due to two factors.  The first reason was the influence of Charlie Munger, who was more interested in buying excellent businesses for the long term than looking for the kind of ugly bargain stocks that Graham advocated.  The other reason was scale.  Buffett simply became too big to operate exclusively in the world of depressed stocks.

Nevertheless, Buffett experienced his greatest returns in the 1950’s and 1960’s when he was small enough to focus on Graham style bargains.

Simple Quantitative Approaches

Graham advocated two quantitative methods of stock selection that make a lot of sense to me.

Method #1: Net-Nets.  The first, and most famous, is the “net net” approach.  He advocated buying stocks when they were selling at 66% or below of the company’s liquidation value.  Why 66%?  If the company were completely liquidated, the owner of the stock would experience a 50% gain.  Graham suggested that investors buy 20-30 net-net stocks selling at 66% of their liquidation value, then selling after two years or when the stock price appreciated by 50%.

Famed investor Joel Greenblatt investigated the performance of net-net stocks when he was enrolled in Wharton in the 1970s.  The underlying results were quite impressive.  One of Joel’s portfolios experienced an annual compound return of 42.2%.

Other academic studies also verify that the returns of net-net stocks frequently deliver impressive results.  Unfortunately, net-net stocks are difficult to come by, particularly during bull markets such as the one that we have experienced since 2009.  During recessions, such as in 2002 or 2009, large numbers of them are frequently available.  In my own portfolio, I plan on purchasing net-net stocks when they are available in sufficient quantities.  Fortunately for small investors, the net-net stocks that are typically available are small companies that large investors can typically not exploit.

Method #2: Low P/E, safe balance sheet.  The second, lesser known, approach that Graham advocated was explained in a 1976 interview that Graham gave shortly before his death.  It was published in the September 1976 issue of Medical Economics.  In the article, he suggested buying stocks when they delivered an earnings yield that was double that of a typical AAA corporate bond.  As a measure of safety, he also suggested that they have a debt to equity ratio less than 50%.  In other words, the stock should be cheap relative to its earnings and it should have double the amount of assets than it has in debt as a measure of the company’s solvency.  Graham tested the method from 1926 to 1976 and found that a diversified portfolio of these of these safe bargain stocks would deliver 15% returns over the long term.  Quite impressive for such a simple method with only two variables.

15% is an outstanding rate of return over a long period of time and it is what I would like to strive for over the next ten years.  If I could achieve this rate of return, I will be able to turn my $50,000 value-oriented IRA into $200,000 over the next ten years.

Over at Alpha Architect, they backtested the simple P/E oriented Graham method and found it still works. The portfolios they tested produced long term compounded annual growth rates ranging between 15.07% and 16.42%, exactly as Graham predicted!

I plan on using this method extensively with my own portfolio.  I also plan on pursuing net-net stocks and other quantitative bargains when they are available.  A key thing to keep in mind is that while these methods succeed over the long haul, there are periods of time when they do not work.  I hope this blog will help me remain disciplined and focused on my own value investment journey.

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.