Marr & Reynard, Investing in Emerging Markets

British financial journalists Julian Marr and Cherry Reynard take the reader around the world in 246 pages. Investing in Emerging Markets: The BRIC Economies and Beyond (Wiley, 2010) is an engaging book, well researched and well written. For Americans, it is also refreshing to have a British perspective because so much of the research on emerging markets is done in London. I follow the economy of one country (which fluctuates between emerging and submerging) fairly closely and am constantly being referred in its press to “the analysts in London.”

The authors begin with a sophisticated introduction to the emerging markets, asking such questions as whether globalization and decoupling can possibly occur simultaneously. They analyze the notion of a commodities supercycle (noting in a different context that “in investment, certainty is the rarest commodity of all”). (p. 80) They weigh the benefits and risks of sovereign wealth funds.

Moving on to the BRIC economies, the authors brush aside ideas designed to rationalize grouping the four economies together that “cross the line from the simplified to the simplistic.” Their view is more dynamic. “Suffice to say that the quartet are the flagships of the three main emerging markets regions of Asia, Emerging Europe and Latin America and their importance to global trade over the coming decades is hard to overstate—not least in the way they interact with each other.” (p. 83)

The bulk of the book focuses on individual emerging market economies, including those better described as the “emerged” emerging markets (Hong Kong, Singapore, South Korea, and Taiwan), with a very brief look at the frontier markets. The general format for the more developed economies is a brief economic history followed by a section making the investment case for the country. Sometimes the investment case is weak. Take Argentina, for instance, which “provides a salutary lesson in how not to manage an economy.” (p. 194)

The authors draw insights from a number of emerging markets experts, many of whom highlight the dangers of investing in emerging markets. Throughout the book the authors raise “the spectre of possibilities such as water shortages in China [and] advances in technology derailing demand for certain commodities.” They also quote the risk list of a CIO (abbreviated here): “What happens when interest rates start to rise? … How is the ‘Axis of overspending’ going to finance their projected deficits? Is China the savior of the global economy or its Achilles’ heel?” (p. 222)

Investing in Emerging Markets is a thoughtful, balanced book which offers an overview of regional and country-specific economies. Naturally, anyone thinking about investing in an individual country should seek out far more information than the authors can provide here. Their summaries are but stepping off points. At least they are solid; readers have been given the wherewithal to avoid both slippery slopes and quicksand.

Kiev, Hedge Fund Masters, a second look

I wrote briefly about this book last year but decided to return to it. Ari Kiev, who died just over a year ago, was best known in the trading world as an author and as a coach to traders at Steve Cohen’s SAC Capital Advisors in the early 1990s. Hedge Fund Masters addresses the kinds of traders he coached.

I took notes on Kiev's book when I first read it, and I’m going to select four self-therapeutic passages from them for this post. I suspect that most of my notes are quotations, but I don’t think it’s important to check their accuracy, though I will provide page references.

* * *

By establishing a vision, you have promised to achieve something. The promise means you are giving yourself permission to begin to act in the realm of the impossible, to create all kinds of openings. In that one promise, you begin to abandon self-doubt and the need for approval. This way of being in the world lets loose huge reserves of energy and creates enormous possibilities. Yet none of this can happen until you take the first step forward in pursuit of a goal with no guarantee of outcome. (p. 218)

Living in the gap makes you vulnerable. Once you’re out there, on the cutting edge, you’ll suffer breakdowns as well as breakthroughs. Although it will not always be comfortable, living in the gap between where you are and where you want to be will make your days far more interesting and action packed than if you traded with the intention of avoiding pain and discomfort. (p. 229)

It is useful to note when an activity becomes tedious, dull, and routine and leads to withdrawal and avoidance. This is the time to consider whether you are facing obstacles and are retreating behind your survival needs or whether these feelings signify that you have reached your goal and now need to raise the stakes. (p. 236)

The development of mastery is, in a sense, an existential and experiential methodology, directed at what is and what can be. You invent your own future through commitment to a goal, identifying what is necessary to produce specific results, and learning how to handle the unknown. (p. 247)

McGuire, Hard Money

As the number of books on investing in gold continues to proliferate, Shayne McGuire’s Hard Money: Taking Gold to a Higher Investment Level (Wiley, 2010) stands out in several ways. Most importantly, the author methodically builds a case for gold by analyzing five drivers of potential price appreciation. They are: the increasing likelihood of fiscal crises in major economies of the world, the return of inflation, a small allocation shift into gold by institutional funds, the rise of China, and gold’s potential return to being the dominant financial asset in the global monetary system.

In the second part of the book McGuire describes in some detail the kinds of elements that might be included in a precious metals portfolio as a subset of an overall portfolio—stocks, ETFs, physical metals. He explains how to buy coins, including rare coins. All in all, a good practical guide for the investor.

Here are a couple of points that struck me as worth sharing.

McGuire argues that gold can be viewed as the “youngest major investment asset class” because “it is only since the early 1970s that it started being broadly perceived as an investment.” Before the collapse of the Bretton Woods monetary system in 1971, gold was money; currencies were “receipts that represented and were exchangeable for hard money.” Therefore it makes no sense to evaluate gold as an investment prior to the 1970s. As McGuire writes, “Evaluating it as an investment over this time period would be like examining the return on investment of a dollar bill: Both moved in lockstep by government decree.” (pp. 68-69) Yes, gold would rise in value in response to an economic shock, often triggered by war. But “even during these periods of financial stress, nobody was investing in gold. People were hiding in and accumulating savings in gold, the way they hide in cash to move away from volatile financial markets and keep savings accounts in dollars today. In the past, investing generally involved taking risks by moving away from gold, which was always seen as money. Today is the opposite. For any fund manager, buying gold today means investing, taking risk.” (p. 69)

Although McGuire contemplates the possibility of $10K gold, he warns the reader of the genuine economic concerns that underlie allegations of gold market manipulation by financial authorities. The problem for financial authorities is that “a gold investment wave can suck resources out of the broader economy,” especially bonds, resulting in a spike in interest rates, “and ultimately deflation and another banking system crisis.” (p. 85) We have only to think back to 1933 and FDR’s confiscation of gold.

One final cautionary note from the author. He writes: “Although there are reasons why a gold boom could endure for some time, I think a gold portfolio is something that I, personally, would not maintain as a permanent portfolio in my overall diversified portfolio of assets. I think of it as a portfolio to be maintained in these extraordinary times….” (p. 145)

Katsenelson, The Little Book of Sideways Markets

Vitaliy N. Katsenelson’s The Little Book of Sideways Markets: How to Make Money in Markets That Go Nowhere (Wiley, 2011) is thoroughly enjoyable, not so much for the message as for the thoughtful and often entertaining way in which it is delivered. It is part of the “Little Book Big Profits” series that began with Joel Greenblatt’s The Little Book That Beats the Market in 2005 (recently updated) and now includes fifteen titles.

Katsenelson’s hypothesis is that we will likely be in a sideways market, personified by the cowardly lion, “whose bursts of occasional bravery lead to stock appreciation but are ultimately overrun by fear that leads to a descent,” until about 2020. (p. 3) His reasoning is that we are experiencing earnings growth but continuing P/E compression: the gains we get from earnings growth are wiped out by a decline in P/E ratios. Even though there can be a lot of cyclical volatility, over the long haul stock prices will stagnate. Until the 12-month trailing P/E falls “significantly below the historical average of 15” (by mid-2010 stocks were trading at more than 19 times 2010 earnings) the sideways market will continue. (p. 27)

If this hypothesis is borne out, buy and hold (never a great idea in any environment) absolutely must be replaced with buy and sell. “A disciplined sell process injects a healthy dose of Darwinism … into the portfolio, weeding out the weakest stocks—the ones that have deteriorated fundamentals or diminished margin of safety—in favor of stronger ones.” (p. 164) That is, once the reasons you bought the stock (valuation, quality, and growth) have disappeared, sell and move on.

Katsenelson takes his reader step by step into the mind of the value investor by relating, in a fictional addendum to Fiddler on the Roof, the story of Tevye’s purchase of Golde, the cow. He also describes his own big-time gambling evening (he was willing to lose a maximum of $40) and that of a half-drunken, rowdy fellow blackjack player to stress the importance of process. He then moves on to the fundamental principles of active value investing.

What differentiates this book from so many others on value investing is that it describes, sometimes through the use of case studies, the thinking of a value investor. Not just his models or his metrics but his assessments. Katsenelson is an empiricist who weighs facts, looks for contraindications, and makes decisions. He makes value investing come alive.

This may be a little book, but it’s packed with insights for both novices and experienced investors. And it is a delight to read.

Shaffer, Profiting in Economic Storms

So you woke up feeling pretty good this morning? Well, Daniel S. Shaffer is out to ruin your mood. In Profiting in Economic Storms: A Historic Guide to Surviving Depression, Deflation, Hyperinflation, and Market Bubbles (Wiley, 2010) he foresees a deflationary depression coming between 2012 and 2014. He bases his doomsday forecast on cycle theory, invoking both natural cycles (especially sunspot cycles) and investment cycles. But he warns that “your investment strategy should include disruptions by regulators or politicians that purposely disrupt the natural order of the markets.” (p. 156)

Shaffer pads his book with rather pedestrian discussions of trading psychology, the reliability of economic releases, accounting irregularities, modern portfolio theory, fallen civilizations, the history of the U.S. banking system, and famous market manias. Shaffer is a Fed and Bernanke basher who suggests that “the Federal Reserve should not be in existence in its current form by 2013.” (p. 121)

Unfortunately, Shaffer adds nothing substantive to cycle research. He pays homage to Welles Wilder’s Delta Society, Elliott wave theory, Fibonacci sequences, and Terry Laundry’s T Theory and includes a few charts to illustrate their applications. How he himself arrived at a projected 40-year cycle low of about 3,500 on the Dow Jones Industrial Average, probably in 2013, remains something of a mystery. Nor is it clear why “hyperinflation has a high potential of showing up around 2020.” (p. 201)

Investors should always be on their toes. Listening to one self-styled prophet will probably provide little actionable information.

Fisher, Debunkery

Ken Fisher’s Debunkery: Learn It, Do It, and Profit From It—Seeing Through Wall Street’s Money-Killing Myths (Wiley, 2011) is a welcome antidote to the intellectual pap, often laced with arsenic, that is regularly dished up on CNBC and in financial planning books.

The reader need not and should not agree with Fisher on every point. Nor should he merely store away talking points for cocktail parties or potential zings for his financial planner. Instead, this book should set the investor on a course of independent thinking, during which he honors Santayana’s oft-quoted statement that “skepticism is the chastity of the intellect, and it is shameful to surrender it too soon or to the first comer.”

Fisher debunks fifty myths, ranging from “retirees must be conservative” to “when the VIX is high, it’s time to buy,” from “so goes January” to “pray for budget surpluses,” from “stocks love lower taxes” to “consumers are king.” Here I’ll share two of his “debunkeries” as well as his thoughts on the usefulness of history.

Bunk 12: “Stop-losses stop losses!” Wrong, claims Fisher. “It would be more accurate to call them ‘stop-gains.’ In the long term and on average they’re a provable money loser.” (p. 51) The reason that stop-losses don’t work is that stock prices aren’t serially correlated: “What happened yesterday doesn’t have a lick of impact on what happens today or tomorrow.” He continues: “If stock price movements dictated later movements, you could just buy stocks that have gone up a bunch. But you know, instinctively, that doesn’t work. Sometimes a stock that’s up a lot keeps going up, sometimes it goes down, or sometimes it bounces along sideways. You know that. So why don’t people understand that correctly on the downside?” It should be clear that Fisher is no believer in momentum investing. As he writes, “momentum investors don’t do better on average than any other school of investors. In fact, they mostly do worse. Name five legendary ones. Or even one!” (p. 52)

Bunk 19: “Beta measures risk.” No, Fisher contends, “it measures prior risk. … It doesn’t measure anything about the present or future.” (p. 75) Fisher’s argument again hinges on his claim that price action is non-serially correlated “by definition.” And if price can say nothing about the future that’s exploitable, how could volatility (which is based solely on price action) be useful, academics be damned? It can’t—at least not in the sense that a low-beta stock implies low risk going forward and a high-beta stock implies high risk. But if used in a contrarian way in specific circumstances beta can be a profitable guide. In V-shaped recoveries “those categories that hold up better than the market during the beginning of a bear that then fall the most in back of a bear market (making them high-beta) bounce most in the early stage of the new bull.” Put another way, “Those categories with the best returns after the bottom had the biggest beta at the bottom. They had more volatility to the bottom and more volatility than the market in the new bull! But the way our brains work, we tend to think: When it’s down, it’s ‘volatile,’ but when it’s up, it’s ‘good’!” (p. 77)

Although Fisher readily accepts the notion that past performance is no guarantee of future results and, as we have seen, rails against those who seek patterns in past price action (or volatility) to shed light on future price action (or volatility), he nonetheless believes that history is the “investors’ lab.” Investing, he writes, is not a craft; becoming a master craftsman does not give you an edge. Instead, investors should model themselves on scientists. “In science, you develop a hypothesis, test, confirm, and retest—continuously. It’s a non-stop query session. While investors don’t have a traditional lab like biologists or chemists, they do have history.” (p. 135) By history he means the kind of stuff that happens in the real world and that is easily researched, such as whether gold is a safe haven and whether high unemployment is a stock killer. In this sense, “history is one important tool for shaping forward-looking expectations” (p. 136) and improving the probabilities of profitable investing results.

Debunkery may not be a core library holding, but it’s a fast, often provocative read.

Keeping a trade alive

Perhaps we can all learn something from, or at least be inspired by, this amazing play.