Know Your Limits

Posted On Nov 5, 2019 By Dave Gonigam

  • Timeless investment wisdom… and recent proof that it works
  • Central banker’s “let them eat cake” message for savers
  • A funny thing happened on the way to the cashless society
  • Is it a good idea to prosecute corporations, ever?
  • Stocks pause for breath while gold craters… “tech” earnings disappoint… services refuse to follow manufacturing into the tank… and more!

“Don’t chase a train that has already left the station,” said the wise hedge fund manager.

“Bill liked to talk in analogies,” recalls our Zach Scheidt. Bill, the wise hedge fund manager, was Zach’s boss and mentor back in the day.

“Bill didn’t want me paying more than what I thought was fair for a position just because the stock had already started moving higher. That kind of stock was a train that had already left the station.”

As Bill put it, “You’ll wind up either paying too much, or taking too much risk with our client’s money. There will always be another train to catch later.”

Today we pull back the curtain on a recent trade in one of Agora Financial’s most successful premium advisories — one that didn’t work out exactly as intended. There’s a lesson there for all of us. Best of all, many of Zach’s readers still came away happy!

As you might recall, Zach was with us last week singing the praises of REITs — real estate investment trusts — as a proven income-generating vehicle during times of low interest rates.

(More about low rates later, by the way. This one’s gonna make you mad.)

There was one REIT in particular that caught his eye three weeks ago — not for yield but for capital gain. He figured it was “buyout bait,” due for a huge instantaneous jump if a bigger competitor came through with an offer. So he recommended shares and call options to members of his Buyout Millionaires Club.

The potential takeover target was Essential Properties Realty Trust (EPRT). Zach gave his readers three ways to play it, depending on their risk tolerance…

  • Plain ol’ EPRT shares for the most risk-averse
  • EPRT call options expiring next April for those who felt comfortable taking more risk
  • EPRT call options expiring this month for those with the most aggressive mindset.

As always, Zach set a limit price for all three trades — a maximum readers should be willing to pay and no more.

Readers had no trouble getting in on the stock trade and the most aggressive option trade at a good price.

But the price of that midtiered trade quickly ran away. The train was leaving the station.

Zach and his team had a lively discussion about what to do. “‘Should we raise our limit price so our readers can get in? Or would that be adding too much risk to the play?’

“Based on my research and the balance of risk and reward,” Zach concluded, “I simply couldn’t justify paying more for this play.”

What’s more, after only two weeks had elapsed, Zach became increasingly concerned about the other two versions of the trade — even though they were well in the green.

But that was the problem. “The higher price makes it more difficult for another retail property manager to justify a buyout.”

So Zach urged readers to bail after only 15 days. The share price had appreciated 6%. The aggressive option trade had jumped 70%.

“Of course,” he told readers, “that’s not the blockbuster overnight gain we would see from a buyout transaction. But 70% is still nothing to sneeze at!”

By taking profits, he explained, “we’re taking a gift the market has given us and we’re not adding risk to our wealth by chasing a position that has already moved above our limit price.”

It’s this level of thought and care that goes into every trade recommendation in Zach’s Buyout Millionaires Club. It’s an exclusive club, to be sure — but membership is available now through midnight Thursday night. Zach extends you his personal invitation when you click here.

The major U.S. stock indexes are taking a breather after notching record closes in tandem yesterday.

At last check, the Dow was barely in the green while the S&P 500 and the Nasdaq were inching into the red.

Among the big movers today is Uber (UBER) — down 7.5% as we write after delivering its quarterly numbers. Traders aren’t buying the “We’re still losing money but sales are up!” routine. Nor are they buying CEO Dara Khosrowshahi’s promises of profitability in 2021. (Neither are we, for reasons we laid out most recently two weeks ago.)

Traders are also unimpressed with Peloton Interactive (PTON) — down 4.25% after delivering its first numbers as a publicly traded company. Turns out making and selling exercise bikes — even if they’re “internet enabled!” — is a costly, capital-intensive business. Who’da thunk it?

Elsewhere, gold got whacked hard in electronic trading starting around 7:00 a.m. EST. At last check, the bid was down $24 at $1,485. Crude prices, however, are jumping — up 1.27% to a six-week high at $57.29.

The noteworthy economic number of the day is the ISM services index. This figure has gotten a lot of attention in recent months because its more famous cousin — the ISM manufacturing index — has fallen into a slump, with three consecutive readings below the 50 dividing line that separates a growing factory sector from a shrinking one.

The worry is that if services follow manufacturing into the doldrums, it spells bad news for the entire economy. But as it turns out, the number jumped smartly in October and comes in way better than expected at 54.7.

Tired of collecting a pittance on your savings? Just be grateful you have a job, peasant!

That was more or less the message from Christine Lagarde during one of her first public appearances in her new role as chief of the European Central Bank.

If you think you’re groaning under the weight of low rates, many Europeans are struggling with negative rates under the policies of Lagarde’s predecessor, Mario Draghi.

But no apologies are forthcoming from Lagarde. Asked about poor yields on fixed-income investments, here’s her response: “Would we not be in a situation today with much higher unemployment and a far lower growth rate, and isn’t it true that ultimately we have done the right thing to act in favor of jobs and of growth rather than the protection of savers?”

Lady in Meeting

Yes, we’re punishing savers but I’m looking very thoughtful while we do it.

Heh… Unemployment in the 19 countries that use the euro as a currency is still 8.2%!

Then again… the official unemployment rate in the United States was 8.1% when Fed Chairman Ben Bernanke delivered a nearly identical message.

It was September 2012. The Fed had just embarked on its third round of “quantitative easing.”

A reporter posed much the same question to Bernanke that Lagarde got last week. And Bernanke gave much the same reply.

“My colleagues and I are very much aware that holders of interest-bearing assets, such as certificates of deposit, are receiving very low returns,” he said. “But low interest rates also support the value of many other assets that Americans own, such as homes and businesses large and small. Indeed, in general, healthy investment returns cannot be sustained in a weak economy, and of course it is difficult to save for retirement or other goals without the income from a job.”

Of course, economic policy is not an either-or proposition of low interest rates versus high unemployment — unless you’re trying to prop up the too-big-to-fail banks, right?

Low interest rates might be one reason physical cash is enjoying a last hurrah on the way to the cashless society.

Or so suggests a new Bloomberg article. “At first glance, cash would appear to be on its way out,” it acknowledges. Sweden is nearly cashless already, and trendy urban shops in the United States take only electronic payments. But “physical currency is experiencing a resurgence…

“In the U.S., for example, currency in circulation stood at an estimated $1.76 trillion as of late September, according to the Federal Reserve. That’s about 8.2% of gross domestic product, up from just 5.6% before the 2008 financial crisis and close to the highest level in at least 36 years.”

Criminal activity alone can’t account for all of that: Thus, the writers aver, “When safe investments such as deposits or government bonds yield little or less than nothing, people aren’t missing out by holding paper money.”

Well, at least as long as paper money is an option. “It’s critical to make all cash digital to prevent citizens from withdrawing physical cash to avoid negative interest rates,” Jim Rickards wrote his readers this week, returning to a familiar warning of his.

But for now, cash is a good thing: “A healthy dose of cash will serve you well in a natural disaster, such as the wildfires raging in California. When credit cards, ATMs and gas pumps don’t work, a Benjamin Franklin $100 bill will still get you food or water when the opportunity presents.

“The elites will still push for a cashless society, but everyday Americans seem prepared to push back.”

“Your item yesterday on the risks of prosecuting Boeing made me ponder whether or not big companies should ever be criminally prosecuted,” a reader writes. “I’d suggest they should not.

“The SNC-Lavalin scandal here in Canada [the one that nearly took down Prime Minister Justin Trudeau] is another example. The relevant decisions, i.e., those which should be prosecuted, are made by human beings at senior levels, not by some mythical corporate body.

“The excuse for not prosecuting was that it would force a big fine on SNC-Lavalin and that would lead to layoffs. Seems the excuse is similar in Boeing’s case.

“I’d suggest that a better way might be to prosecute the appropriate people as individuals (as in the CEO and/or whoever the CEO can finger), ban the use of corporate money on defense lawyers — make them pay their own way just like they’d make their subordinates do — and not levy fines on the company. Incarcerate the responsible people if they’re found guilty.

“Fining a corporation for the misdeeds of its leaders leads to those same leaders paying the fine with money that isn’t theirs anyway, and for them it’s then back to business as usual — how’s that a sanction on those people?

“Sling the bad apples into the hoosegow and the corporation will promote up the next people in line. The next people would take way greater care, and the corporation would not need to lay off anybody lower in the food chain just to cover the cost of the fine, etc.”

The 5: You raise a valid concern. Here in the States people still argue 17 years later about whether the feds should have gone after the Arthur Andersen accounting firm for enabling the epic fraud at Enron.

The Supreme Court overturned Andersen’s conviction in 2005 on grounds that the trial judge fouled up big-time with jury instructions, but by then it was too late; under the weight of the prosecution, the entire auditing side of the business was essentially defunct by 2002.

From here, it seems the problem comes back to the “hired gun” culture of corporate America (and elsewhere). For too many companies, executives collect a fat salary, but they have little to no ownership stake. They have no skin in the game.

And so they’re eager to cut corners for a short-term bump in the share price — because often their compensation is tied to the share price — often at the cost of the company’s long-term health. If those decisions turn out to be shortsighted, it’s no problem for them because they’ve already moved on to the next opportunity.

That’s one reason the gap between the pay of CEOs and the pay of rank-and-file workers has grown so huge in recent decades. What’s more, research we spotlighted five years ago found that the higher the CEO pay, the worse the long-term performance of the stock price!

We’re too humble to say exactly what the solution should be. (It takes enough of our collective brainpower just to uncover good investment ideas.) But we do know the lack of accountability is reaching a crisis level…

Best regards,

David Gonigam

Dave Gonigam
The 5 Min. Forecast

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