The Great Debate — Canavan versus Gowdie — Part Two

Madam Chairperson, as the final (and only) speaker for the affirmative side, I intend to expand on the base case outlined in yesterday’s Rum Rebellion.

Before doing so, in the interest of reasoned discussion, we acknowledge there are points of agreement between ourselves and the negative side (Greg).

As pointed out by my learned opponent, my argument is based on the impact a 70% fall on Wall Street would have on index fund and index-hugging investors.

As my colleague rightly points out ‘while the “market” might appear overvalued, that doesn’t mean every stock is too.

On this point we are in complete agreeance.

Since 2015, value stocks — the boring stuff Warren Buffett buys and holds — have fallen further and further behind the performance of growth stocks (Amazon, Apple, Tesla et al).

Port Phillip Publishing

Source: Financial Times

[Click to open in a new window]

Growth is the flavour of the decade.

Eagle-eyed observers will see the same pattern of disconnect occurred during the dotcom boom.

Back then, a good deal of airspace was also created between the blue (growth) and pink (value) lines.

The bursting of the tech bubble helped sort that imbalance out. Growth stocks fell much harder than value stocks.

It’s a fact that not all stocks (and for that matter, all stock markets) have been lifted higher by the rising tide of investor enthusiasm.

Three Deep Value Stocks Currently Under-Priced: These ASX gems could potentially deliver market-beating returns as the economy recovers. Click here to learn more.

Anything glitzy or glamourous or involving gizmos is what’s wowing the crowd. Dull and pedestrian is definitely out of fashion.

Which is why, even the one of the very best stock pickers — Buffett’s Berkshire Hathaway (pink line) — has fallen off the pace of the S&P 500 (blue line).

Port Phillip Publishing

Source: Yahoo! Finance

[Click to open in a new window]

We concur with our colleague’s view ‘there are individual stock picks that give you the ability to take less risk than buying the market.

And therein lies the difficulty for the vast majority of investors…most lack the talent needed to identify and research those ‘value needles in the growth haystack’.

My colleague (and speaker for the negative team) has an excellent track record in stock selection and portfolio management. But that’s an exception, not the rule.

A quick break while I whisper this away from the debate…please don’t tell him this, but I’ve told my wife that should anything happen to me, Greg is the person she needs to contact about managing our portfolio…true story…just keep that between you and me.

OK, back to the topic at hand.

The furphy of ‘relative’

From my experience, the average investor lacks the skill, analytical capacity and emotional discipline to continually identify real long-term value.

Which is why they leave it to the investment industry to manage.

Putting SMSFs to one side, according to the Australian Financial Review (emphasis added):

most Australians have their super in either a “balanced” fund or a lifecycle strategy. Regardless of age, members of balanced funds tend to have about 70 per cent of their money allocated to growth assets [shares, private equity] and the remaining 30 per cent in defensive assets [fixed interest, cash].

A lot of Aussies have the bulk of their investment capital invested in your garden variety ‘balanced’ super fund…which is basically an index hugger.

And as the speaker for the negative side pointed out last week, the same holds true in the US…‘Passive investing now controls over 60% of equity assets, and the majority of that is linked to the S&P 500. A large portion of these assets are in the retirement plans of conservative investors.

An awful lot of mum and dad investors — here and in the US — are unbeknown to them, standing in front of a runaway train. The only unknown is when the collision is scheduled for.

If the US market falls 70% (or more) and our market ‘only’ goes down 60%, then that’s a 40%-plus hit (70% growth asset x 60% loss) to their balanced fund.

This is where the furphy of ‘relative’ performance needs to be addressed.

If the average balanced fund loses (say) 40%, then fund manager/s who lose slightly less than this will instruct their marketing departments to roll out the press release…relative to our competitors we only went down X%.

Fat lot of good ‘relativity’ does if your portfolio goes from $1 million to $650k (a 35% loss).

Intangibles versus tangibles

The concentration of the S&P 500 Index in a handful of stocks is another fact the affirmative and negative sides agree on.

The top 10 stocks account for 27% of the index…and the top five, almost 20%.

Port Phillip Publishing

Source: Slick Charts

[Click to open in a new window]

This is where I start to struggle with shares (in general) being a ‘real’ asset class.


Well, what’s really real?

According to Bank of America research, 84% of the S&P 500 assets are ‘intangible’…

Port Phillip Publishing

Source: Daily Shot

[Click to open in a new window]

What are intangible assets?

This extract is from Investopedia (emphasis added):

Intangible assets are typically nonphysical assets used over the long-term. Intangible assets are often intellectual assets. Proper valuation and accounting of intangible assets are often problematic. Such is due in large part to how intangible assets are handled. The difficulty assigning value stems from the uncertainty of their future benefits. Also, the useful life of an intangible asset can be either identifiable or non-identifiable. Most intangible assets are long-term assets meaning they have a useful life of more than a year.

So, what’s an intangible — goodwill, brand name, IP, patents — really worth?

At present, it’s a case of ‘pick a number, any number’. People don’t care…it’s all about momentum.

The only way analysts can possibly put a ‘value’ on this stuff is using that industry measurement relative.

Relative to the value of Tesla’s (mind-blowingly stupid) intangibles, then Amazon is worth X and Apple worth Y.

But is any of it real?

No. It’s purely subjective. It all depends upon the mood of the day, week or year.

Raconteur, the creators of the following infographic, provide this commentary on tangible assets (emphasis added):

Tangible assets are easy to value. They’re typically physical assets with finite monetary values, but over the years have become a smaller part of a company’s total worth. Technology disruption continues in artificial intelligence, robotics and cloud computing. As such, intangible assets have grown to represent the lion’s share of corporate valuations. But without a physical form and the ability to easily convert them into cash, working out what these assets are truly worth can be challenging.

Reread that last bit…working out what these assets are truly worth can be challenging.

The infographic is a little hard to read, so here’s the link to the original.

Port Phillip Publishing

Source: Raconteur

[Click to open in a new window]

The majority of the US glamour stocks have 80–100% of their worth backed by the valuing challenging vagaries of intangibles.

One day, first mover investors could wake up and decide ‘you know what, I don’t think this intellectual stuff is worth what it’s priced at…time to sell’.

The intangible puffery supporting valuations can easily disappear. So, what’s really real?

By the way, you know what’s considered a tangible asset? Good old cash. That boring stuff everyone loves to ridicule.

However, when the chips are down, it’s the one asset people are desperate to own.

Greg is correct, money in real (genuinely real) assets will weather the coming market storm far better than index funds.

However, to sort the fakes from the real stuff, you need to either possess the stock picking skills or outsource this to somebody who does.

And even then, only allocate an amount you feel comfortable with being belted around by a market in full-blown panic mode.

The one asset we differ on… bitcoin

There is one ‘real’ asset Greg and I do differ on…bitcoin.

If ever something was valued purely on intangibles, it has to be this very clever piece of computer code. It’s backed by nothing other than blind belief.

The cultish fervour in this fabricated-out-of-thin-air stuff completely baffles me.

What is it worth? Basically, what some other sect member thinks (or more to the point, doesn’t think) its ‘value’ is.

Ah, but this is another debate for another day.

However, I will leave this for you to ponder.

Gold has been a store of wealth for thousands of years. Will it still be here in another 10, 20, 100 or 1,000 years? I think so.

Bitcoin has been (and I’m experiencing a tightness of the throat as I type this) a store of wealth (there I got it out) for 10 years…will it still be here in another 10, 20, 100 or 1,000 years?

Or will an even smarter programmer come up with a crypto that’s even better? And we won’t even mention what desperate governments might or might not do.

Until next week…


Vern Gowdie Signature

Vern Gowdie,
Editor, The Rum Rebellion

Vern has been involved in financial planning since 1986.

In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners.

His previous firm, Gowdie Financial Planning, was recognised in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top five financial planning firms in Australia.

In 2005, Vern commenced his writing career with the ‘Big Picture’ column for regional newspapers and was a commentator on financial matters for Prime Radio talkback.

In 2008, he sold his financial planning firm due to concerns about an impending economic downturn and the impact this would have on the investment industry.

In 2013, he joined Fat Tail Investment Research as editor of Gowdie Family Wealth. In 2015, his book The End of Australia sold over 20,000 copies and launched his second premium newsletter, The Gowdie Letter.

Vern has since published two other books, A Parents Gift of Knowledge, all about the passing of investing intelligence from father to daughter, and How Much Bull can Investors Bear, an expose on the investment industry’s smoke and mirrors.

His contrarian views often place him at odds with the financial planning profession today, but Vern’s sole motivation is to help investors like you to protect their own and their family’s wealth.

Vern is Founder and Chairman of The Gowdie Advisory and The Gowdie Letter advisory service.

The Rum Rebellion