The US Economy vs. the World; the 80/20 Rule in Investing; Top Traders' Favorite Book
The US Economy vs. the World; the 80/20 Rule in Investing; Top Traders' Favorite Book
“We will not have any more crashes in our time.”
Read on nicholasvardy.com
Welcome to the 1200+ Global Guru fans and 2050+ Twitter followers (@NickVardy) who have joined us in our first four weeks on substack.
Today at a Glance:
· Quote: Keynes Crashes
· Chart: The Global Economy
· Article: Invest in the Pareto Principle
· Speculation: Bull Market in Emerging Markets?
· Book: Market Wizards
One Quote:
Keynes Gets it All Wrong
“We will not have any more crashes in our time.”
-John Maynard Keynes (1926)
English economist John Maynard Keynes’ 1936 magnum opus, The General Theory of Employment, Interest, and Money, laid the foundation of the philosophy that dominates the economics profession today.
Yet few economists realize that the 20th century’s most influential economist was a gung-ho financial speculator early in his career. As a young man, he made and lost fortunes betting on highly leveraged commodity and currency futures.
And the quote above reveals precisely why. Like many bright young things, Keynes was overconfident. He pitted his brains against Mr. Market’s brawn.
No prizes for guessing who won.
Keynes famously made his trading decisions each morning while still in bed. He read the morning newspapers before placing trades. Brokers reported to him by phone.
During the Roaring ’20s, Keynes was as caught up in the fervor of the market as anyone.
He remained stubbornly bullish on stocks and commodities during the market crash of 1929.
The result? He lost over three-quarters of his net worth, thanks to poorly timed bets.
The lesson?
Even the most brilliant economists fail at speculation.
And Keynes' failure led him to adopt a much more Warren Buffett value investing style.
But more on that in future issues of The Global Guru.
One Chart:
Countries by Share of the Global Economy
In 2022, the global economy surpassed $100 trillion for the first time.
The chart below depicts the global economy can as a pie, with the size of each slice representing the share of global GDP contributed by each country.
Gross Domestic Product (GDP) measures the total value of economic output—goods and services—produced within a given time frame by both the private and public sectors.
Source: Visual Capitalist
Key points:
· The United States, China, Japan, Germany, and India account for the largest slices of the pie. Together they account for more than half of global GDP.
· China is 73.2% the size of the U.S. economy. Measures that show the Chinese economy as larger than the U.S. are adjusted for Purchasing Power Parity (PPP).
· Most major European economies- the United Kingdom, France, and Russia are comparable to U.S. state economies like California, Texas, Florida, and New York.
One Mental Model:
The Pareto Principle
In 1906, economist Vilfredo Pareto observed that 20% of the population owned 80% of Italy’s wealth.
Soon, experts realized the Pareto principle applied to many situations.
Twenty percent of your efforts generate 80% of your results. Twenty percent of your customers account for 80% of your profits. Twenty percent of your activities account for 80% of your happiness.
Look at your investment portfolio through the lens of the Pareto principle.
You’ll likely find 80% of your gains come from 20% of your investments.
Let’s say you have 100 stocks. You find that 20 of them account for 80% of your profits.
Take 20% of those 20 stocks – four stocks – and they likely generate 80% of the gains of your top 20 stocks.
In the end, you’ll find that four stocks out of 100 – just 4% – generate the bulk of your gains.
Hendrik Bessembinder, a professor at Arizona State University, found that U.S. stocks fit the skewed returns of the Pareto principle remarkably well:
“When stated in terms of lifetime dollar wealth creation, the best-performing 4% of listed companies explain the net gain for the entire U.S. stock market since 1926.”
The Pareto principle teaches that the key to making money in stocks is to bet big on a handful of big winners.
And when you are lucky enough to invest in a top performer, hang on to it.
Little else matters.
One Speculation
A new bull market in emerging markets?
Like beauty, a bull market is in the eye of the beholder.
The popular definition is a 20% rebound from a market’s lows.
The popular iShares MSCI Emerging Markets ETF (EEM) has done just that, rallying 20% off its October bottom.
Based on that measure, emerging markets have just entered a bull market.
What’s more, market breadth recovered as well, with a broad range of stocks participating in the rally.
What does this mean for the months ahead?
According to research by Sentimentrader.com, this is the 8th time in 35 years that emerging markets have rallied 20% from at least a two-year low.
Such a rebound has a record showing longer-term gains, with only one failure in 35 years.
This has meant a rally of at least 30% in emerging markets within the next six months every time.
Key points to keep in mind- or why “this time it’s different.”
· With about 40% of the index in China, EEM is essentially bet on the rebound in a market fraught with political risk, and weighed down by the delayed impact of Covid-19
· The U.S. dollar has pulled back close to 10% since its highs in October. This boosts dollar-denominated returns substantially. Ant rebound in the USD would dent future returns.
· Despite the rally, over 85% of global economies are experiencing slowing growth. Combined with slowing inflation in Q1, such an environment does not favor “risk on” assets like emerging markets.
One Book:
Market Wizards by Jack Schwager
Ask financial traders worldwide to name the book that has influenced them the most…
Chances are they’ll name Jack Schwager’s 1989 classic, Market Wizards: Interviews with Top Traders.
(In second place, you’d have Edwin Lefèvre’s Reminiscences of a Stock Operator, which I have also written about.)
Schwager went on to write a handful of other Market Wizard books, including the most recent: Unknown Market Wizards: The Best Traders You've Never Heard Of.
But 30 years after its publication, Schwager’s first book still sets the standard by which all similar books are judged. And it remains one of the best books about trading.
The book contains interviews with many of the world's top traders, including Paul Tudor Jones, Bruce Kovner, and Stanley Druckenmiller.
Each trader offers his distinctive investment philosophy. Each approach is unique.
So what’s the most critical lesson from Schwager’s classic?
The market wizards are like world-class athletes or musicians. They are the Michael Jordans and Tom Bradys of their professions.
And they operate on a level few of us will ever reach.
But studying what these masters of their craft have in common can make us all better investors and traders.