Week #46 Essence of Peter Lynch; Why I Buy Bombed Out Stocks; "China Miracle" RIP

The Rule of 72; Testing My Predictions for 2021

Today at a Glance:

One Quote: "That's all there is to it."

One Strategy: Buy Bombed Out Stocks

One Dead Narrative: China Miracle RIP

One Rule: “The Rule of 72”

One Prediction: How’d I do?

One Quote

Some event will come out of left field, and the market will go down, or the market will go up. Volatility will occur. Markets will continue to have these ups and downs. … Basic corporate profits have grown about 8% a year historically. So, corporate profits double about every nine years. The stock market ought to double about every nine years… The next 500 points, the next 600 points — I don’t know which way they’ll go… They’ll double again in eight or nine years after that. Because profits go up 8% a year, and stocks will follow. That's all there is to it.

                                                                                         -Peter Lynch

Peter Lynch’s quote offers three essential bits of wisdom.

First, remember that market fluctuations are normal. Some event will always come out of left field, sending stocks down or up. But over the long haul, corporate profits have grown around 8% annually. View volatility as your ally. It provides chances to buy low and sell high.

Second, stocks go up over time. Despite corrections and crashes, stocks have historically gained ground over decades. Corporate profits double every nine years or so. Stocks ought to double in nine years as well. Over time, stocks follow profits up.

Finally, temper greed with patience. When others turn fearful amidst volatility, recall Lynch's advice. Buy bargains. Don't chase speculative bubbles. Restrain your inner speculator.

One Strategy

Buy Bombed-Out Stocks

“The test of a first rate intelligence is the ability to hold two opposed ideas in mind at the same time and still retain the ability to function.”

-Voltaire

We all have our shortcomings.

I have mine.

On the one hand, I understand that stocks are driven by earnings growth. And I invest the bulk of my portfolio accordingly.

On the other, I firmly believe that over the short term, financial markets are driven by market sentiment- and little else.

And I also know that I have an "inner speculator" who needs an outlet to meet that need.

As a result, I've developed a speculative (as opposed to "investing") strategy that fits my contrarian bent.

I’ve always made the quickest money buying stocks, sectors, and countries left for dead.

In other words, I love to buy bombed-out stocks.

My First Trade

Here’s the first such trade that put me on this trajectory.

After the Russian stock market crash in August 1998, I bought a Russian oil company named Tatneft – no longer listed on the NYSE- for $5.00 a share in early September.

I placed a GTC sell order at $15.00, happy at the prospect of tripling my money over the next year or so. The market rebounded sharply. And it the stock hit $15 within about eight trading days.

I had tripled my money in next to no time. I was hooked.

I took away several lessons from this.

1)    Buying bombed-out stocks when they are down 90% (or more) offers terrific payoffs. Buy a stock down 98%; if it recovers to 90% down, you've made 4x your money.

2)    Market sentiment can turn on a dime. You need to act fast to make the biggest gains.

3)    The harder it is psychologically to place a trade, the more likely you will profit.

4)    Timing the exit is even harder than buying.

Sure, tripling your money is great. But leaving money on the table -as I have - also leaves me squirming.

I repeated this strategy with cruise ship stocks after the pandemic and Ukrainian cell phone companies after the Russian invasion.

I currently have a similar trade on in a financial newsletter publisher where I expect to triple my money.

A word of advice: I follow this strategy with a small part of my portfolio.

The remainder I invest in a range of far less risky stocks.

One Dead Narrative

China Miracle RIP

As a lad growing up during the Cold War, I was bombarded with two relentless media narratives:

First, the mighty Soviet Union would soon dominate the U.S. militarily.

Second, Japan would inevitably overtake America as the #1 economic power.

Today, the Soviet Union no longer exists, consigned to the ash heap of history. Japan has slid to the humble rank of the world's #4 economy, overtaken by the U.S., China, and, as of 2023, Germany.

Just two short years ago, China seemed to defy the fate of Soviet military power and Japanese economic strength.

The Western media heaped praise on China for its handling of COVID-19. China's economy rebounded rapidly, growing faster than any other major nation.

My, how swiftly the narrative has changed!

Today, the China growth story lies in tatters.

Here are seven key facts that signal the demise of China as a potential #1 power:

1. China's GDP has shrunk to just 64% the size of America's, roughly where it stood back in 2017. Just two years ago, China's economy was 75% the size of the U.S.

2. The World Bank has slashed China's expected annual growth to 4.5% over the next two years. That's a whole percentage point lower than it predicted a decade ago. The IMF sees China's growth languishing at 3.9% annually over the next five years. - a marked slowdown from the 10% average pace from 1980-2010.

3. China's debt-driven infrastructure binge has burdened the country with pointless airports, empty ghost cities, and "bridges to nowhere." For example, the relatively poor province of Guizhou is improbably home to 23 of the world's 100 highest bridges.

4. China's fertility rate has plunged to just 1.1 births per woman - one of the lowest rates on Earth. Demographics is destiny, and China's shrinking population heralds a Japanese-style malaise.

5. President Xi's regulatory crackdown on private businesses has chilled entrepreneurship and destroyed over $1 trillion in wealth.

6. Venture capital flows into China have shriveled to just 32% of America's level, down from 85% in 2018.

7. Foreign direct investment into China's strategic sectors has collapsed by 60% since 2015.

Make no mistake: China is not about to implode just yet. Reports of the Communist giant's impending demise remain greatly exaggerated.

Still, all signs suggest the Middle Kingdom's grand aspirations to lead the global economy have been set back. And it just might be forever.

One Rule

“The Rule of 72”

Patience pays when growing wealth. Harnessing the mighty power of compounding requires time. Yet, with discipline, even modest gains can double your money surprisingly fast.

The Rule of 72 offers a quick shortcut to calculate how many years it takes to double your money.

You divide 72 by your annual rate of return.

Generate 10% a year? It takes 72/10 or 7.2 years to double your money.

The graphic below applies to the Rule of 72 shortcut.

Here are three takeaways.

First, park cash in a savings account, earning 0.6% yearly. At that crawl, it takes over a century for money to double. Inflation has averaged 3.3% over the last century. That means that taking inflation into account, an investor would see their money lose value.

In contrast, the S&P 500 has averaged 11.5% annual returns. Applying the Rule of 72, your money doubles in just six years.

Second, slight differences in returns matter hugely over long horizons. Real estate plods along at 4.4% yearly, doubling every 16 years. Yet, your money doubles twice as fast at the stock market's pace. Over decades, this difference compounds into a staggering difference. Had you invested $100 in the S&P 500 in 1928, today, you'd have over $600,000.

Finally, regular investing converts modest gains into wealth. The S&P has doubled roughly every decade since 1949. By regularly investing even small amounts, compounding turns your money into a snowball over time. As Bernie Madoff famously admitted, compound interest is an unstoppable force.

The key takeaway is simple yet profound: harnessing the power of compounding requires patience and discipline. Avoid the restless pursuit of quick gains. A long horizon and steady contributions transform modest savings into life-changing wealth.

One Prediction

So How'd I do?

Market pundits make predictions all the time.

But few are called on whether they were right or wrong.

Below is a video of predictions I made back in 2020 at the depths of the COVID-19 pandemic.

If you take the time to watch the video, you'll see that many of my points still stand.

Three things stick out to me.

First, my predictions were timeless. I would feel as comfortable making them today as I did then.

Second, I based my predictions on principles, not prophecy. I reaffirmed that my most significant edge in the market is my understanding of history. In financial markets, the same stories play out year after year, decade after decade.

Same story, different characters

Third, the insight on buying bombed-out stocks and sectors is the one that has made me the most money.

Most of these contrarian bets have generated substantial profits. I only regret that I did not hold on to them long enough.

If you appreciate a historical perspective on markets, head to The Bubble Blog.

There, I share excerpts from my upcoming book on the History of Financial Speculation.