There's No Accounting for Bad Taste

Trump's impeachment isn't a big deal to investors... Another topic the market is ignoring today... The poster child of 'cool'... What's cheap?... 'There's no accounting for bad taste'... Maybe I haven't changed that much after all...

You'd think the market would care a lot more about politics than it seems to these days...

Sure, what's happening in Washington can move the markets in the short term. But more times than not, it doesn't have a major impact... and certainly not always how you expect.

Take all this impeachment stuff, for example...

The U.S. House of Representatives voted to impeach President Donald Trump on December 18 – more than a month ago. It was only the third time in nearly 250 years of our country's history that the House voted to impeach a president.

This news might seem like it should be a major concern. Yet, the benchmark S&P 500 Index is up about 4% since the impeachment vote... and continues to hit new all-time highs.

Shouldn't the markets be down at least 5% with the impeachment trial happening in the Senate this week? Isn't this a big deal since this type of thing doesn't happen every day?

Clearly, though, impeachment is not a big deal... based on the market's march higher over the past month. Or maybe, more accurately... this particular impeachment is not a big deal.

Last Thursday, I (Dan Ferris) went to the Wall Street Journal's website...

A breaking news headline flashed on my computer screen, saying the Trump administration illegally froze $214 million intended to provide "security aid" to Ukraine last summer.

The allegations of the withheld aid – published in a report from the Government Accountability Office ("GAO"), the federal government's independent watchdog – landed as impeachment proceedings started in the Senate. The GAO said the White House Office of Management and Budget "violated the [law] when it withheld [the aid] for policy reasons."

Again, this seems like a nugget of news that – at the very least – should cause investors to squirm a little bit. And yet, the markets continued to shake off the uncertainty... At about 10:30 a.m. Eastern time on Thursday – an hour after U.S. markets opened for trading – the S&P 500 was up about 0.5%. The index ended the day up 0.8%... a new all-time high.

It wasn't a big move higher... But it also wasn't a down move.

Maybe investors are simply well-versed in legalese and know nothing will change the Republican-controlled Senate's vote on impeachment. The vote is expected to go along party lines... and therefore, it's expected to result in an acquittal for Trump.

Or maybe the market knows that withholding aid is illegal, but not the "Treason, Bribery, or other high Crimes and Misdemeanors" our country's founding fathers offered as the only impeachable offenses when they put together the U.S. Constitution in 1787.

If I sound like I'm complaining about the market's political agnosticism, I'm not...

In fact, it's just the opposite. I feel vindicated... After years of thinking politics was a huge deal for equity investors, I finally got it through my thick head that it mostly doesn't matter.

That's what I said last Thursday on the Stansberry Investor Hour podcast...

A listener wrote in, asking if former Vice President and current Democratic presidential candidate Joe Biden would be a better president for the stock market. He reasoned that this could be the case because investors hate uncertainty, and Trump is unpredictable.

But as I explained, I don't believe it matters who gets elected. If you think Trump is so different (better or worse) than Obama... or Obama than Bush... or Bush than Clinton, elder Bush, Reagan, Carter, Ford, and so on... then maybe you're not paying attention.

I adopted this view because I finally realized that the skillsets of getting elected and serving in office are too different. It's highly unlikely that one person will ever possess both...

Anybody who can do what it takes to get elected will turn in a mediocre performance at best in office. And anybody capable of a great performance in office can't possibly get elected.

Presidents probably have more in common with dishonest used-car salespeople than with good mechanics or car engineers. (Apologies to honest used-car salespeople everywhere.)

The last time I believed politics could significantly impact the markets was on the night of Trump's election...

Like most Digest readers, I vividly remember that night in November 2016... I won about $1,500 through a Las Vegas gambling site by betting that Trump would win.

Throughout the evening, as it became more likely that he would become our next president, I watched the S&P 500 mini-futures contracts tank 5%... then come screaming back.

I also watched the Mexican peso futures melt down, since Trump promised to undo the existing North American Free Trade Agreement during his campaign... Now that was some serious politically driven market action!

Ever since then, the stock market has screamed upward... hitting new all-time highs again and again. Even Trump's protectionist tariffs against China and other countries couldn't keep stocks down.

I'm not saying the government can't suppress entrepreneurial and other economic activity. It certainly can. I'm just saying that such activity has proven far more resilient in the face of all kinds of policies I would have thought were much more destructive... with the upshot being that it's a bad idea to overreact to political developments (at least here in the U.S.).

Nowadays, the market just doesn't care too much about politics... which is probably a good thing. But unfortunately for many folks, it also doesn't seem to care about something else...

The market doesn't seem to care about the fundamentals of the businesses it represents, either...

I doubt that's a good thing.

Take Apple (AAPL), for example... The tech giant's earnings didn't double last year, yet the stock market chose to double its valuation from 13 times earnings to 26 times earnings.

Why, you ask?

It beats the heck out of me.

Folks just decided that they must own Apple's stock. They need to own it despite reports (here, here, and here) that the company is losing share in the global smartphone market.

You would think that's a big deal... since about two-thirds of Apple's revenue comes from its iPhones. And for the fiscal year that ended in September, its revenue and profits fell slightly.

But hey, the new iPhone is cool. And there's the whole "ecosystem" thing – where you buy an iPhone and you're stuck in Apple's grasp forever. Except, you're not... You can switch to Android at any time, and the biggest thing you lose is the ability to say, "Hey babe, check out my iPhone."

Marketing guru Scott Galloway has claimed an iPhone signals that you're a better mate than an Android user. Regular Digest readers know I value Galloway's insights, but this claim is ridiculous and untrue... Galloway enjoys making controversial statements, exuding a bit of "bad boy" coolness as he does (though I do recommend his book, The Four: The Hidden DNA of Amazon, Apple, Facebook, and Google).

Now, I'm not really sure why it's cool to say the largest public company that has ever existed – at a market cap of roughly $1.4 trillion today – is the poster child of cool.

When I was younger, nothing popular was cool...

If your favorite band became too popular, you complained that it had gone "commercial" – saying its members had sold out. And you voiced those complaints nice and loud, whenever and wherever as many of your friends as possible could hear you.

Then, you spit, cussed, and took a drag on your cigarette... all moves that reasserted your coolness.

It makes me wonder what's not popular among investors today – what's truly dirt-cheap...

So last week, I asked a bunch of my contacts – including several Stansberry Research colleagues – a simple question: What's cheap today? And I received some interesting answers...

Perhaps the most clever response came from economist and asset manager John Hussman. He replied to me on Twitter: "Cash is super cheap if you're using the S&P 500 to buy it."

Longtime Digest readers will recognize Hussman as the guy who found the five valuation metrics that have correlated most negatively with the S&P 500 in recent decades. In other words... when these metrics have been low in the past, the S&P 500's returns have been high over the next decade. When they've been high, the S&P 500's returns have been poor.

These metrics are higher than ever today...

For example, the S&P 500 price-to-sales (P/S) ratio is one of the metrics that Hussman tracks. This P/S ratio currently sits at nearly 2.4... higher than it was even during the dot-com peak (2.36).

According to Hussman, when these metrics get to the type of level they're at right now, the S&P 500's returns are negative for the next 12 years.

Another ingenious response came from former investment banker Paul Portesi... Time.

There's something devilishly clever about saying the most valuable thing in the world is cheap. But it really is a great answer if you think about it... Since you would probably give everything you had for more time, it's never too expensive. It's always cheap.

Believe it or not, I did receive some specific, investing-related responses, too...

My colleague Drew McConnell – co-editor of our DailyWealth Trader service – explained that pre-1933 gold coins are cheap right now. As Drew detailed in a brief e-mail last week...

The premiums for most of these coins are at – or near – their all-time lows... I see it as a no-brainer way to buy gold if you like it. Then you get the optionality of higher premiums if the coin market ever perks up.

I like how Drew specifically mentions the "optionality" of these coins...

No matter what else they're looking for, all great investors constantly search for optionality.

In this case... besides the upside of owning gold, optionality means you also get additional upside potential if these coins become popular with collectors again. With the premiums on these coins near all-time lows, you'll pay less for that upside today than ever before.

And my colleague Bryan Beach – editor of Stansberry Venture Value – sent along a Grant's Interest Rate Observer issue from November, titled, "Take My Wells, Please." It details how cheap U.S.-based oil-producing wells are today. As Grant's analyst Evan Lorenz wrote...

So acute is the distress that wells denoted "proved, developed and producing" are on the block for prices to yield unlevered internal rates of return of 15% to 20%.

Lorenz also quotes an expert, who explains that most of the value from an oil well comes in its first five years of production. And although equity and debt markets for oil wells are somewhere between tight to nonexistent, hedging markets are open for business...

So if you're looking to get into this business today, you can hedge out your commodity price risk for the first five years. By doing that, it becomes more likely that you'll at least get your initial investment back (at the juicy 15% to 20% returns Lorenz noted in the Grant's issue).

But you can't hedge out your expenses or the possibility that the well will run dry and will need to be plugged. Plugging a dry well would cost about $75,000 to $80,000, according to Lorenz.

The biggest hurdle here is that public companies big and liquid enough for most folks aren't trading as cheaply as the individual wells. So to get in on this opportunity, you'll have to be an accredited investor or know the oil business well enough to do all the legwork yourself.

My favorite answer came from Greg Diamond...

Regular readers know Greg is the editor of our Ten Stock Trader trading service. When I asked my colleagues for what's cheap today, he replied with a simple, one-word answer...

Volatility.

We can monitor the amount of volatility in the markets at any given time through the Chicago Board Options Exchange's Volatility Index ("VIX"). It's often referred to as the market's "fear gauge"... because it tells us if the majority of investors are fearful or not.

The VIX measures the one-month expected (or "implied") volatility for the S&P 500. It's the options market's expectations of how much the index will swing over the next month. The higher the VIX, the bigger the expected move.

When stocks fall, volatility generally rises. So a bet on rising volatility is a bet that stocks will fall.

Today, the VIX sits at around 13. It reached an all-time high of roughly 80 during the last financial crisis... And its all-time low was less than 10 in late 2017. So as you can see, the VIX's current value tells us that investors are mostly complacent right now.

A couple years ago, I downloaded all the VIX's closing-price data since its inception in the early 1990s...

I discovered that the long-term average was around 19... but the long-term "modal value" – the value that appears most often – was about 12. In other words, the VIX spends more time at about 12 than any other value.

For a brief time, I tried to use this information to trade VIX futures... I roughly broke even. But more important, I learned a lot about these futures, which I'll never touch again.

You see, VIX futures are defective. They simply don't work.

The nearest-term contract (called the "front month") should roughly reflect any moves in the VIX. But when the VIX soars, this contract doesn't rise nearly as much as the VIX itself... If the VIX doubles or triples, you're lucky to get a 50% move higher from the front month. And it's worse for the second month, the third month, and all the other months.

This disconnect happens because there's no real tie between the futures and the VIX. There's no deliverable VIX commodity... like you have with gold, pork bellies, wheat, or Malaysian palm oil.

VIX-related exchange-traded funds ("ETFs") are based on futures, so they perform poorly, too. These ETFs are some of the worst garbage securities on the market...

Some VIX-related ETFs are debt-based, meaning buyers basically lend money to investment bank Barclays or another big institution... with zero promise to get repaid... and zero interest payments along the way. That sounds like a pretty good deal for Barclays!

Now, I want you to look at a long-term chart for one of these VIX-related ETFs...

The iPath Series B S&P 500 VIX Short-Term Futures ETN (VXX) is the biggest VIX-related exchange-traded product. VXX has about $878 million in net assets today. ("ETN" stands for exchange-traded note, which just means it's debt, not equity like an ETF.) Take a look...

As you can see, the chart looks a lot like a ski slope, falling from the left to the right... a record of endless value destruction. To me, VXX – and all the other VIX-related ETFs – is nothing more than a legal scam to separate unknowing investors from their money.

You shouldn't get all technical with trading VIX futures. Instead, there's a much better – and safer – way for investors to "buy volatility" and profit from rising fear in the markets...

Hold plenty of cash and own some gold.

In a serious equity rout – which almost nobody is predicting right now – those two assets should treat you well. They'll protect your wealth... and allow you to take advantage of all the countless cheap opportunities that arise when other investors have been wiped out.

Perhaps a better question than 'What's cheap today?' is 'Does anybody even care what's cheap?'...

That's the 800-pound gorilla in the room.

Buying what's cheap has effectively gone out of style in the markets. Or to put it like Rob Arnott and his colleagues at global asset manager Research Affiliates did in November...

The current underperformance of value stocks relative to growth stocks [over the past 12 years] has exceeded most, and in emerging markets all, previous drawdowns.

In other words, buying cheap stocks has been a worse idea over the past 12 years than in any previous period in history. That's true, even though, as Research Affiliates pointed out elsewhere in the research report...

Historically, value stocks around the globe tend to win more often than they lose, beating growth over five-year rolling intervals approximately 55% of the time... rising to 70% over rolling 10-year intervals.

Of course, what happened in the past doesn't necessarily tell us anything about what will happen in the future. But the thing is, it isn't just the past we're talking about...

It's the way humans respond to the markets. They love it when markets rise... and hate it when they fall. I can't imagine these human emotions ever changing in a meaningful way.

But being obsessed with owning the biggest, highest-quality, fastest-growing companies can't remain a great idea forever. Ultimately, so many people will have thought it – and acted on it – that it will no longer be a great idea.

Then, these stocks will begin to fall. And as they fall, many of the humans invested in them will panic... and head for the exits.

Maybe once that happens, buying what's cheap will start to look good again...

In another recent report, Arnott and his Research Affiliates team noted...

Since 2007, well over 100% of the shortfall of value relative to growth is due to value becoming relatively cheaper... In the most recent 12-year period, the revaluation component appears to be the key to understanding why growth stocks outperformed value stocks.

This example is like the valuation increase for Apple that we mentioned earlier... except in reverse for the value stocks.

Apple isn't more expensive than it was a year ago because of growth. As we noted, it hasn't even grown... Its revenue and profits shrunk in the fiscal year that ended in September.

Likewise, value stocks are not cheaper right now because these companies earn so much less than faster-growing companies. They're cheaper simply because investors would rather pay a lot more for $1 worth of growth-stock earnings than for $1 of value-stock earnings.

In other words, it's all relative...

The outperformance of growth stocks isn't because those businesses are that much better, on average. The outperformance only exists because the majority of investors have decided they like these stocks better... for reasons that have nothing – or at least proportionally not enough – to do with the difference in the respective businesses' fundamentals.

Growth stocks are expensive because people like them. Value stocks are cheap because people don't like them. Nothing deeper than that. Nothing is inherently better about either.

It's like one of my college professors once said when I criticized modern, atonal classical music...

We were talking in his office one day, and I asked, "Who in the world thinks this is music?" He both lightened the mood and satisfied me with his simple answer, "Well, there's no accounting for bad taste."

There's no accounting for value-averse investors. There's no accounting for anyone who wants to pay twice as much for Apple, even though its revenue and profits both fell last year. There's no accounting for the market not caring about a presidential impeachment.

Maybe it's all just a matter of taste or fashion...

For most investors today, it's fashionable to own Apple's products and its stock. And it's tacky to own cheap assets – like pre-1933 collectible gold coins and oil-producing wells.

I think I've grown a lot since high school. I don't smoke cigarettes anymore. I don't worry about bands going commercial. But maybe I haven't changed that much after all...

The cheap, unpopular stuff is still a lot cooler to me than the expensive, popular stuff.

New 52-week highs (as of 1/22/20): AllianceBernstein (AB), Automatic Data Processing (ADP), Becton Dickinson (BDX), Blackstone (BX), Quest Diagnostics (DGX), Electronic Arts (EA), Western Asset Emerging Markets Debt Fund (EMD), Fidelity Select Medical Technology and Devices Portfolio (FSMEX), Alphabet (GOOGL), Intuitive Surgical (ISRG), iShares U.S. Home Construction Fund (ITB), JD.com (JD), Coca-Cola (KO), Lennar (LEN), Lonza (LZAGY), Medtronic (MDT), NVR (NVR), PepsiCo (PEP), ResMed (RMD), ProShares Ultra Technology Fund (ROM), Service Corporation International (SCI), Sea Limited (SE), ProShares Ultra Utilities Fund (UPW), ProShares Ultra Semiconductors Fund (USD), and Aqua America (WTR).

In today's mailbag, a native of Wuhan – ground zero for the recent virus outbreak in China that we wrote about in yesterday's Digest – shares his thoughts on the situation... Have a question or comment? As always, e-mail it to us at feedback@stansberryresearch.com.

"Thanks for the report this evening. Wuhan is my hometown. I spent 20 years there before immigrating to the U.S. I think the economic impact of the virus outbreak is going to be worse. The big story today is the government announced they will cut off Wuhan. No one will travel out of Wuhan after 10 a.m. this morning. The public transportation within the city, including bus, subway and ferry also stopped.

"The whisper from the ground is that the actual number of infected is much higher and already put a severe strain on the local health care infrastructure. If the situation is not extremely serious, they won't attempt to quarantine a major metropolitan area with 11 million population." – Paid-up subscriber Kejian N.

Good investing,

Dan Ferris
Vancouver, Washington
January 23, 2020