In Search of the Perfect Investment

Half the country is up in arms about Washington —  from “alternate facts” to crazy cabinet appointments, from Muslim bans to midnight tweets slamming a judge or two.

The other half is tagging along, giving Mr. Trump the benefit of the doubt, for now.

Here’s my theory on how to make sense of it all and  what implications it will have for our investments in the next few years.

Two things are going on:

First and foremost, there’s the Trump businesses. They come first. It’s not America First. It’s Trump First. The hotels, the overseas real estate, the clothing businesses, etc. Foreign dignitaries stay at the Trump Hotel in Washington to curry favor. If you don’t do business with Trump, your people are banned from coming to the U.S. Trump has no business interests in the seven countries he’s tried to ban immigration and refugees from. The Secret Service is paying huge rent for space in the Trump Tower. Government events are held at the hugely-expensive, lavish Mar-a-Lago Trump Florida operation.Then there’s Nordstrom. See below. The list goes on and on. The man has interests in places we don’t know about. Hence no public tax returns. And there never will be.

Friend Putin is the richest man in the world. He stole his wealth from Russia. That’s called kleptocracy. We’re not there, yet.

Second, Trump needs to retain his power base — the Republican party. Hence, let them pursue their own agenda, so long as it doesn’t affect his goal of getting richer. The Republican agenda includes reducing government, slashing regulations (even sensible ones) and (most importantly) cutting riches for the ultra-rich. The real reason the Republicans hate Obamacare is that it levied a hefty tax surcharge on the high incomes of their main contributors.

All this should be good for corporate and private earnings — hence the market’s solid rise of the last three months:

But our Federal government is about one quarter of our GDP. Whatever monies you cut out of its spending comes out of someone’s pocket, when they then can’t spend and down it all comes.

I’m not forecasting a Trump Recession in the next two-three years — though a lot of my friends are. History is on their side, though. This chart is from a recent presentation by Joachim Fels of PIMCO, called “Into the Unknown.”

If you’d like to review all the slides in the deck, click PIMCO_Into_the_Unknown_Joachim_Fels_Presentation

I don’t talk to many hedge fund managers. But I scour for tidbits, for a hint on what the best are doing. This is the best I’ve found in recent days:

A Quiet Giant of Investing Weighs In on Trump by Andrew Ross Sorkin of the New York Times.

He is the most successful and influential investor you have probably never heard of. His writings are so coveted and followed by Wall Street that a used copy of a book he wrote several decades ago about investing starts at $795 on Amazon, and a new copy sells for as much as $3,500.

Perhaps that’s why a private letter he wrote to his investors a little over two weeks ago about investing during the age of President Trump – and offering his thoughts on the current state of the hedge fund industry – has quietly become the most sought-after reading material on Wall Street.

He is Seth A. Klarman, the 59-year-old value investor who runs Baupost Group, which manages some $30 billion.

While Mr. Klarman has long kept a low public profile, he is considered a giant within investment circles. He is often compared to Warren Buffett, and The Economist magazine once described him as “The Oracle of Boston,” where Baupost is based. For good measure, he is one of the very few hedge managers Mr. Buffett has publicly praised.

In his letter, Mr. Klarman sets forth a countervailing view to the euphoria that has buoyed the stock market since Mr. Trump took office, describing “perilously high valuations.”

“Exuberant investors have focused on the potential benefits of stimulative tax cuts, while mostly ignoring the risks from America-first protectionism and the erection of new trade barriers,” he wrote.

“President Trump may be able to temporarily hold off the sweep of automation and globalization by cajoling companies to keep jobs at home, but bolstering inefficient and uncompetitive enterprises is likely to only temporarily stave off market forces,” he continued. “While they might be popular, the reason the U.S. long ago abandoned protectionist trade policies is because they not only don’t work, they actually leave society worse off.”

In particular, Mr. Klarman appears to believe that investors have become hypnotized by all the talk of pro-growth policies, without considering the full ramifications. He worries, for example, that Mr. Trump’s stimulus efforts “could prove quite inflationary, which would likely shock investors.”

And he appears deeply concerned about a swelling national debt that he suggests could undermine the economy’s growth over the long term.

“The Trump tax cuts could drive government deficits considerably higher,” Mr. Klarman wrote. “The large 2001 Bush tax cuts, for example, fueled income inequality while triggering huge federal budget deficits. Rising interest rates alone would balloon the federal deficit, because interest payments on the massive outstanding government debt would skyrocket from today’s artificially low levels.”

Much of Mr. Klarman’s anxiety seems to emanate from Mr. Trump’s leadership style. He described it this way: “The erratic tendencies and overconfidence in his own wisdom and judgment that Donald Trump has demonstrated to date are inconsistent with strong leadership and sound decision-making.”

He also linked this point – which is a fair one – to what “Trump style” means for Mr. Klarman’s constituency and others.

“The big picture for investors is this: Trump is high volatility, and investors generally abhor volatility and shun uncertainty,” he wrote. “Not only is Trump shockingly unpredictable, he’s apparently deliberately so; he says it’s part of his plan.”

While Mr. Klarman clearly is hoping for the best, he warned, “If things go wrong, we could find ourselves at the beginning of a lengthy decline in dollar hegemony, a rapid rise in interest rates and inflation, and global angst.”

Mr. Klarman is a registered independent and has given money to politicians from both parties. He has donated to Jeb Bush, Chris Christie, Marco Rubio, John McCain and Rudolph W. Giuliani as well as Hillary Clinton, Cory Booker and Mark Warner.

While he has remained largely outside the public eye, Mr. Klarman surprised some of his friends and peers over the summer when he issued a statement after Mr. Trump criticized a judge over his Mexican heritage, saying he planned to support Mrs. Clinton: “His words and actions over the last several days are so shockingly unacceptable in our diverse and democratic society that it is simply unthinkable that Donald Trump could become our president.”

In his recent letter, he explained for the first time his decision to say something publicly. “Despite my preference to stay out of the media,” he wrote, “I’ve taken the view that each of us can be bystanders, or we can be upstanders. I choose upstander.”

From the letter, it is hard to divine exactly how Mr. Klarman is investing his fund’s money. His office declined to comment on the letter, which I obtained from a source. His fund currently has more than 30 percent of its funds in cash. He has lost money in only three of the past 34 years.

What investors say publicly and what they do in the markets can be different things. Mr. Buffett campaigned publicly against Mr. Trump, but he has nevertheless invested in the market since his election – about $12 billion, according to a recent disclosure. George Soros, who also actively campaigned against Mr. Trump, bet – wrongly so far – that the stock market would fall; he lost about $1 billion.

Most hedge funds have found themselves on the losing side of trades over the past several years, a point Mr. Klarman addressed in his letter. Noting that hedge fund returns have underperformed the indexes – he mentioned that hedge funds had returned only 23 percent from 2010 to 2015, compared with 108 percent for the Standard & Poor’s index – he blamed the influx of money into the industry.

“With any asset class, when substantial new money flows in, the returns go down,” Mr. Klarman wrote. “No surprise, then, that as money poured into hedge funds, overall returns have soured.”

He continued, “To many, hedge funds have come to seem like a failed product.”

The lousy performance among hedge funds and the potential for them to go out of business or consolidate, he suggests, may become an opportunity.

Perhaps the most distinctive point he makes – at least that finance geeks will appreciate – is what he says is the irony that investors now “have gotten excited about market-hugging index funds and exchange traded funds (E.T.F.s) that mimic various market or sector indices.”

He says he sees big trouble ahead in this area – or at least the potential for investors in individual stocks to profit.

“One of the perverse effects of increased indexing and E.T.F. activity is that it will tend to `lock in’ today’s relative valuations between securities,” Mr. Klarman wrote.

“When money flows into an index fund or index-related E.T.F., the manager generally buys into the securities in an index in proportion to their current market capitalization (often to the capitalization of only their public float, which interestingly adds a layer of distortion, disfavoring companies with large insider, strategic, or state ownership),” he wrote. “Thus today’s high-multiple companies are likely to also be tomorrow’s, regardless of merit, with less capital in the hands of active managers to potentially correct any mispricings.”

To Mr. Klarman, “stocks outside the indices may be cast adrift, no longer attached to the valuation grid but increasingly off of it.”

“This should give long-term value investors a distinct advantage,” he wrote. “The inherent irony of the efficient market theory is that the more people believe in it and correspondingly shun active management, the more inefficient the market is likely to become.”

How Mr. Klarman wants investors to behave in the age of Trump remains an open question. But here’s a hint: At the top of his letter, he included three quotations. One was attributed to Thomas Jefferson: “In matters of style, swim with the current; in matters of principle, stand like a rock.”

The Nordstrom flap

Nordstrom dropped the Ivanka clothing line saying “sales of the brand have steadily declined.”

Her father tweeted and then re-tweeted his anger:

Look what happened today (Wednesday Feb 8) to Nordstrom’s stock:

Click on the image if you can’t see all of it.

Every company should be so lucky as to be slammed by Mr. Trump. You can read more of the story in Forbes.

Lifting weights wrongly. From reader George Ralph:

Harry, “Don’t do stupid” is good advice but “lay off the weights” is bad advice.  Strength training, including weight lifting, if done right, can help avoid accidents like falls and hurting one’s back.  The problem with lifting weights is not the weights.  The problem is that most men, rather than using good technique and lifting a reasonable amount that is beneficial, have to see how much they can jerk up, down, in or out 1 or 2 times and then brag, “I’ve still got it”.  I’m no body builder at 73 years old and certainly no expert on lifting but I’ve been lifting weights for about 15 years and the one thing I consistently see people doing wrong is men trying to lift more than they should and women lifting less than would be most beneficial to them.

Stuff:

+ Passwords are best when they’re all in lower case. They’re easier to remember and easier to use. With some devices — e.g. Roku — it’s really difficult to insert capital letters and make them stick. Most systems won’t accept your password, if one of your letters is not in the case it should be. Make them all lower case.

+ The older I get,  the less I want to have anything to do with dietary supplements, vitamin pills and painkillers.  To wit, a recent Harvard study suggests the frequent use of ibuprofen or acetaminophen may be a killing your hearing.

+ Internet scamming, pfishing, ransom-waring, thievery etc. is getting more enticing. To wit: Two emails I received today. They contain horribleness.

+ Quora.com is the biggest time waster of all. But it’s also the most fascinating. Sample:

Favorite sign

Favorite Borowitz of the week

TAMPA (The Borowitz Report)-In a blistering attack on the media, President Trump said on Monday that the press has consistently refused to report the voices he hears in his head every day.

Trump praised the “really terrific information” he gets from the voices, which often speak to him when he is roaming the White House in his bathrobe in the middle of the night.

“They tell me that I won by the most votes ever and had the biggest Inauguration crowd ever,” Trump said. “These are fantastic voices and they’re doing a great job.”

Trump said the refusal to report what the voices tell him makes the media “the most dishonest people on earth.”

“There might be a hundred people protesting outside the White House, and at the exact same time, five hundred voices talking to me inside my head,” he said. “Guess which the press will write about?”

Offering an example of the media’s deceitfulness, Trump referred to the widely circulated story about him hanging up on the Prime Minister of Australia. “What they didn’t say is that I had to hang up because I was getting an incoming call in my head,” he said.

Trump said that because the voices in his head “keep saying that I’m the best President ever,” he does not expect the media to quote them anytime soon.

“If you want to find out what the voices in my head are saying, don’t even bother reading the newspaper,” he said. “Follow me on Twitter.”

Harry Newton, who apologizes for this being the first blog this week. I tried to think seriously about what was happening and what it means for investments. Are we becoming a kleptocracy, like so many failed countries in South America, Africa and Asia? Or will be pull out of this? Will our checks and balances and our three branches of government save us? Who knows? What I do know is that investors, businessmen and markets don’t like volatility and uncertainty. America is a strong resilient country. But we often don’t realize how so much of our daily lives depends invisibly, but decisively on politics.  Through all of this, it might be good to have least five years of living expenses neatly tucked away in cash — not gold, not jewels, not artwork. Just cash. Trust me on this one.