How to Make Volatility Your Friend


This article was written by Joshua M. Brown

I am on vacation.

Here are two doors you can walk through:

Door number one – you spend 15 years putting $1000 into an investment every month, with the possibility of seeing that investment get cut in half twice.

Door number two – you spend 15 years putting $1000 into an investment every month, with the same annual performance of what’s behind door number one, but no drawdowns.

Which would you choose?

On the surface, you’d choose door number two. Of course you would, who wouldn’t?

But it’s the wrong choice. The trick here is to remember that you’re adding to the investment at a rate of $1000 per month. That’s when you realize that door number one, with its twin 50% crashes, is the better option.

It’s the harder choice to live with, of course, but that’s what the money’s for. Had you done this over the disappointing period for stock returns between 2000-2014, you would have lots of money to show for your troubles. Much more money than had you chosen the steadier option.

Eric Nelson at Servo Wealth explains how this is possible, by looking at an investor who chose to buy $1000 worth of the S&P 500 each month over the 15-year period versus the investor who chose to buy the more stable Vanguard Short Term Bond Index.

Despite only saving $180,000 cumulatively, your total ending portfolio value was $352,202—twice as much as you saved—for a rate of return on your contributions of +8.5% per year!     How can this be?  The S&P 500 only averaged +4.1%.  But not all of your savings averaged 4%.  Some money went in after 2001 and 2002 and 2008 and 2011 when shares were extremely depressed and subsequently earned returns of +12%, +15% and +20% or more…

We can see the opposite effect when we observe the outcome of dollar-cost-averaging the same amount into the low-risk bond fund.  Remember, it had the same annual compound return over the 15-year period.  But the amount of accumulated wealth was only $228,294, almost $130,000 less than what you netted from the S&P 500.

Josh here – The magical part is that the two investment choices both did around 4.1% annually on average. But by taking advantage of the short-term declines – systematically (which is the key) – investors can learn to embrace the volatility that ends up punishing some, but rewarding others with higher than average returns.

Conditioning yourself to love drawdowns is not easy – and the more money you have at risk, the harder it is. Younger people with 401(k) plans and newer brokerage accounts can use the power of DCA (dollar cost-averaging) – this is one critical advantage they have over their parents and grandparents. If they take advantage of it, the magic of compounding doesn’t take very long to appear.

Don’t flee from volatility, understand how it helps you and make it your friend.


He is a New York City-based financial advisor at Ritholtz Wealth Management. He helps people invest and manages portfolios for them. You can also find him on CNBC’s “Fast Money” show.

In my humble opinion, you can even get more bang for your monthly investment plan by putting your money to work on days that the stock market is down 1.5% or more.

Disclaimer – Past performance is not a guarantee of future results. This content is provided for informational purposes only! It is not to be viewed as a recommendation or endorsement of any particular security, products, or services. 



Insider buying of U.S. bank stocks

Happy Valentine’s Day from Smart Money and a gift from Jamie Dimon who surprised the markets with a large purchase of JP Morgan shares. He announced on Thursday that he was buying  500,000 shares of the company that he runs. He is investing about $25 million of his own money. The stock was down 20 percent for the year. Is this a sign that JP Morgan stock is undervalued?

Mr. Dimon already owns 6.2 million shares and he hasn’t been a big purchaser of stock. The last two times he bought 500,000 shares was back in July 2012 and January 2009. He’s not the only one, several bank insiders have bought stock in the past couple weeks.

“These purchases have been significant. In the case of Citigroup, the CEO and Chairman bought $1 million each. Four insiders at Huntington Bancshares recently bought $1.3 million. Radian’s CEO not only bought shares, but the bank initiated the first company buyback plan.”

Not only are U.S. bank stock prices down 20 percent on average, but most of the big banks are trading at a substantial discount to tangible book value.

  • Goldman Sachs: 0.87
  • Regions Financial: 0.84
  • Comerica: 0.79
  • Morgan Stanley: 0.72
  • Bank of America: 0.72
  • Zions: 0.72
  • Citigroup: 0.58

JP Morgan is one of the few banks that trades above tangible book value at 1.1 and Wells Fargo is another at 1.62! However, Mr. Dimon has a track record of buying his company’s stock at opportune times.

I am waiting for the big banks to get uglier

My previous post contained reasons why the European banks are in terrible shape and how the selloff in Europe has spread to North American banks. Investors are worried that there is a risk for some European banks to fail. I expect more negative news regarding some Italian banks, plus ongoing problems in Greece may resurface soon, adding more fear of a banking crisis.

I have also recently learned that sovereign wealth funds of oil-producing countries have 48% of their assets invested in the financial sector. I believe that many of these funds have been selling bank stocks because they need money to fund their social programs at home due to lower-income from selling cruel oil.

Now, bank earnings for the four quarter were very good but it didn’t stop the selloff. First quarter earnings could be ugly if the price of crude oil doesn’t find a bottom soon. Fears of oil trading below $20.00 will add doubts that the banks can handle large loan losses from the oil patch.

The Federal Reserve has lost some credibility, more reactive than proactive

In remarks Thursday to a Senate committee, Fed Chair Janet Yellen acknowledged that the central bank hasn’t even studied the possibility of negative interest rates. Hello, the ECB, BOJ and the Swiss have already adopted negative interest rates. Don’t you think that the Fed should have done their homework regarding the possibility of adding another policy tool to their tool box to avoid a U.S. recession? I am not even sure that it is an effective tool but there are lots of data that should be studied.

The Fed is still on the fence regarding future rate hikes which is still a big issue for me. I am waiting for a clear direction on interest rate policy before investing in U.S banks. Being Canadian, I have only a limited amount of U.S. funds to invest.

That being said, U.S. bank stocks are cheap and most of the major ones are trading at big discounts to book. I would look for more announcements of insider buying and share buybacks. They could stay cheap for the next quarter or two but for long-term investors, insider buying is a positive signal to allocate some funds into the financial sector.

Now go out and spend some money on Valentine’s Day. Help keep the economy from going into a recession.

Is there a banking crisis brewing?


Last year I wrote a blog post on how U.S. hedge funds were shorting Canadian banks based on their loan exposure to the oil patch. If you eliminate the drop in value of the Canadian dollar, the actual stock prices have dropped marginally. Plus when you short a stock, you have to pay the quarterly dividend until you repurchase it. The short trade has been a poor bet so far if you add back the cost of having to pay the bank dividends.

However, it seems that hedge funds have turned their attention to shorting European banks. Everyone seems to think there is some kind of crisis. The stock prices of European banks seem to be telling us something is wrong! As of the closing prices of Feb 8th, the Year to date prices are: Deutsche Bank down 35.6%, Credit Suisse down 33.4%, BNP Paribas down 25.3% and UBS down 22.8%, yikes!

Here are some concerns about European banks:

  • Ongoing restructuring and litigation charges.
  • Flattening yield curve/negative rates.
  • Slower European growth.
  • Asset management slowdown. Asset management has suffered because wealthier clients aren’t investing.
  • Book value issues: European banks did not take the big write-downs that U.S. banks took; there’s concern there may be more asset write-downs that would cause book values to decline.
  • Capital positions: While the U.S. banks were out raising capital and selling new shares in 2008-2009, the European banks didn’t. The result: U.S. banks don’t need to raise capital, but European banks probably do.

I understand why there is concern in Europe but investor anxiety regarding banks has spread to U.S. banks causing a selloff. Part of the downdraft has been caused by the debate on future interest rates hikes by the Fed. Raising interest rates are actually good for bank profits from their loans. International exposure is another headwind for many U.S. multinational banks. Finally, many banks are trading below book value because investors believe that some of those assets contain oil loans that will be written off.

I have no doubt that short sellers are also pushing these stocks as far as they can go, into irrational territory. What is happening now is that guys who were long these stocks are being forced to sell simply to reduce exposure. Bank of America is down 27.1%, Citigroup is down 26.7%, Wells Fargo is down 14.5% and Goldman Sachs is down 17.2%.

The chart below is three financial indexes, XFN is Canadian, XLF is U.S. and EUFN is Europe.


According to Hedge Fund manager Kyle Bass, more pain in the banking sector

Bass is best known for making a winning bet on the subprime mortgage crisis and later profiting from his call that the Japanese yen would fall in tandem with a projected round of monetary stimulus by the Bank of Japan.

Kyle Bass has been ringing the alarm bells about China’s banking system and the yuan for months. The premise of Bass’ bet goes like this: China’s banking system has grown to $34.5 trillion, equal to more than three times the country’s GDP. The country is due for a loss cycle as cracks begin to show in its economy.

When that happens, central bankers will have to dip into China’s $3.3 trillion of foreign exchange reserves to recapitalize the banks, causing a significant depreciation in the value of the yuan. He said China’s export-import industry requires China to maintain $2.7 trillion in foreign exchange reserves to continue operating smoothly, citing an International Monetary Fund assessment.

Bass confirmed Wednesday he is devoting much of his fund to his bet the yuan will depreciate. He characterized shorts against the currency, including his, as totaling “billions.”

The market will ultimately come to view a 10 percent yuan devaluation as “a pipe dream,” he said. “When you look at the size of the imbalance and the size of their economy, it’s going to go 30 or 40 percent in the end, and it’s going to be the reset for the world.”

China’s controlled devaluation of the yuan this year has sparked growth concerns that shook the equity markets around the world and contributed to the worst January for the Dow and S&P 500 since 2009. If Kyle Bass is right on China’s banking problem, than stock market declines around the world will get even worse.

I have been slightly bearish on stocks since mid-December and most of my January posts have contained more negative than positive views. However, North American banks are in much better shape than during the great recession. Canadian banks have been on my buy list for quite awhile. I am now adding some U.S. banks to the list. I am patiently  waiting for a bottom in oil prices and more information on future loan loss provisions.



Are you ready for a great near term buying opportunity in North American bank stocks or is there another banking crisis coming?




Money managers betting on a rebound in crude oil, selling growth stocks.

Oil Produx v prices

U.S. oil production continues to defy forecasts because it hasn’t declined. Refiners are processing as much of the stuff as they can, the glut of oil, gasoline and diesel fuel keeps growing. The U.S. has now stockpiled 1.2 billion barrels of crude. The growing supply in Cushing, Oklahoma and elsewhere has analysts concerned that oil will start becoming difficult to store.

Another factor driving oil prices higher was speculation that OPEC members may strike a deal with Russia to cut production. Analysts reviewing the possibility of the deal are doubtful that such a meeting could take place but some argue that Russia’s options for tackling a deteriorating economy are running out.

The Russian economy, along with other less stable oil producing nations, are under major strain with economists predicting further contraction in 2016. It looks like Russia could be facing a second year in recession. The Kremlin is now in a difficult position where it has to choose between further spending cuts or drawing down its sovereign wealth funds.

U.S. ratings agency Fitch said the Russian government has asked ministries to identify 700 billion rubles ($9 billion) of cuts, which will help with the deficit but will also likely dent demand in an economy weakened by lower oil prices and rouble volatility.

Several analysts agree that Russia is trying to talk up the oil markets by hinting at the possibility of production cuts and its willingness to holding meetings. A OPEC deal is unlikely, given the fact that Iran is just now returning to market.

“Genscape reports that a first shipload of oil left Iran for South Korea as sanctions against Iran were lifted. The tanker, Serena, left Iran on Jan. 15 and docked at Fujairah before setting a course for South Korea on Jan. 20.

“The ship had been moored for a year, and Iran is estimated to have about 40 million to 50 million barrels of crude or condensates in storage on tankers”, according to Genscape

The oil bulls point to the fact that Warren Buffett has recently invested a billion dollars into the oil patch by adding 12.5 million shares to his Phillips 66 stake. Berkshire now has $5.9 billion invested in the company representing around 14 percent of the outstanding shares.

Now, market sentiment has changed dramatically giving oil producers a pass when reporting poor results but hammering growth stocks. Two out of four FANG stocks beat earnings estimates but only Facebook remains in positive territory in 2016. Growth stocks like Tesla, Salesforce and LinkedIn have been pounded. The chart below is the year to date price of the FANG stocks.


On the other hand, BP reported a 91% drop in profit, Exxon’s profits dropped by 58% and Chevron lost $588 million. Now, keep in mind the average price of crude oil was around $46 a barrel in the fourth quarter and it looks like average price for first quarter will be in the $32.00 range. Next quarter earnings could look even uglier. Despite all these negative factors, the year to date chart below illustrates that money is still flowing into these stocks.


What do think, has oil hit a bottom? Should you follow Warren Buffett’s bullish bet on oil?