How to Protect Your Wealth During the Current Market Meltdown

Hello, everybody. Thanks for joining the webinar today. I know it's been a while since I've done one. I missed you. Know that you can access New Constructs on the web, www.newconstructs.com, @NewConstructs on Twitter. Feel free to email me anytime with questions, and, you know, I highly recommend, you know, going through our site, looking at tutorials, looking at the past webinars. We've got a lot of really, what I would call, sophisticated tools and detailed tools to help clients prepare for markets like this. And I'm going to go through a few slides. I'm going to talk about a few posts that I've done in the past. I'm going to get straight to the point. What kind of stocks should you be in? What kind of market should you be in? How do you prepare for something like this? How do you protect yourself from something like this? That's not the kind of research you're going to get from many people. Let's face it, Wall Street is about trying to sell you on trading, right? This is my standard slide deck for most of my meetings. And the first thing I like to emphasize is, right, look, Wall Street's not on your side, okay? You know, we recently published— we recently highlighted some research about how Wall Street analysts aren't even incentivized to fix The misleading earnings that they know are in corporate reports, right? So look, let's face it, Wall Street is not in the business of preparing you for a downfall. Wall Street is in the business of creating— of creating bubbles in the market. And, you know, look, you don't believe me? Call me, we'll talk about it. Talk to some people who have been on Wall Street and we'll let you know. We'll let you know. They'll let you know, you know, what they think, what they believe, and what they think is important, right? So, uh, look, Cramer, CNBC, Wall Street Journal, Investment Business Daily— just answer me this one question about those firms. Do they make more money when the markets are going up or when the markets are going down? Do trading volumes go up when markets are frothy and happy Or do trading volumes go down in bear markets? In case you don't know the answer to the question, trading volumes go way down. Viewership goes way down. Scottrade, Schwab, those guys, they lose tons of— their margins and their profits go way down in bear markets. There's less activity. There's less interest in CNBC. There's less people buying the Wall Street Journal. So there's an incentive. And remember, it's very difficult to do the dirty work that's required to be successful in investing, right? If you're gonna be a real investor, you actually need to read the entire 10-K, right? Or entire annual report. That's what Warren Buffett says he does, but who does that? Anybody? Who do you think does that? You think Wall Street analysts do it? Are you kidding me? No. No, they don't have time. They haven't been incentivized to do it. I was on Wall Street before the tech bubble. Very few did it then. Many fewer, much fewer people do it after the tech bubble. Ask anybody with experience on Wall Street. They'll tell you the same thing. They know. Disclosures are getting more complex. And by the way, FASB's not helping. The SEC's not helping, right? And you know what? It's not necessarily FASB's fault, but businesses are becoming more complex. Transactions are becoming more complex, more subjective. More disclosures are required to understand what's going on. Income statements, balance sheets, cash flow statements are just not dynamic enough. It's not accounting's fault. Accounting can only do so much to simplify. The more they simplify, the more difficult it is to get to the truth. So, accounting has to be complex. Disclosures have to be exhaustive in order for us to understand what is going on. Nobody knows better than I have. I started out as an auditor. I was an executive compensation consultant, and then I ran global forensic accounting and valuation for Credit Suisse's equity research department before, during, and after the tech bubble, right? I've seen it all. I know what's going on. And let me tell you, it's difficult. And when I advise FASB on a regular basis as part of being on the Investor Advisory Committee, you know, I'm often surprised by how many other investors and standard setters, how often and how naive they are about how companies Look for and exploit accounting loopholes. Why am I surprised that they're naive? Because a recent survey that was featured in MarketWatch highlighted 2 huge things. One, 20% of CFOs admit intentional misrepresentation of EPS, and that magnitude of misrepresentation is 10%. Now, here's the part that didn't surprise me. Analysts usually don't actively detect poor earnings quality. They have little to no incentive to do so. That's the rest of that. So if you believe you can rely on Wall Street research, it's time to wake up and smell the coffee. If you want to know just how much you're missing by not reading the MD&A alone, we're seeing about 3,000 per year, or per, you know, one per company that we cover, material hidden items in the MD&A. These are unusual charges or gains. used to obfuscate real financial performance. Write-downs are huge too. These are big numbers. These are big adjustments. So what do you do to protect yourself? Well, you got to be in stocks that have actually good cash flows and good valuations. That's the only way to protect yourself. Look, at the end of the day, if you're in expensive stocks, you're in trouble. If you're in attractive stocks, you're not going to be in as much trouble, right? So you protect yourself in a market like this by understanding what cash flows are about and looking at stocks that can be relied upon, right? And, you know, I'm going to be specific here. I'm going to say the most attractive stocks, right? Right? These are stocks that actually have cash flows and cheap valuation. Nothing's gonna get crushed more in a downward market than dangerous stocks, right? Because those are the stocks most likely to correct because they're so overvalued and don't have real cash flows, have the most misleading earnings. So to give you an example, dangerous stocks, right? People who follow us understand Dangerous stocks are companies that have misleading earnings and very expensive valuations. Every stock on the most attractive, most dangerous stocks list has misleading earnings. That means that their GAAP earnings are rising and positive while their economic earnings are declining and usually negative. So that's what's going to blow up, right? And they've got expensive valuations on top of that, right? A lot of these cases— look, they got the Wendy's Company, right? The price to economic book value is 45 times. The stock price implies that the cash flows are going to be 4,500% greater than what they are currently. They've got misleading earnings. This is where you're going to get blown up. This is what you've got to avoid, right? I don't want to pretend to be a market timer. I think market timing is tough. As one of the smartest people I've ever heard on CNBC said, the market timers hall of fame has no one in it. Market timing is very difficult. If you can do it, be my guest. Technical analysis, it's great until it doesn't work, right? I just had a meeting with a senior executive at one of the major self-directed firms, and that's exactly what he said to me. And more and more people are waking up as we meet with some of the top institutional money managers in the country, top self-directed investment management firms, top hedge funds. We're seeing an awakening to risk. And markets like what we've seen today in the last few weeks are awakening people's consciousness about risk because they've been asleep for it for a long time. And here's one of my posts that I— here's a post that I wrote back in 2010. What this shows is really exactly how crazy markets have been. You look at the market back from 1926 up to the most recent time, look for 60 years, this is what the market was doing, 9%. And then from the '80s, mid-'80s to 1999, 9%. Wow. You went from a 9% CAGR to almost a 20% CAGR. It's been ridiculous. And things haven't changed that much since, from '85 to the last bubble, the last time it crashed, right? 7.4% over the last 25 years, right? The correction This is normal. This is the new normal where the markets are actually going to be very volatile and lower because we're pumping the market up. The Fed is pumping the market up as much as it possibly can, right? So you got to be an intelligent stock picker. You got to be able to be in the stocks to survive. How to be successful post all the speculation? You've got to recognize that investing is not just about being in momentum stocks. Investing is not about being in what's popular. Investing is about understanding cash flows. It's about understanding risk, which is what we do. Attractive and better, attractive and very attractive, that's good risk. Dangerous and very dangerous, that's bad risk. It's as simple as that. That's how you succeed in markets like this. That's how you gird yourself for the inevitable correction in what is a frothy market. Frothy markets all around the world. And I don't believe that we're gonna see a long time, a long-term down bear market. I'm long-term bullish, as you'll see in my more recent market outlooks. I'm long-term bullish because I believe that innovation is strong. I also believe that in the United States, you know, we're the tallest midget, right? So, you know, even if things are bad around the world, the one place where people are going to still put their money, right? This is my outlook for 2014. Long-term bullish. That's the key, right? I point out how lower interest rates, right? There's a new paradigm for capital allocation. Get lower interest rates, more things are profitable. There's less competition. There's still high competition for high-return activities, but we're seeing in the innovation side of our society that more capital is able to flow to higher ROIC businesses because of technology. And in many ways, it's offsetting the fact that the hurdle has been lowered for what it means to be successful and offsetting the fact that a lot of capital is flowing to low-return activities. This is kind of crazy, sophisticated economic, macroeconomic talk. But I just, you know, look, for those that want to understand how much thought there is behind what we're doing here at New Constructs, I want you to, you know, see these posts, see these outlook reports. And for those who are listening after we've written or after we've done the webinar, you can see the thinking behind this, right? This was done back in January of 2004. We published January 30th, 2014. You can see even back then, the distribution of stocks in the market, not so great. The 3,000 stocks we cover, you can see a large chunk of them, almost half, get a dangerous rating. Another 200 get very dangerous, while in total, maybe 290, a little over 282, Get an attractive or better rating. There's not a lot of good stocks out there. So you got to make sure you do your diligence or you're going to get blown up. If you don't believe me, take a look at what Kyle put together here just recently. A quick list of stocks that have outperformed from our most attractive or most dangerous stocks list, right? This This doesn't include stuff that may be in the danger zone, right? So the market is down about 6% since August 17th till today. Attractive stocks, Brocade, very attractive rating. It's up 5% in a down market. Target, down only 2%. Nvidia. Sorry about that. I got to remember to switch my screen. Here's a quick chart on this. The stocks, as I mentioned before, that have outperformed. Most attractive stocks that have outperformed the market, dangerous stocks that have underperformed. So for example, as I was saying, Brocade up 5% while the market's down 6%. Target only down 2%. Nvidia only down 4%, right? And I'm not gonna say that, look, sometimes the attractive stocks, they're gonna go down even worse. But when all of this flattens out, and as I said, we're not in a forever long-term bull market. Right. I'm sorry, bear market, or even a really terrible, you know, 6 to 12 months kind of bear market. I think we're going to see some major corrections. The difference here is that when markets bounce up, the bad stocks, the dangerous stocks, they're going to be left in the gutter, and value is going to move from the weak hands to the strong hands. Weak hands are companies that don't really make a lot of money. Strong hands are companies that do. The market only survives If it allocates value to strong hands. Because if it allocates value to companies that just suck money away and don't create real cash flow, the market dies. It doesn't work, right? That's, that's, that's part of a study that Carnegie Mellon did on zero-intelligence traders several years ago, highlighted in a report that Michael Mauboussin published several years ago called The, um, The Tail That Wags the Dog. Or I'm sorry, the invisible lead steer. That was the title of the article he wrote it out while I was at Credit Suisse, the invisible lead steer. And what it's a study from Carnegie Mellon, it's in the public domain that focuses on the allocative efficiency of a market with zero intelligence traders. And what that study showed is that zero intelligence traders in a double auction market structure, which is what we have in our stock market. that zero-intelligence traders were actually able to allocate capital. The market was still able to allocate capital effectively despite the intelligence of the traders, right? A key point. Really what it comes down to is that at the end of the day, the survival of the stock market is dependent upon allocating capital to those companies that give the most back. Otherwise, the markets die. All the capital gets destroyed, right? If the market go ahead— went ahead and gave valuations to companies that didn't create any money, that didn't create cash flow, and then eventually that catches up with the market, well then guess what happens? Everyone loses their money. See ya, right? So in order to sustain itself, the market has to be intelligent about allocating capital. And that's why I'm telling you, attractive stocks are where you've got to be, and dangerous stocks are what you got to avoid. 3 stocks on the most dangerous list that have meaningfully underperformed the market: Valero, down 16% while the market's down 6%. Twitter down 10%. Charles Schwab down 11%. All these guys get a dangerous or very dangerous rating. Any questions? One of the questions came in early. When to get back in? I'm half in cash since Monday. As I said, market timing is not my forte. It's not my strength. I'm not going to pretend to be able to predict the market. All I'm going to say is that if you do choose to make an investment in anything other than an index fund, you need to make sure of one thing. Your expectations about the future performance of that company's cash flows are materially different from that of the market. There's no reason to be in a stock if you believe the same about the future. As the market. You have to have a different opinion. And that's what New Constructs lets you do. We quantify market expectations in our models. We make sure that when it gets an attractive rating, you've got low expectations and you've got strong cash flows. That's the key. That's how you survive. Avoid dangerous stocks. Misleading earnings, extremely expensive valuations, right? Look at these stocks. These are all misleading earnings, expensive valuations. 40 of them every month. Avoid. Or if you're a client, you got a portfolio, right? Make sure you're in stocks that get a green rating. Avoid stocks that are orange or red. Just don't do it, right? Or if you are going to be technically oriented and you're going to make— do a technical strategy, Then add us as an overlay. Because if you've got a choice of a bunch of technical candidates that look good, at least then choose the one, or put more money in the ones that also have good fundamentals. The good fundamentals are what create the oasis in the desert of a bear market. It's the only way to survive because they're actually creating cash flow. And when Everything hits the fan. The only way you survive the oasis in the desert is the businesses that create cash flow. They're sustainable. They'll be around. They will bounce back. They will make you a lot of money in the medium and long term. These short-term dangerous stocks, right? You heard me talk about Netflix. Man, have I been wrong about Netflix, right? I predicted the demise of that stock a long time ago. And please check my research. I stand by it. That is a momentum trade waiting to blow up. And I highly caution you. I mean, when markets were bad, it was down bad. Did it bounce back a lot? Yes, it bounced back too. It's a ticking time bomb. Expectations that high are just too unrealistic. So dangerous stocks, here's the list. Avoid them. Very— the small-cap dangerous stocks for August, the large-cap dangerous stocks for August. Look what's on this list. These are what you want to avoid. If you're a client, you get access to this, right? Again, as I was showing in the portfolio, I'm sorry, I had this thing on the wrong screen. But if you have a portfolio, Throw the stocks into our system. Make sure you put money into the attractive, right? In our system, right, you can track tons of portfolios. You look at MLPs, you can look at dividend funds, right? Make sure you're gonna put money in things that get an attractive rating. If you have access to our screeners, you can go through and say, you know what, if I wanna be in technology, then you know what, I need to be in very attractive stocks in technology. What are my options? Boom. Here are the options, right? If I want to be in very attractive funds and I want to stick with large cap, here's how the screener works. Attractive, very attractive. Boom. Here's options, right? We're here to help you. We're here to help you make intelligent decisions about risk. We're here to help you manage The landscape of risk. The psychology of the market, the only way to combat that is to stay disciplined, right? That's one of the things I say here in How to Be Successful Post a Speculative Movement, right? It's all about singular focus on applying true investing principles, true value investing principles. If you want to play the game, you know what? Then be prepared to lose the game as well as win because markets don't always go up. And if you're relying on technicals, well, then you're bound to get burned at some point, right? Here comes a question about return on invested capital. Is there a lower limit? Well, I think the answer to that question is yes, and you get that by looking at the details on your portfolio, right? So if in your portfolio And you want to understand— let's look at a stock here. More details on Apple, right? Our return on invested capital quintile. You don't want to be in the bottom quintile for return on invested capital. I believe our quintiles are broken down in the appendix of our report. But pretty much anything below— I guess we took that out. I don't remember exactly what the breakdown is. Feel free to email me, david.trainer@newconstructs.com, and I will actually look up because I don't remember. It's been so long since I set this up. I don't remember what bottom quintile is. But typically, anytime the return on capital is below the cost of capital, Which is what you will see in every one of our reports. We will show you charts and data that compare returns on capital to the cost of capital so that you always understand that. We will always help you understand risk and earnings quality and valuation. Nobody does that better than New Constructs in the world. And I think we've got a lot of institutional clients that attest to that. including Wells Fargo, top managers at Morgan Stanley, Merrill Lynch, some of the top hedge funds in the world that I'm not even allowed to mention because they tell me if I let people know that they're a client, they will fire me because, quote, they don't want anyone to piggyback on their due diligence. And I gotta tell you, I'm going all around the country, I'm traveling a lot these days, which is part of why I've, uh, we've not been doing as many webinars, plus it's August, we figure nobody really cares. But despite the fact that it's August, I'm getting, I'm getting asked to do a lot of meetings with professional investors, uh, wirehouses, RIAs around the world because people are risk-conscious and they realize there's a big gap in the research process. Because over the last several years, last 15, right? CNBC, market psychology, technical trading. This has taken a— played a large role in investment decision-making. And during that time, analytical skills have atrophied. Annual reports have gotten longer, more complex, more difficult. But there are still plenty of needles in the haystack. Somebody's got to do that dirty work. We've created proprietary technology to do that. And I think anybody who's curious about how we do that, we've got a webinar on our technology. It's fantastic. I've talked to all the biggest data collection firms in the world. Nobody has anything like it. You know why? Because nobody has the expertise we have. Nobody understands how to work with FASB like I do, or the SEC, or filings. Nobody's got the expertise that our analysts have, and that expertise combined with our technology gives us the best data in the world. the best earnings quality in the business. It allows us to predict bankruptcy, fraud, right? Provide the best protection in the business. You know what else it does? It allows us to be independent and unbiased. We don't take data from anybody else. We do our own diligence so that we can be completely and totally aligned with you, our clients. So, How to protect yourself in a market that's blowing up? Focus on being in stocks that are attractive, that have good risk-reward, positive and rising economic earnings, high returns on capital, and cheap valuations. This is what will serve you well over the medium and long term. I can't speak to the short term. I'm not going to pretend. to be able to predict the future day to day, week to week, month to month, year to year. But I will repeat what Warren Buffett says, value wins over the long term. In the short term, the market is a voting machine. In the long term, it's a weighing machine. That's another way of saying if you're making cash flows, your weight is going to be fine. If you're not creating cash flow, you're going to have no weight and you're going to disappear. The same thing I said about the double auction market structure. If you got cash flow, the market will reward you. It has to, because if it allocates its value to companies that disappear, the market implodes, the market disappears. So that's where the capital has to go. These are the companies, the stocks where it deserves to be. It may not be popular. It may not be as fun. It may not be as entertaining. I'll admit it. I'm not as entertaining as this guy. I'm not as good-looking. I'm not as funny. Probably not even as smart. But I am more trustworthy. And I do believe, despite the fact that everyone loves to think about the psychology of the market and focus on momentum, And oh, you know, the market can be irrational longer than we can be solvent for value investors. And it's true, right? A lot of value investors got put out of business during these heady markets. And as I had a meeting with a very astute institutional investor at a big wirehouse, said to me one time, yes, but the irrationality of the market can be limitless. At times, yes. But the question to you, is your risk tolerance limitless? How did you feel in these turbulent markets? Did you feel safe like our clients feel because they're in the right places? People that follow our advice, did you feel better? Did you feel good putting your head on your pillow at night knowing that you've done the diligence that you owe to your family, to your clients, to your investors? That's what it's about, my friends. That's what it's about— long-term health and honesty. Do your diligence. Don't believe what Wall Street tells you. Focus on the truth. Focus on profits. Focus on valuation. That's what's going to keep you safe over the long term. That's what you need to do in order to survive turbulent markets. Thanks very much. Please feel free to