The Ultra Rich Dumb Money Bubble

“Never confuse the size of your paycheck with the size of your talent.” – Marlon Brando

balloon dog(Photo: Charles Nouÿrit )

Over the last 5 years while most of Americans have struggled, the wealth and lives of the ultra rich have gotten better and better. For example the Knight Frank Luxury Investment Index (which should really be renamed “Dumb Stuff the Ultra Rich spend their Money on Index”) is up over 40%. If we dive deeper into the numbers we will find that over the last 5 years expensive watches are up 33%, Chinese Ceramics are up 43%, Collective stamps are up 83%, Art is up 12% and classic cars are up 115%. The problem with all of the items is that their price is not determined by any intrinsic value but rather by what someone else is willing to pay for it. If someone wants to spend millions of dollars for a small ceramic bowl they have all the right to do as they wish, but what is interesting to me is at what point does this ego fueled party come to an end?

I believe what we are witnessing now is rather unique time in history. Just like during the dot com bubble when the newly made rich day traders all thought they were geniuses we now have hubris bubble among the ultra rich. There are now a great many newly made billionaires who all believe they are geniuses, failing to see that the rising tide of liquidity has been lifting all the boats for the ultra rich.

Nothing signifies this more than the art market. I find it so amazing that the same people who would never venture into penny stocks, for the fear of losing due to market manipulation, would not think twice about spending millions in the art market, which is tremendously more corrupt and manipulated than the stock market ever was.

I fail to see any intrinsic reason besides ego to spend tens of millions of dollars on a painting or over 50 million on a stainless steel balloon dog. Now you might call me a simpleton who does not understand high art, and you may be right. But if I do not understand art I find it hard to believe that some newly made Russian oligarch who owns a coal mine is that much more knowledgeable in it than me.

The rich buy art for the same reason hip hop artists buy expensive champagne. How many people would actually buy Cristal if the bottle said Yellow Tail or if there were no other people there to see them buy it and drink it? Just like I am certain that most people would not be able to tell the difference between a $2000 bottle of champagne and $50 bottle, I am more than willing to bet that some newly made Chinese billionaire can’t tell the difference between a $5,000,000 painting of blotches and squiggly lines from a $500 painting of blotches and squiggly lines.

The ultra rich have been bidding up prices among themselves for a while now, and sooner or later the party will come to an end. Make no mistake, the super rich have always overpaid for items that enhance their status and stroke their ego, this has been going on since the beginning of time. The only difference now is that there is a lot more self delusion as to why this is actually a good investment option.

This might be one of those rare times where a constantly rising stock market, low return on cash, tremendous liquidity and old fashion hubris is causing a lot of the onetime smart money of the ultra rich to become dumb money. And like all dumb money in the long run, it usually does not stay with its owners for very long.

Here is a great piece 60 Minutes did on the art world from a few years ago; the situation has become even worse since then.

Michael Page

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Does Corruption Improve Stock Market Performance?

He’s a businessman … I’ll make him an offer he can’t refuse.” – The Godfather

(Photo: Artemuestra)

Having spent the last 2 weeks on vacation in Russia, I was amazed by the beauty, the people, the art and also the amount of corruption which exists in this country. After talking with many people, I learned that it is almost impossible to do any legitimate business in Russia without bribes, kickbacks and payoffs. The next logical question that comes to mind is why would anybody do business there? Why would anyone invest in any publicly traded company in Russia, since fraud and corruption are so prevalent?

 I thought it would be interesting to do some basic ‘back of the napkin calculations’ to see how corruption effects stock market performance. Transparency International publishes an annual Corruption Perception Index which ranks countries “by their perceived levels of corruption, as determined by expert assessments and opinion surveys.”

In the developed markets, the top 5 least corrupt countries year after year tend to be New Zealand, Finland, Denmark, Sweden and Singapore. The most corrupt are Italy, Israel, Spain and France and United States.

In emerging markets, the top 5 least corrupt countries are Chile, Taiwan, Poland, South Korea and Malaysia. The most corrupt are India, Mexico, Philippines, Indonesia and Russia (no surprise).

Having a rating for the counties over the last 10 years, I wanted to compare them to the average (arithmetic) stock market performance of those countries over the last decade to see if there were any correlations. Having full data for 10 years of Corruption Index and stock market performance for over 35 countries, I put together the chart below for developed markets.

As you can see, the least corrupt countries (those with highest Corruption Index Scores) tend to have better performances in the stock market over the last 10 years as the trend line shows. The picture changes once we look at emerging markets. If we look at 10 years of data in emerging markets, the countries which are more corrupt have had better market performances. 

It seems for developed markets, corruption does not pay, but in emerging markets corruption does seem to pay, rewarding the most corrupt countries with higher market performances. This is rather puzzling. Why would a corrupt country have better market performance? My guess is that corruption cuts both ways.

For example, if you own a publicly traded company in Russia that makes widgets, you are probably skimming the profits from the top and short changing the shareholders. At the same time, you are also bribing politicians to get more lucrative deals and paying off the local officials to make it difficult for other widget manufacturers to do business and compete with you. Thus improving your profit margins in the process. In the long run, it’s a losing formula for the overall economy. In the short run, the markets do not seem to care how the profits are derived. It is also possible that shareholders are bidding up the price of stocks in corrupt countries in expectation that things will improve and that the upside will hold rewards. Just another way of saying “things can only get better”.

So in corrupt countries, corruption does seem to improve stock market performances at least in the short run. However, in developed countries, corruption seems to have a negative effect on markets.

A word of caution about my findings, it’s very possible the data sample of 10 years might be too small and if we looked at a much larger data set the conclusion might be different. Also there’s a chance that we are simply seeing a correlation and not a causation.

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How NOT To Make Money With A Time Machine – Investing in Art

“Success is what sells” – Andy Warhol

(Photo: Wikipedia)

Less than a year ago a family from the Middle East paid a record sum of over 250 million dollars for a painting called “The Card Players” by Paul Cézanne (See above). Many people might say that the seller made a good deal and turned a hefty profit. That may be the case, but how good are returns on the most expensive pieces of art ever sold?

If you had a time machine and could go back in time and purchase the painting for the original price, what kind of return on your money would you see today?

Wikipedia keeps a list of the highest prices ever paid for paintings. I researched the list and included all the record prices paid for paintings for which I was able to find the original sale price. Since we know the sale prices and dates, we can determine how much the painting appreciated each year (geometric mean). Below you can see what kind of return you would get on your money if you purchased the art compared to investing it in the stock market over the same time.

Let’s take a look.

(Photo: Wikipedia)

Painter:

Vincent Van Gogh

Title:

Portrait of Dr. Gachet

Sale Price:

$82,500,000

Year Sold:

1990

Original Sale Price:

$58 (300 francs)

Original Year Sold:

1897

Years From Origin

93

Painting Annual Growth Rate:

16.5%

Annual Stock Market Return During same Time:

9.89%

 


  

 (Photo: Wikipedia)

Painter:

Pablo Picasso

Title:

Garçon à la Pipe

Sale Price:

$104,200,000.00

Year Sold:

2004

Original Sale Price:

$30,000.00

Original Year Sold:

1950

Years From Origin

54

Painting Annual Growth Rate:

16.30%

Annual Stock Market Return During that Same Time:

12.20%

 


 


(Photo: Wikipedia)

Painter:

Vincent Van Gogh

Title:

Irises

Sale Price:

$53,900,000.00

Year Sold:

1987

Original Sale Price:

$58 (300 francs)

Original Year Sold:

1897

Years From Origin

93

Painting Annual Growth Rate:

16.5%

Annual Stock Market Return During that Same Time:

9.76%

 


 


(Photo: Wikipedia)

Painter:

Thomas Eakins

Title:

The Gross Clinic

Sale Price:

$68,000,000.00

Year Sold:

2007

Original Sale Price:

$200.00

Original Year Sold:

1876

Years From Origin

131

Painting Annual Growth Rate:

10.20%

Annual Stock Market Return During that Same Time:

9.30%

 


 


(Photo: Wikipedia)

Painter:

Pablo Picasso

Title:

Le Rêve

Sale Price:

$48,400,000.00

Year Sold:

1997

Original Sale Price:

$7,000.00

Original Year Sold:

1941

Years From Origin

56

Painting Annual Growth Rate:

17.10%

Annual Stock Market Return During that Same Time:

12.92%

 

Looking at the numbers, if you were able to buy the most expensive painting in the history of the world at the original price, your return would be only a few percent higher than that of the overall stock market! After you take into consideration storage, maintenance and insurance on the paintings, a big chunk of that out-performance would most likely evaporate.

Over the long term there are very few things which are more profitable than the return on the broad stock market. Particularly on things which don’t produce anything and derive all their value based on what someone else would pay for it.

But if we focus on art as an investment, it has performed surprisingly well in relation to the stock market over the past 25 years (although with a lot more volatility). But that says nothing about it’s performance moving forward.

It’s hard enough to pick a stock that you think would do well over the next few years, it is even harder to predict which artist and which piece of art would appreciate in the future…if at all.

As the time machine example demonstrated that even with perfect hindsight your performance would only be at best slightly better than the stock market. But since we don’t have perfect hindsight or a time machine it is rather foolish to think that we have the ability to predict which art piece would appreciate the most decades from now.

Buy art because you like it, not to make money.

Michael Page

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When all that Glitters is not Gold

“[Gold] gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.” – Warren Buffett

(Photo: DigitalMoneyWorld)

A few years ago I read a great book on history of gold by Peter Bernstein called The Power of Gold: The History of an Obsession. It outlined the history and man’s fascination with the yellow metal. If I invested in gold back when I read the book, I would have doubled by money by today.

Gold has been the most consistent store of value for thousands of years and has risen in price over 200% over the last decade, compared to the 12.6% return of the S&P500. $3000 invested in gold ten years ago would be worth over $15,000 today.

Here is an interesting graph of gold prices in British Pounds dating all the way back to the year 1265. (courtesy of Zerohedge)

With all the talk and the incredible run up in gold prices the question might be “why did I miss the rally and why am I not investing in gold today”? The answer to both questions is that I simply don’t know and don’t understand how to value gold and frankly I have yet to meet anyone else that does.

When you buy a stock you, have some idea of the value of the stock based on presumed earnings and growth of the company. With bonds you know what yield you are receiving but gold, at most, retains its value and increases with inflation but produces nothing. Gold is basically whatever someone else will pay for it.

 Let’s take a look what happened to the price of gold once the United States got off the gold standard.

The chart above shows inflation adjusted price of gold in 2011 dollars and goes all the way back to 1791. As you can see in the early 1970’s once US got off the Gold Standard, the price of gold jumped almost 300% only to come crashing down. If in hind sight it is safe to say that gold was in a bubble in late 1970’s, I don’t understand why it is not safe to say that gold is in a bubble now, since in 2011 dollars they are trading at roughly the same levels.

There’s no logical reason for gold to increase in value over that of inflation for a very long period of time. Gold might still continue to go up in price but there is no reason for it to outperform true inflation in the long run.

The argument of “The government will only print money” to justify any gold price is similar to “There is only so much waterfront property” to justify any price for a waterfront real estate. The argument might be correct but it avoids the big question, “At what price?”

The other factor that bothers me is that there are just too many people talking about gold, all using the same clichés. This reminds me of the 90’s internet stock bubble and make me suspect that this might end in a similar fashion.

But I think Warren Buffett had the best quotes about how to view gold:

“I will say this about gold. If you took all the gold in the world, it would roughly make a cube 67 feet on a side…Now for that same cube of gold, it would be worth at today’s market prices about $7 trillion dollars – that’s probably about a third of the value of all the stocks in the United States…For $7 trillion dollars…you could have all the farmland in the United States, you could have about seven Exxon Mobils, and you could have a trillion dollars of walking-around money…And if you offered me the choice of looking at some 67 foot cube of gold and looking at it all day, and you know me touching it and fondling it occasionally…Call me crazy, but I’ll take the farmland and the Exxon Mobils.”

Have I missed a big rally in gold? Yes, but I have missed many good deals and will continue to do that in things that I don’t fully understand. I would rather not make money in something I don’t fully understand than make a lot of money in something I don’t fully understand. The latter gives you a false sense of confidence, which in the long run always ends badly.

On a side note, last year I crossed another thing off my Bucket List, which was to hold an actual gold bar in my hands. At the time, it was worth over half a million dollars! If you are ever in London, I highly recommend visiting the London Banking Museum and doing the same, it’s an opportunity of a lifetime. Then walk over to Olde Cheshire Cheese and grab a pint or two, or for even more fun do it in reverse order.

Michael Page

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How to get Paid to do Nothing – The Power of Compound Interest.

“The most powerful force in the universe is compound interest”. – Albert Einstein

(Photo: DanOrbit)

One of the most important things you need to know about investing and becoming rich is “Compound Interest”. It’s a concept that everyone thinks they understand but in reality do not.

Compound Interest is actually a very difficult concept to grasp because our brains are wired to think linearly not exponentially. For example, if I came to your house and gave you a magical rabbit that grows in size by a pound a day, how many days would it be until the rabbit becomes big enough to start creeping you out? You can quickly do the math in your head; say a rabbit weighs 5 pounds, so after 60 days the rabbit would be 65 pounds, so a rabbit no matter how cute being the size of a beer cooler starts to become creepy. The math and visualization for that problem is very easy for us to grasp since the growth is linear.

Now let’s try an exponential problem. Let’s say we take a football stadium and make it water tight and I kneel on the 50 yard line with an eye dropper and each minute double the amount of drops I put on the field, how long would it take me to fill up the whole stadium?

(Photo: Baardman)

Minute 1 = 1 drop from the eye dropper

Minute 2 = 2 drops from the eye dropper

Minute 3 = 4 drops from the eye dropper

Minute 4 = 8 drops from an eye dropper

….and so on.

(Photo: Rogue Soul)

At this rate how long would it take me to fill the whole stadium? Take a guess? A day, a month, a week? The answer is under 50 minutes. That’s right, starting with 1 drop from an eye dropped and doubling every minute you can fill up the whole football stadium with water in less than 50 minutes.

Now how long would it take to fill up all the world’s oceans? Take a guess. The answer is under 90 minutes. And a little over 90 minutes to fill up all the volume of the earth.

(Geek Alert: I show all the math here)

So if we start with one drop from an eye dropped and double the number of drops we would be able to fill up all the world’s oceans in less than 90 minutes. That is the power of compound interest, and as you can see it is very difficult for us to calculate and visualize it. But this is the most powerful tool in growing your wealth and becoming rich.

The secret to growing your wealth is putting as much money away as you can and not touching it and allowing it to grow with compound interest. The most amazing thing is that the longer you do nothing the more you are rewarded.

Let’s say we put away $10,000 and can grow it at 10% a year.

1 $10,000  
2 $11,000 $1,000
3 $12,100 $1,100
4 $13,310 $1,210
5 $14,641 $1,331
6 $16,105 $1,464
7 $17,716 $1,611
8 $19,487 $1,772
9 $21,436 $1,949
10 $23,579 $2,144

For doing absolutely nothing and leaving your money to grow you have more than doubled it. The beauty of it is that each year you get rewarded more and more for doing absolutely nothing. The first year you do nothing, you are rewarded $1000 but by year 10 you get paid $2144 for doing absolutely nothing. There are not very many things in life that allow you that luxury.

When I still had my day job, I was making average salary, living in a tiny 1 bedroom house where I was paying $640 a month rent, and driving a Hyundai Excel. Every 2 weeks when I got my paycheck my order of business was to write a check for half my salary to invest in an index fund and the other half I would deposit in my bank for expenses. I forced myself to live on 50% of my salary. Even if everything stayed the same in my life and I continued to make an average salary, I would still be rich today due to saving and compound interest. You do not need to be rich to become rich.

I am certainly not saying you need to deprive yourself of everything, but what I am saying is that everything you buy which depreciates in values is contrary to you becoming wealthy and you are either making your money grow or making it shrink.

Many people think that they will one day wake up and be rich and they keep waiting for that day which will turn it all around for them. In reality, most wealth is created by simply putting money away and allowing it to grow slowly, systematically and methodically. Overnight riches are extremely rare.

The longer you can put off instant gratification of being a consumer the easier it will be for you to become wealthy.

Even the big creepy rabbit, although probably lacking magical powers, agrees with me.

(Photo: Anomieus)

 

 Michael Page

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Investing Lesson: The “Can’t Happen Here Syndrome”

“In the long-term we learn absolutely nothing” – Jeremy Grantham

(Photo: artemuestra’s photostream)

 If you were living in Japan in the late 80’s you were living on top of the world.   Besides seeing your investments grow close to 400% over the last few years on the Tokyo stock market and your real estate prices almost double you were also the envy of the world.  In the late 80’s Japan a country the size of Montana was responsible for close to 40% of world GDP which was truly staggering.  From electronics to economical and reliable cars it would seem that Japan would run the world, and the Japanese stock market showed as much. There seemed to be no price too high to pay for a Japanese company and there was no price too high to pay for land.  To the point where office space was going for $93,000 a square foot in downtown Tokyo in the late 80’s.

But trees don’t grow to the sky and like every good party this one came to an end in 1989.  Cut to almost 30 years later, not only has the Japanese stock market not reached the heights of 1989 again, it recently hit an all time low.  If you invested $10,000 in Japanese stocks in the late 80’s, in 2012 you would have roughly only $2500 left.   A lost decade turned to two lost decades and now going on three.

I vividly remember, after the Internet bubble crash in the late 2000’s, seeing so many talking heads discussing how the lost decade could never happen in America and how this slide in stock prices is only temporary.  After all, the US could never be like Japan.  The Japanese people are used to conformity, Americans are not.  Japanese CEOs are proud and would keep the debt on the books, where American companies would write the dept off taking a loss and moving on. Japan had hyper-inflated real estate prices, America did not, that would happen 5 years later.  America has a much stronger corporate governance and much better political leadership than Japan. What transpired in Japan could never happen here in the US.

Well, financial history might not repeat itself but it certainly rhymes.  As we can see from the chart below, since 2000 the US stock market has followed the path of the Japanese stock market 11 years earlier in a haunting manner.

Here is the performance of SP500 since the Internet bubble compared to the Nikkei 250 since their bubble 11 years earlier.

This is not to say that the US stock market has to follow the Japanese path from here on out, or that we will hit a low in Jan of 2014.  It does mean that the “Can’t Happen Here” scenarios occur in finances a lot more than people want to admit.  When talking about finances, be wary of anyone who says “Can’t happen here” or “This time is different”.  The world is a lot more complex than their simplistic understanding of it.

Michael Page

 

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