The two major financial events we witnessed over the past week evidence a growing Wall Street greed, which we attribute to increasing austerity and/or the inability to achieve economic growth by the usual means. In other words, the ruling sentiment seems to be “if you can’t make it legitimately, make it any way you can.”
First case in point: JP Morgan Chase (JPM). Anyone who believes this $2 billion + “accident” came from hedges gone awry is someone who would buy the Brooklyn Bridge… or more appropriately, make a wager against somebody like the recently deceased Amarillo Slim, a legendary professional gambler known for his exceptional skills at poker -- and proposition bets.
Proposition bets are also known as “side bets,” i.e., wagers regarding the occurrence or non-occurrence of an event during a game that does not itself determine the entire game’s final outcome. Certainly the derivatives involved in the JPMorgan debacle fit this definition. It’s clear that the company met disaster as it was trying to make a bunch of money from its own favorite types of proposition bets.
With the traditional banking business of making loans not growing both because of lack of opportunities in this economy as well as the problem of excessive regulations in a complex society, or ironically, because standards for making loans are a little bit too high right now, other avenues for generating profits are given a whirl.
Is this a canary in a coal mine? Well, at this point we don’t know. But we do know the problems that JPMorgan Chase has to deal with in terms of growth characterize a lot of other financial institutions. Morgan Stanley (MS) is certainly another one. This second-largest stand-alone investment banker is the primary underwriter of the Facebook IPO. Underwriters, as I’m sure you all know, get paid a fee based on the size of the initial funds invested in the companies they take public.
Facebook’s IPO, the biggest internet public offering of all time, occurred last Friday. After much haranguing and shouting going back and forth over what the initial price should be, Morgan Stanley picked a value of $100 billion (we all love round numbers) or $38 a share – which would have made it the most valuable U.S. company ever at the time of its stock market debut.
And for a few minutes there on Friday, it seemed that Morgan Stanley had done a pretty good job, as the stock jumped from 38 to 45. But as I write this column today, looking at the price of FB on my computer screen, I see that it’s trading at a little under 34. For those poor souls (and they were all retail clients) who bought the stock at the initial price, they could find themselves down as much as 25%. Morgan Stanley in all likelihood is laughing all the way to what’s left of its investment bank.
For in a world in which there is not much growth, the pickings are slim, and virtually all investment banks are now shadows of their former selves.
Without a real plan for growth, the world remains on a knife’s edge, with the only thing that’s changing is the distance we will fall if we step off in one direction or the other. On one side is massive inflation, on the other, massive unemployment, deflation, depression – whatever you want to call it.
Under these circumstances, our approach to investing is more and more to try to find individual investments with downsides that are dwarfed by their upsides. In this slow growth, highly tumultuous world, the probability of an upside is somewhat small, even in the best of cases. That’s a big change. But if things go right for such investments, that upside will be there. It’s just that, again, there is far less chance of everything going right than of it going wrong.
Still, for each of these investments there has to be a positive expected value. By expected value we simply mean that if you could repeat the experiment enough times, you’re likely to end up well in the black. For example, if there’s only a ten percent chance that a stock will go up five-fold, and a ninety percent chance the stock will go down ten per cent, your expected value would be nearly fifty percent. That’s a situation where your chances of losing are far greater than your chances of winning – but the payoff if you do win will be substantial.
There aren’t many stocks that qualify here, but they do exist, and through our newsletters you can find them faster and more easily. We’ve identified a particularly good bet in the pharmaceutical space, for example. It has an admittedly less than a 50 percent probability of success in treating Alzheimer’s, or of establishing an ever greater franchise in another area it specializes in, Diabetes. But success in either of these areas is likely to move the stock up fifty to one hundred percent. And though chances of success may be less than fifty percent, the downside on this stock is no more than twenty percent – in other words, positive expected value.
Similarly, we’ve picked a company in the tech area which is in the process of trying to extend its hegemony in manufacturing. If the company is successful (and we rate those chances very high) and if there is lower demand for the products it manufactures (and here’s where the odds may not be quite as good), it will become a near monopoly manufacturer of the latest and greatest technologies. And this could happen within the next six to twelve months. Again, if this happens, our subscribers could see a proverbial 5- or 10-bagger.
There’s also a third category of stock we like in this context, and here we might be cheating a little bit because the odds in this case are more evenly tilted between massive gains and substantial losses. This would be the junior miners. These stocks nearly all trade at a fraction of asset value. And unlike the well-known senior miners, relative to their capitalization they have massive reserves to exploit. What they lack is funding. But in a world in which we believe gold will be one of the few asset categories to produce very positive and strong results, these junior miners will very likely find funding sooner or later. For specific picks we refer you to our flagship newsletter The Complete Investor.
To sum up our perspective: please beware of the limited growth opportunities that surround us – and the increasingly greed-driven agendas of some of Wall Street’s biggest players.
But also know that even in this environment there will be those few that grow to the sky. Just keep in mind that you have to pick more than one or two in order to increase your chances of success – and achieve the kind of outsized gains we think you deserve.