Merry Christmas 2018! Thoughts about Socialising, Conformity and the Recent Market Turmoil

This post will go over some of my thoughts that have been on my mind over the Christmas holiday. In true minimalist style, I have not purchased a Christmas tree nor have I purchased any gifts for anyone, and I will not be attending any Christmas parties. I have caught up with some friends and family over the holiday period but little else. Although it is cliche to say this, Christmas is highly commercialised these days, and personally I don’t celebrate Christmas too heavily, but many other people do, and I think my lack of engagement in Christmas activities puts a distance between me and others.

Ultimately the main issue is that often the cost of human connection and intimacy is conformity, but conformity is often costly.

Socialising and conformity

As I have discussed, an idea that has been on my mind recently is the cost of socialising. Many of us like to think that we are independent, that we do what we want regardless of what others think, but going against the grain and being very different is harder than you may think. It is natural and normal to conform. In fact, I would argue that we are hard-wired to conform. It is something that we evolved to do. There is a famous psychology experiment (the Asch conformity experiments) that shows just how powerful conformity is and how susceptible we all are.

Even though I like to think of myself as independent, I do conform to a degree, and conformity is sometimes important because it allows you to fit in to a certain culture with which others are familiar. Taking the example of Christmas, if you do not give gifts or engage in any Christmas activities, this will clearly put a barrier between you and others.

There have been moments in my life when I have been too independent, too much of a freethinker, and this has isolated me from society, which leads to misanthropic feelings, and this can have very negative mental health outcomes and can lead to depression. It is important to find the right balance between independence and conformity. As a man who enjoys independence and freedom as well as systematically minimising all forms of obligations (debt, social norms, customs, tradition, etc) this has been one of the realisations I have come to this year, that there is some value in conforming, but it needs to be controlled and I need to practice conformity in a way that still allows me to be myself and to be authentic. Most importantly, conformity needs to be practiced from a position of independence and freedom. This reminds me of the concept of exit, voice and loyalty. You can be loyal i.e. you can conform to something or someone’s values, but you need to have the freedom to be able to voice your own views or values, and if your values or views conflict too much with those with whom you are loyal, then you need the ability to exit. This is where having huge passive income and minimal obligations helps. For example, if you have a huge mortgage and three children to support, and you work a job you hate, you are trapped in this job. You are forced to conform or be loyal in this arrangement without the freedom to voice or exit. However, if you suddenly hate your job but you live off passive income, have no debt, no children, no mortgage, and no obligation or commitments, then there is nothing stopping you from voicing your displeasure or exiting entirely.

Although I do believe there is some value in conformity, I should say that everyone is different and that I do believe there are many who value nonconformity. We are typically more comfortable when we are in environments that are familiar, that fit in with our own culture. When someone is noncomformist, e.g. to take an extreme example, if someone comes to work wearing clothes that are inappropriate (e.g. wearing underwear), then this creates discomfort. Something just doesn’t seem right. However, conformity can go too far. Too much conformity creates a fakeness that many find unappealing. Although familiarity can put people at ease and build human connection, you can go too far to the point where you are fake and this also creates unease. There is value therefore in conforming in moderation but it is also important to have the courage to be yourself, to reveal your true thoughts, and to be authentic. Usually the ability to be your true self and to be authentic comes when you are financially secure and when you have few obligations.

I should also add that conformity is not just about whether you give gifts or wear certain clothes to work. Most of us conform but aren’t really aware that we conform simply because we feel that what we do is what we are supposed to do. For example, most people drive cars, get married and have children without even thinking about it because this is seen as normal. If you’re a cycling, if you’re single, and if you’re childfree, this is seen as unusual, but I think society nowadays tolerates individual freedom, so even if you are a single childfree cyclist, you will be considered different but you will not necessarily be socially ostricised. In my opinion, it is very important to be aware of how much culture affects you because when individuals conform to most cultures, they usually impose upon themselves large obligations. Among most cultures there is an expectation that a person’s youth is a period of freedom. However, the expectation is that once someone has enjoyed his or her youthful freedom, they need to become adults, they need to accept adult responsibilities, and they need to “settle down.” I argue that you don’t need to ever settle down, that you don’t need to accept large obligations. You can be free forever.

The recent market turmoil

I will change topics now and talk about the markets. The markets have done very poorly over the last few months. In my opinion, we have gone through an eight-year-old bull market without a major correction, which is the longest in history, so we are due for a crash soon. This recent turmoil in stocks may be the start of the next financial crisis but there are many credible institutions (e.g. JP Morgan) predicting the next financial crisis will occur in 2020.

Donald Trump’s policies do not help, especially the tariffs between the US and China. Importers will need to pay the tariff and pass it on to customers, which creates inflation as the cost of living rises. Furthermore, corporate tax cuts and higher government spending increases money supply in the economy. All these factors increase inflation, which necessitates the central bank increasing interest rates. Higher interest rates means corporate profits fall as companies need to pay higher interest to service their debt. Furthermore, tariffs don’t just mean importing products into America become more expensive. Once tariffs are applied to Chinese goods coming into America, the Chinese will apply retailiatory tariffs, which block American exports going to China, which in turn hurt sales. Because Chinese companies cannot export to the US as much, this impacts on Australia as we export a significant amount of raw material to Chinese companies who then transform these raw materials into consumer goods to be exported to the US. History has shown that protectionism benefits no one. Both parties lose out.

In my opinion, throughout a market collapse it is important to stick with your investment plan rather than sell in a panic. In an earlier post I spoke about “age in bonds” or owning your age in government bonds e.g. if you are 30, own 30% bonds. This rule is a guide and can be modified to fit your risk appetite e.g. if you can tolerate more risk then consider putting 50% of your age in bonds (e.g. if you are 30, you own 15% bonds).

The problem most people have is they cannot predict their risk appetite. When markets are going up, they think they can tolerate high levels of risk, but once markets actually collapse and they are confronted with large and sudden declines in wealth, they realise that they cannot stomach volatility, and they panic sell and crystallise their losses. Therefore, in my opinion, if the recent bull market has lulled you into complacency and now you are feeling nervous, it is a good idea to reflect on what your true risk appetite is, and in the future you can buy more (or less) defensive safe-haven assets (such as bonds, gold or cash) in order to align the asset allocation in your investment portfolio to your actual risk appetite. Over time, as you live through more market crashes, you start to get a feel for what your actual risk appetite is. It is not something that is easy to predict. It is something you need to adjust as you experience it in real life. One of the biggest mistakes in financial planning is when the financial planner hands you a form and you fill how much risk you are willing to take. In my opinion, no one really knows how much volatility they are able to withstand until they actually expereince it in person. Until someone feels $100k of their wealth being wiped out in one day can they truly appreciate how much volatility they can stomach.

It is also important to keep in mind why you are investing. For me, investing in stocks is mostly about generating dividends, passive income, and thereby providing freedom. Therefore capital gains do not matter much because my intention is to hold these stocks or ETFs forever. The recent market correction therefore can be seen as an opportunity to load up on more high-dividend ETFs. For example, with the market collapse, the iShares S&P/ASX Dividend Opportunities ETF (ASX: IHD) currently has a dividend yield of 13% according to Bloomberg. Of course, even if you are a dividend investor, there are benefits in diversifying into bond or hybrid ETFs. Although high-dividend ETFs such as IHD currently have a yield of 13% whereas government bond ETFs such as BOND have yield of 2.3% and HBRD, a bank hybrid ETF, has yield of 3.7% it is important to remember that although dividend yields are higher than bond yields, dividends can be cut.

If the market correction we are currently experiencing gets really bad, I will not be surprised if companies start announcing dividend cuts. It happened after the GFC, and it can happen again. This is where bonds can be useful because bonds are more likely to be paid to investors. If a company faces distress, bondholders by law are paid before stockholders. Bonds or hybrids then can be useful for income investors seeking passive income because they provide not only stability in price but also stability in income. Even though yields are lower for bonds or hybrids, this reflects the lower risk, the fact that these payments are less likely to be cut in the event of economic distress.

Disclosure: I own IHD and HBRD.

Why Save Money If You Love Your Job?

Many people tell me that they love their job, so they don’t want to save up any money. They are happy to spend everything they earn.

When I started working, I noticed that many people had this attitude. They said they loved working and they envisaged themselves working for the rest of their lives. With this carefree attitude, they took on mortgages, got married, and had multiple children. They assumed that their salary would be there forever, so they behaved as if this were the case.

Then the organization I worked for announced that, due to the 2009 global financial crisis, there would be job cuts. A spill and fill was performed and about 40% of people lost their jobs, and many of the people who lost jobs had huge mortgage debts and multiple children.

I don’t know what happened to everyone who got fired. Many of them were old, which makes it less likely for them to find another job. Some were able to get other jobs, but they mainly just grabbed onto whatever they could find because they were desperate for some income to feed their children and pay for whatever obligations they had.

I remember when I started working. I was enthusiastic and passionate. I had just finished university and was entering the workforce for the first time. I thought I would work forever as well.

After the restructure, I realized then that even thought I started off loving my job, the downturn in the economy forced management to fire people, and the working environment became toxic as a result.

Things change, and you must be prepared for change.

Your circumstances today will not necessarily apply tomorrow. The only constant is change.

This is why having money saved up is important. If you have enough money saved up, you can live off your investments forever and never need to worry about working. This is why you must live off dividends.

It was after this painful incident that I realized that I needed to save up and invest. About six years later, I am still working at this organization, and the horrors of the past have been forgotten, and people are once again telling me that everything is fine, the economy is great, that I should get a mortgage, buy a sports car, etc.

But I know from experience that things can change quickly.

This is why you must save money. You must be prepared for change.

My Thoughts on “The Big Short”

Yesterday I was watching a movie called The Big Short and it’s an awesome movie about the GFC. The movie makes me wonder about whether we are in for another financial crash. Stock and property markets went down about 50% in America and most countries around the world, but since then central bank injections of cash seem to have restored everything.

This movie blames the property crash on subprime loans, but at the end of the day subprime lending popped the entire American housing bubble. The bubble was there in the first place, and the bubble was in property, not just subprime property but also prime property, which is why property prices in the US fell across the board.

This movie also really exposed how corrupt and fraudulent the financial system is. The biggest injustice of all, in my opinion, is that investment banks created these toxic assets (CDOs, etc) and then when they were worthless they simply did a deal with the government to unload it onto the government in return for printed money (or bailout money). This pretty much means the banks can do whatever they want knowing that if things go wrong they can simply get the government to bail them out. If you or I started a cafe and the business failed, the government will not bail us out. However, this does not apply to bankers, the holders of capital. Capitalism, therefore, does not apply to capitalists. Bankers can create bubbles, create bad assets, and then sell these assets, and if everything goes wrong they can just tell the government to take it off their hands. There should be no bailout, and those who held CDOs should have been left to learn the errors of their ways. By bailing them out, you only reward bad behavior.

Looking at it this way, the banking industry is simply an arm of the government. Banks are simply government business enterprises.

The original view was that if the government prints money to buy these toxic assets off bankers, this would cause inflation, but these toxic assets are usually highly leveraged, and more debt actually increases the amount of the money in circulation, which is inflationary. As debt prices go down (e.g. there is a debt bubble that pops) then this means the expectation is that loans will not get paid, and the amount of money in circulation goes down, which is deflationary. The government printing money simply restores the money supply back to original levels. 

How to invest

My investing strategy is pretty simple. I’ve been focusing mainly on dividends and looking at funds that provide low volatility. The perfect ETF on the ASX, in my opinion, is Betashares’s HVST, which has a double-digit yield and pays monthly. It also uses derivatives to lower volatility by selling futures when volatility is high. If the market crashes, I’m sure this fund will go down, but it won’t go down that much, and while everything is rosy, this fund will produce great dividends, which is awesome.

If there is a GFC 2, I expect to take a hit. My net worth will go down, but I have been loading my portfolio up with funds that are designed to be low volatility (such as HVST) as well as other defensive investments like gold mining ETFs (ASX: GDX) as well as bond funds, and so if my net worth goes down, it won’t go down much, and when the market bottoms, I will definitely be plowing as much money as possible into leveraged ETFs expecting the government to print money to restore the economy. While the market is likely in bubble territory now, it’s also a good idea to keep debt levels low because a major risk when there is a market crash is that a margin call will be triggered. Keeping debt low reduces the risk of this happening. Furthermore, as the market bottoms, if your debt levels are low, you have more ability to take on more debt to invest when the market bottoms, which means you can leverage into leveraged ETFs and achieve “double leverage” to magnify your returns once central bankers start firing up the printing presses.

Bottom line is that at this stage you should load up your portfolio with defensive assets, e.g. cash, bonds, gold, as well as “smart beta” low-volatility ETFs, but don’t go all into these defensive assets because it’s almost impossible to determine when a bubble will pop. As they say, a market can stay irrational longer than you can stay solvent, so often when a bubble is formed, it’s often best to simply ride the bubble and make money, but always have a plan to protect yourself if the bubble bursts. There must be a plan B.

 

The Dismal Future of the Australian Economy

gold price vs asx200 27 august 2015
GOLD vs the ASX200 (Commsec)

The recent volatility in stock markets has gotten me worried. Everyone keeps telling me to relax because “economic fundamentals are sound,” but when I ask them to explain how this is true, it’s revealed that they don’t really know what they’re talking about. It seems that most people just hope for the best and rationalize away bad news.

The Chinese stock market is certainly wobbly. Some say the Chinese economy is very healthy. After all, they have low debt and a massive foreign exchange reserve. They are the biggest lender nation in the world with the USA the biggest creditor nation. However, we don’t really know much about the true size of China’s debt because there is significant activity in the underground economy that is not transparent, and I’m not too confident in official figures provided by the Chinese government. Of course, China has been manufacturing products from t-shirts to smartphones, but the government has in recent years been intervening in the economy to prop up the stock and property markets. It’s uncertain whether these distortions can be held together by the government or whether the market will eventually strike back.

America has resorted to printing money, which has resulted in surges in the stock and bond markets. However, unemployment is still high and wage growth is low. Printing money doesn’t seem to have done anything other than make the holders of stocks and bonds wealthy (these are mostly wealthy people anyway).

In Australia, our economy used to be dominated by two sectors: the banks and the miners. The miners dug resources from the ground and shipped them to China. China makes goods and ships them to US consumer who buys these goods.

But the American consumer (or consumers from any other developed country) is not buying as much as they did before the GFC. This means China is slowing down, the price of resources is dropping, and the mining sector in Australia is getting crushed. We only have the banks left, and how do they make money? The balance sheets of Australian banks is mostly in loans to consumers who buy real estate. Real estate prices have been going up thanks to profits from mining. In other words, banks do well because house prices have been sustained by profits from the resources sector. Now that mining is dead, what will sustain us? Where are our strong fundamentals? House prices only go up with people buy houses, but to buy houses you need to make money in the first place. You can’t make money from houses without putting money into it in the first place.

Many who have bought stocks have made great wealth from quantitative easing, but now that tears are emerging in a bubbling world economy held together by printed money, it’s time to look at investing in gold.

Gold tends to shoot up significantly when stocks tumble, and when stocks go down, gold tends to go sideways or go up anyway, so there doesn’t seem to be any downside to investing in gold.

Personally, I will be buying this shiny metal from now on.