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Three Card Monte

If someone forwarded this to you, my name is Paul, you can read about me here. This Substack grows via word-of-mouth, so please forward to your friends. If you like this writing, you will enjoy my books Master, Minion and Raising a Thief as well as the podcast.

“Nature is not benevolent.” Lao Tzu

Add to the list of recent surprises that the best investment strategy so far this year was to abandon any notion of prudence or risk management and put it all on red, meaning buy Apple. I could have sold my entire portfolio Dec. 31, invested it on Jan. 1 in Apple, sold it Friday, and been up a cool 32%.

Half of the rise in the stock market this year is due to just 3 stocks!

Full disclosure: I didn’t do that. Instead, I am still tabulating the results (some investments report with a lag) it looks like my UNAUDITED return was around …1.4%. Markets, politics, and our own lives are Three Card Monte, meaning sometimes it is hard to discern what truly matters versus a distraction.

Photo: ZioDave.

Regarding markets, I entered Q1 positioned bullish stocks (betting they would rise) on a belief that inflation was falling and we were close to the end of the tightening cycle. Below is a long-run chart of inflation. It looked to me like the recent, post-pandemic spurt in inflation was rolling over. A number of faster-moving indicators suggested the labor market was loosening as well, which likely would have helped.

Instead, a banking crisis appeared (SVB collapsed), almost out of nowhere. Inflation only came down a tiny amount and is still above 4%. Despite this, it appears households poured billions into the stock market and into those three stocks (Apple, Microsoft and Amazon) specifically. We don’t yet have accurate data on household flows, but it is likely another jump up in this line below. Institutional investors have been somewhere between very bearish and cautious.

Why did households pour money into Apple? I don’t know. I wouldn’t buy these stocks here. I suspect there are better deals than Apple, meaning a $1 of risk can offer a higher future return. Because prices embed expectations about the future, these stocks now assume strong earnings going forward at a time when almost every central bank is trying to slow growth and the bank problems will constrain credit.

Below is Apple’s Price to Earnings ratio. PE ratios are a simple measure of how optimistic investors are on the stock or more explicitly the future earnings of a company. If the PE of Apple merely falls to its pre-pandemic average, the stock will shed 30% and the S&P will fall 2%.    

My point—I was right (stocks rose) but for the wrong reasons. The collapse in SVB changed the Fed’s willingness to raise rates and likely the necessity to do so which led to a rally in bond prices, which helped boost stocks, particularly the most popular stocks. In short, my attention was in one direction and the truth was elsewhere, Three Card Monte.

Politics are similar. On election night in 2016, I was sitting at a bar in Austin, Texas staring at The New York Times election prediction that Clinton had a 70% chance of becoming President. 70% isn’t 100%. In a moment, everything changed and what had been on the periphery suddenly moved front and center.

Somewhere, out of the corner of my eye, I knew chunks of the US electorate were enduring flat real wages, rising opioid deaths, and trying to make sense of reality via fractured media, like Twitter, that is particularly susceptible to grifters. I had no idea having a darker-skinned President, Obama, could produce a psychological rift in some people. I am not a lawyer and don’t know if the charges against Trump will stick. But politics is full of Three Card Monte. One of the exonerated central park five, Yusuf Salaam, summed it up in a single word, “karma.”1

Finally, there is Three Card Monte in our own lives.

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