Nick Giambruno’s Note: For the first time on February 8, I’ll share a stage with Doug Casey’s longtime friend and colleague Bill Bonner at the Legends of Finance Summit.
Readers familiar with Bill know he’s a big-picture guy who doesn’t make stock recommendations. But over the years, he put together special trades to take advantage of out-of-whack markets.
Bill calls these trades educational tools. But as you’ll see below, they could’ve also been very profitable if you’d followed them…
On a trip to India a few years ago, the financial press was very eager to hear what I had to say.
They invited me on their television shows. They interviewed me for magazines and newspapers. The local paper ran a full-page interview and sent out an artist to do a sketch of me.
I thought they might have had me mixed up with someone else. I’m not used to people taking me so seriously.
“Noted Western Economist Gloomy on World Recovery,” was the headline in the paper.
In all these interviews, I had more or less the same message. I told them that the recovery was largely fake, since it was purchased with fake money and depended on fake interest rates.
Stock prices would fall, I said. The property markets in the U.S. and Britain would sink further. There would be some spectacular bankruptcies – including some bankruptcies by nations.
The one thing that Indian investors seemed most interested in… and I assume you are interested in, too… was my new “Trade of the Decade.”
But I’m not going to give you a typical investment analysis or a target for GDP growth or for the Dow for this. Instead, I’m going to talk to you about history and philosophy.
I hope that’s OK.
An Out-of-Whack Market
I had great luck with my first Trade of the Decade around the turn of the millennium. I recommended selling U.S. stocks and buying gold. It worked out very well on both sides.
[Editor’s Note: Gold went on to become the best-performing asset class of the decade, soaring over 500%. And when the financial crisis hit between 2007-2009, the Dow plummeted 54%.]
So people wanted to know what my trade would be for the next decade. I gave it some thought and came up with something. I thought this one would work out, too…
But first, let me explain how it works. Behind the Trade of the Decade is a simple observation: things that are out of whack tend to get back into whack. Over a 10-year period, you have a fair chance that they’ll return to normal.
This is another way of describing the phenomenon known as reversion to the mean. One of the surest phenomena in the natural world is that things that are extraordinary will eventually become less extraordinary. And over a 10-year period, you have a decent chance that that’s what will happen.
So what’s my Trade of the Decade for 2010-2020?
At the time I started my second trade, the U.S. Treasury market was out of whack. It had been going up since 1983. Investors were lending money to the world’s biggest debtor at what were historically ultra-low interest rates. And they did this at a time when that debtor was engaged in the biggest borrowing and spending spree in history.
This was not normal. It was downright weird.
I figured that, sometime before 2020, the Treasury market would get whacked hard. So on one side of the trade… I’m short U.S. Treasurys.
On the other side of the trade, I had more trouble. Because I was looking for something to buy. And nothing was cheap.
Even gold… which I expected to go up much higher… was not cheap. As near as I could tell, an ounce of gold bought about as much – in terms of consumer products – as it did 700 years ago… and maybe even as much as it bought 2,000 years ago.
Gold had already reverted to the mean, after being seriously undervalued in 1999. Now, most likely, I figured it would become overvalued when the current monetary system began to break up.
But that’s a different phenomenon. It’s not reversion to the mean, at least, not for gold. It’s a reversion to the mean of the monetary system… I’ll get to that in a moment.
What I needed for the buy side of the trade was something that was historically undervalued. Which led me to Japanese small-cap stocks, which had been going down since 1989.
So that was the new Trade of the Decade. Sell U.S. Treasurys. Buy Japanese small caps.
But I’m going to give you an even better Trade of the Decade. The problem for non-Japanese investors is that the small caps may go up… but if the yen goes down, you might lose your gains…
An Even Better Trade…
So how about this?
Instead of selling U.S. Treasurys, sell Japanese government bonds. They’re probably even more overvalued than U.S. Treasurys. And with the Japanese borrowing more than ever… as the Japanese savings rate declines… it seems a fair bet that Japanese government debt will go down at least as much as U.S. debt. Maybe more.
By buying Japanese small caps and selling Japanese bonds, you take out the currency risk. You have an even better Trade of the Decade.
Even after running higher in recent years, Japanese small-cap stocks are extraordinarily under-appreciated. The Japanese government debt, on the other hand, is extraordinarily over-appreciated.
[Editor’s Note: The Nikkei index, a measure of the Japanese stock market, is up 119% since the start of 2010. Japanese government bonds have fallen 1%.]
But the first point I want to make is that this is just an idea. It’s not a substitute for a serious investment strategy.
The second point I want to make is that you can only have a serious investment strategy if you’re willing and able to think deeply about ideas. And if you do think about them enough, you’ll have a decent chance of doing well.
That’s because most people – including most serious investment professionals – don’t think about them very much. That’s what I mean about philosophy: You have to think long and hard about how the world works. And history is about the only tool we have to work with.
Editor’s Note: Check your inbox tomorrow for the second part of Bill’s special three-part series. In it, he’ll dive deeper into the “reversion to the mean” theory.
And be sure to save your spot to the Legends of Finance Summit on February 8 at 8 p.m. ET. Bill’s teamed up with Nick Giambruno and Doug Casey to show you how to profit from his latest trade. Find all the details here.