The Investment Scientist

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1, I got accepted into Oxford University Business School’s Executive MBA program. I will go to Oxford to attend classes starting in January. The program requires me to go to Oxford one week out of every five for a year and a half with a total of sixteen modules.

2, I’ve nearly finished my second book “Entrepreneur Wealth Management Made Easy.” I expect to publish it in the first half of the new year.

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unnamed (1).jpgAs of the market close on Monday, December 17th, both the Dow and the S&P 500 have a 14% discount, the Nasdaq has a 18% discount and the small cap Russell 2000 index has a 22% discount.

On the Asian front, the Chinese market has a 27% discount, the Hong Kong market has a 22% discount, and the Japanese market has a 12% discount.

On the European front, the German market has a 21% discount, the UK market has a 14% discount, and the French market has a 15% discount.

According to my wardrobe theory of investment, this is a good time to buy stocks. If you were excited about buying stocks a few months back (when these markets were raising prices to new highs), you should be even more excited now!

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wardrobe-interior-500x500.jpgInvestors are extraordinarily good at hurting themselves. They all plan to buy low and sell high, and yet what they all end up doing is buying high and selling low.

They do that by 1) piling onto the market when it is riding high and bailing when it is dropping low; 2) chasing the immediate past “winner” whether that is gold, emerging market stocks or the S&P 500 only to see the winning streak fizzle. Basically, they are systematically overpaying for assets.

If that sounds like you, well you are not alone. But here is the good news. I am going to give you a simple trick that can help correct your destructive tendency and thereby make you a much better investor.

So are you ready? Drum Roll, please …..

Treat your investment portfolio the same way you would treat your wardrobe.

What are you talking about? Are these two even comparable?

For simplicity’s sake, let say you acquire your entire wardrobe from Neiman Marcus. If Neiman Marcus has an across-the-board 50%-off sale, would you throw up your hands in despair and say,“Darn it, my entire wardrobe just lost half of its value. I better sell it all at the flea market or I will lose everything?”

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lead_720_405.jpgThe recent market volatility reminds me of an ancient Greek historian, Thucydides. He wrote “The History of Peloponnesian War,” about the war between the then reigning power Sparta and rising power Athen. He famously wrote: “What made war inevitable was the growth of Athenian power and the fear which this caused in Sparta.”

Fast forward to two thousand five hundred years later. A Harvard University political scientist, Professor Graham Allison coins the term “The Thucydides Trap” to describe the power dynamic between the reigning power and the rising power. Through an extensive study of historical precedents, he found there are sixteen cases where a major nation’s rise has disrupted a dominant one. Twelve of these ended in wars. For example, the rapid industrialization of Germany rattled Great Britain’s established position at the top of the pecking order, leading to the first World War.

In his book “Destined For War: Can America and China Escape the Thucydides Trap?” Allison argues that this historical metaphor is the best lens through which to observe the US-China relationship.

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150106094958-market-correction-1024x576.jpgAs of yesterday’s closing bell, the Nasdaq Composite is already in correction territory, down more than 12% from its high. However, the other two indices have yet to reach the correction stage, which is marked by a drop of at least 10%: the Dow is down 8.4% while the S&P 500 9.4%.

I am going to look at the recent market drop from two perspectives: statistical and economical.

Looking through the lens of statistics, a correction is long overdue. Why? Well, the historical odds of a correction are once every two years, those of a bear market once every five years. Yet the last time we had a correction was in 2011, seven years ago. Is it well-overdue?

Looking through the lens of economics, there are two exogenous economic forces that are influencing the market. One is the Trump tax cut, the other is the Trump trade war. These two forces are driving the market in opposite directions.

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Recently, some of my clients asked me a very good question: “Why is my portfolio not doing as well as the S&P 500 index? Shouldn’t we invest more in US stocks?”

The answer is very simple. US equity is only one component of their portfolio, and it happened to do the best this year. The best component of the portfolio will always do better than the whole portfolio. That does not mean we should not diversify.

In fact, I hear similar questions all the time. Seven years ago, it was “Why didn’t we invest more in emerging markets? There’s no way the US market will do better than emerging markets.” Five years ago, it was “Why shouldn’t we put everything in gold? All of my friends are investing in gold.” In each case, I had to twist their arms to get them to stay invested in US stocks, and now they are thanking me.

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hdhp-300x180.pngIn my last newsletter I wrote about how a Health Saving Account (HSA) is the best retirement saving vehicle with triple tax benefits. However, not everybody can have a HSA – you must have a High Deductible Health Plan (HDHP.) Those of you who have traditional PPO/HMO health insurance are not eligible.

This begs the question, who should use the HDHP with a HSA? Here are the simple answers followed by a discussion.

  1. High income folks especially those in top three tax brackets of 32%, 35% and 37% should use a HDHP.
  2. Healthy folks should use a HDHP.
  3. Low income folks who are frequently sick should stay with PPO/HMO.

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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