I’ve got some good news for you.
I hope it’s welcome too.
Everything everywhere is going wrong for most investors.
The “safe” stocks in the market are getting crushed. Those companies like IBM and Caterpillar are leading the market down.
China is set to report its lowest GDP growth in years. We previously estimated China needs 6% to 8% GDP growth to keep from falling into a debt-driven death spiral. Now it’s looking at 4% or worse.
It’s still ugly out there, but there is something very good that has happened recently that should have all investors excited.
The End Of An Era
The thing we’re most excited about in this downturn is that some of the stupidest, most ridiculous situations in the market are getting eliminated.
I’m not talking about pockets of strength, but pockets of stupidity.
These pockets of stupidity are getting completely routed and it’s all part of painful process (for many), but an essential one that benefits as all.
Here’s one great example of a pocket of stupidity that honestly made no sense at all.
We covered this a little over a year ago and said, “[This is], for lack of a better word, insane.”
Well, it’s finally playing out as we expected.
At the time, the Obama administration announced it was going to make a lot of revisions to the decades old Cuba policy.
Although the announcement was typically light on details, the move signalled the administration is committed to softening relations with the communist dictatorship.
Investors leapt into action. And when investors look for Cuban investments, they go straight to the Herzfeld Caribbean Basin Fund (CUBA).
This fund (which we’ll refer to as CUBA) purportedly invests in stocks which will benefit from opening up of Cuba to the U.S.
Of course, two minutes of research will show many of the fund’s top holdings are only tangentially connected Cuba:
[CUBA] has been marketed as the way for investors to play Cuba for years.
The thing is though, it’s top holdings only have very loose ties to Cuba.
Here are some of the fund’s top holdings, the percentage they make of CUBA, and have only marginal connections to Cuba:
Copa Holdings SA (CPA) – 5.6% – is the holding company of Copa Airlines, a south and central American air carrier based in Panama with a big presence in Havana.
MasTec (MTZ) – 5.8% – is an infrastructure builder that, according to it’s official profile, operates “primarily in the United States.” It builds everything Cuba would need like telecom networks, electric grids, oil and gas, and everything a first world society needs.
Coca-Cola FEMSA S.A.B de C.V (KOF) – 6% – is the central and South American bottling company for Coca-Cola. It has distribution networks in Mexico, Guatemala, Nicaragua, Costa Rica, Panama, Colombia, Brazil, and Argentina carries a market value of more than $17 billion.
Royal Caribbean Cruises (RCL) – 7.4% – operates 41 cruise ships.
While none of the CUBA holdings are a direct play on Cuba, it is filled with companies that have indirect exposure or that could benefit from a lifting of trade restrictions.
So, if you look beyond the marketing of the fund, it’s not really a direct play on Cuba at all.
However, that didn’t stop investors from plowing so much money into it that the price soared out of control.
You see, CUBA is a closed-end fund which means it trades like a stock. It’s market price trades at a discount or premium to the value of the assets it holds.
When we warned against the fallacy of investing in the fund, it was trading at a 26% premium to the Net Asset Value (NAV) of its holdings.
That was basically the equivalent of paying $1.26 for a dollar bill.
Again, absolutely insane.
But it would get worse.
As the chart below from CEFConnect shows CUBA’s market price continue to rise even though it’s underlying assets didn’t move nearly as much:
The green line is the the stock price and the red line is it’s underlying NAV.
You can see how crazy it got.
At it’s peak, to use our example above, buying CUBA in May of 2015 was the equivalent of paying $1.60 for a dollar bill.
It’s a price that can’t, wouldn’t, and didn’t last. Today CUBA is trading at a 7% discount to the value of its holdings.
That’s a much more reasonable price and signals a very good trend in the markets today.
And The Good News Is...
And that’s where the good news comes in.
The recent sell-off has been painful for many, but it has been a healthy and much needed dose of reality.
Honestly, $100 oil made no sense to your editor. I’d say $30 makes a lot more sense.
That’s just one though. There was also rare earth elements, 3-D printing, all the other micro-bubbles that formed their own pockets of stupidity.
Now, one of the last pockets of stupidity is evaporating and the markets are getting much more rational.
Although there will be exceptions (Zika Virus stocks anyone?), a more lower-price and more rational market will be much easier to invest successfully in than an irrational one.