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Even the billionaires have this problem

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From Richard Smith, Founder, TradeStops:

Eric Arthur Blair — better known by his pen name, George Orwell — is the British author who wrote the timeless classics Animal Farm and 1984. Phrases still in use today — like Orwellian, Big Brother, and Thought Police — are a result of those novels.

Orwell was also known for his essays. In 1946, the year after World War II ended, he wrote the following in a piece titled “In Front of Your Nose:”

“We are all capable of believing things which we know to be untrue, and then, when we are finally proved wrong, impudently twisting the facts so as to show that we were right. Intellectually, it is possible to carry on this process for an indefinite time: the only check on it is that sooner or later a false belief bumps up against solid reality, usually on a battlefield.”

Orwell also has a famous quote: “To see what is in front of one’s nose needs a constant struggle.”

Long before the phrase “cognitive bias” gained attention in the 1970s, Orwell and many others (all the way back to the ancient Greeks) knew something basic about human nature.

It can be very hard to see what is “in front of your nose” — in other words, the glaring evidence right in front of you. There are countless ways to be distracted or misled … or focused on the wrong thing … or thrown off balance by emotion … or a dozen other things.

At the same time, every so often and seemingly like clockwork, there’s an example in the news where human judgment fails spectacularly.

Such-and-such person makes a decision (or a string of decisions) so terrible that the age-old question arises: “How could anyone make such an obvious mistake? How in the world did that happen?”

They probably failed to see “in front of their nose.” And it was probably due to cognitive bias.

Cognitive biases help explain the “why” behind certain bizarre quirks of human nature

They can be described as “systemic patterns of deviation” from rational thought.

These biases are “systemic” in the sense they are built into the brain, which means everyone has them as part of the brain’s default setting. They are not glitches or flaws in day-to-day functioning, but a result of the brain’s architecture.

Cognitive biases are literally everywhere. Anyone with a brain is susceptible to them.

But how do cognitive biases make it hard to see something obvious?

Take confirmation bias — one of the better-known biases (there are hundreds of them) — as an example. Confirmation bias is the tendency to filter information in a way that supports a desired belief.

If you deeply want to believe “X,” for example, your brain will seek out and register information that confirms the validity of X. At the same time, your brain downplays or ignores inputs that go against X.

The stronger your desire to believe something, the more powerful this effect becomes.

Confirmation bias can sometimes be so strong that it creates a reality distortion field — where the person in the grip of the bias is no longer able to process reality accurately.

In markets, this can get expensive. The problem is that different cognitive biases can combine and reinforce each other, leading to irrational behaviors that cost a lot of money.

You may have heard a version of this joke:

Q: What do you call a short-term trade that doesn’t work out?

A: long-term investment.

Here’s how that works:

Bob believes a certain stock will have strong earnings and a string of profitable quarters ahead. He buys the stock, assuming the earnings report will be a catalyst for a nice move higher.

Alas — the earnings report is bad. The company failed to meet expectations. The outlook is “meh” and was supposed to be great. The stock goes in the wrong direction. It gaps down and starts drifting lower.

At this point, Bob experiences the cognitive bias known as “loss aversion.” His desire to avoid a loss is stronger than his desire to seek gains. So, he holds onto the losing position.

If he waits a little while, Bob reasons, then maybe the stock will come back. Never mind that his whole thesis for buying the stock in the first place (strong earnings and rising profits) has been trashed.

Now that Bob’s short-term trade is a “long-term investment,” he has a vested interest in seeing the stock go up. This translates to an emotional desire — Bob deeply wants the stock to make a comeback.

Confirmation bias then takes hold: Bob’s brain starts paying attention to articles that are friendly to the idea the stock might come back … while discounting or ignoring evidence that the stock could go lower.

There is so much written about publicly traded stocks, it’s almost always possible to find a bullish article or someone making a weak bullish case somewhere — even if the stock is a total dog. Caught in the grip of confirmation bias, Bob seeks out these bullish articles. The stock keeps falling.

Bob ignores the strongly negative evidence — the warning signs in front of his nose — and stays with the position. A year later, the stock has fallen dramatically … and badly damaged Bob’s portfolio.

This can happen to anyone. It even happens to hedge-fund billionaires.

The tricky thing about cognitive bias is that, much of the time, you don’t even know it’s there. The bias factors play out in the realm of the subconscious.

At no point did Bob (our hypothetical investor) realize that he was acting irrationally as the stock kept going down. In the real world, Bill Ackman (a billionaire) did the same with Valeant Pharmaceuticals.

But cognitive biases can be trickier still — because they still distort things even when you spot them.

When a bias is strong enough, it creates a form of “cognitive illusion.” This causes you to see something that isn’t there, or to wrongly perceive an irrational course of action as rational. And even if you recognize what’s happening, the illusion persists.

We can use a visual cognitive illusion to demonstrate the point.

The “Müller-Lyer Illusion” was developed in 1889 by Franz Carl Müller-Lyer, a German sociologist. A version of it from Daniel Kahneman’s book, Thinking Fast and Slow, appears below.

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As you look at the illusion, ask yourself: Which of the two horizontal lines is longer?

The correct answer is: It’s a trick question. Both of the horizontal lines are exactly the same length. (You could prove this by taking a measurement.)

The illusion persists even after you know the correct answer. The bottom line still looks longer, even when you know the truth. This is due to a quirk of how the brain works and how certain shapes are interpreted relative to depth perception.

Certain types of cognitive bias can create a similar type of illusion. But these illusions are patterns of thought or beliefs rather than visual brain teasers. That makes them far more dangerous.

In the world of investing, persistent cognitive illusions (created by built-in cognitive biases) can lead to irrational decision making, which winds up costing investors money. Sometimes a LOT of money.

And the real challenge is, you can study up on the various biases … and be fully aware that you have them (just like everyone else) … and still fall victim to them anyway.

This is another benefit of using a set of rules that exists outside your brain … while interpreting market data with the help of software that informs and guides decision making.

A well-designed software algorithm doesn’t see with human eyes. Technically speaking, it doesn’t “see” at all. It just crunches a vast stream of ones and zeroes. That helps make the algorithm a reliable interpreter — an impartial judge, if you will — when programmed correctly.

And this, again, is why software can be such a help to investors.

You won’t always know when your cognitive biases (which all investors share) are negatively impacting your investing decisions. And sometimes those biases will distort your perception … even if you are well aware of them and know they exist.

But well-designed investment software can help you see “in front of your nose” in terms of making rational decisions with the help of data — thus increasing the likelihood of investment success.

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Richard

Crux note: As if the the challenge of savvy investing wasn’t hard enough, you have to fight against your own subconscious… But that’s why Richard created TradeStops.

His philosophy is to cut your losses and let your winners ride… And the results speak for themselves.

You can discover why one satisfied investor called TradeStops his “safety net” right here.


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Two easy ways to cut through the B.S.

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From John Engel, Analyst, Stansberry Venture Technology:

Investing in cutting-edge drug discovery can offer huge payoffs…

But it will never be safe or easy. I (John Engel) had to learn this the hard way. Even today, I continue to use this lesson to my advantage as a biotech analyst for Stansberry Venture Technology.

In today’s Digest, I want to discuss something most people experience but don’t talk much about: failure.

So let’s start where I did, many years ago, as a research associate for one of the largest pharmaceutical companies in the U.S.

I’m not ashamed to admit that my first few months in drug discovery were humbling. It took many years of practice before I truly gained my footing.

Back then, I had an advantage that most people aren’t lucky enough to have…

I had tapped into a wealth of experience by befriending an older, wiser colleague who we’ll call “Dr. A.” He had seen the biotechnology industry grow from a pipe dream into the multibillion-dollar industry it is today. He loved to tell me how easy I had it, with all of the advanced tools that exist now.

For reasons unbeknownst to me, Dr. A offered to show me the ropes. Of course, I eagerly accepted.

Often, he’d size me up before showing me a new technique. I’d master it, and a few months later I’d show him that “advanced tools” had found an easier way. It was a fun game. That’s probably why he put up with me.

Still, what we were working on wasn’t trivial. We knew that a successful outcome could potentially add an additional $100 million in annual revenue for the company. We took it seriously.

Once, after watching me stumble my way through a difficult experiment, he stopped by my workbench. With a straight face and an unsympathetic tone, Dr. A said, “John, you stay in this business long enough, you’re guaranteed to fail.” Then he walked away.

I’ll never forget the confusion I felt…

Did I botch the experiment? Did I overlook something so simple that even my mentor thought I had no future in this business?

It turns out, Dr. A had watched me perfectly execute the techniques. He just knew something I didn’t: It wasn’t the experiment that had failed, it was the molecule I was working with at the time.

In hindsight, this minor speed bump foreshadowed much bigger problems. A couple years later, still working on the same project, I found out what Dr. A really meant when he said I was “guaranteed to fail.”

At the time, the project I was working on was well ahead of schedule. We were on a roll and nailing every milestone in development.

You can probably guess what happened next…

We hit a major snag and our good fortune dried up.

The biomolecule (a protein) that we developed had a hidden flaw that we discovered only after scaling up – a step to produce large quantities of the protein in pilot fermenters.

At high concentrations, the protein “fell out” of the solution. You could see it with the naked eye, sort of like a shaken-up snow globe. It made downstream purification a nearly impossible task.

I remember working long hours that summer trying to find a resolution. Nothing seemed to work. We knew going into year-end progress meetings that it was all over. Two-plus years of work and upwards of $1 million invested in the project all disappeared overnight.

As a bench scientist, nothing was worse than having to throw a project in the trash. I wasn’t ready for that… In research, success isn’t guaranteed. As Dr. A put it, the only guarantee was that I would fail along the way. I’m just glad the first failure happened early in my career.

It seems every week, another drug failure hits mainstream headlines…

Take Axovant Sciences (AXON), for example. The company aimed to solve the world’s Alzheimer’s crisis with a groundbreaking pill. The thing is, the pill wasn’t much better than a shot of espresso. What Axovant had going for it was a huge marketing push and a big-name CEO.

Last August – just a few months before the company released its Phase III data – I told one of my colleagues in a private e-mail…

Axovant Sciences [has] a pill that increases the signals between neurons, but it does nothing to stop the disease. I’ve seen the CEO [David Hung] interviewed a few times. I’m disgusted at how much garbage the guy spews from his mouth. Harsh, I know, but he’s what’s wrong with the biotech industry.

Axovant’s pill amplified neural signals (as does caffeine). But at best, the pill was a Band-Aid on a bullet wound for Alzheimer’s patients. It had no real effect on the course of the disease.

What’s worse, Hung was shamelessly selling his previous success developing cancer therapies.

Hung, who both founded and served as CEO of Medivation, made more than $350 million when he sold the company to pharma giant Pfizer (PFE) for $14 billion. Folks expected to see him do it all again with Axovant, but they were wrong… Hung left the company right after things hit the fan. His tenure as CEO lasted less than a year.

As for the drug, here’s what things looked like when the company publicly announced its failure in Phase III. Axovant’s stock fell again when the company killed the project a few months later…

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Due diligence could have saved most investors from this bloodbath…

A few things stood out as I analyzed the company’s position.

First, drug giant GlaxoSmithKline (GSK) tested the drug in 13 clinical trials. Axovant mentions this in its corporate filings, right before it says the following…

While the 35 mg intepirdine dose group achieved statistically significant improvement in the CDR-SB at 12 weeks and was numerically superior at 24 weeks and further time points, the benefits at 24 weeks and beyond were not statistically significant.

(“CDR-SB” is a score for mental acuity, and “statistical significance” is proof that the drug does what it’s designed to do. It’s also important to note that 13 clinical trials is an extensive amount of testing.)

If you had done a little digging, you would have discovered that Glaxo had sold the drug for peanuts after conducting its trials. The deal closed after Phase II testing, which on average costs $20 million.

Add another $10 million (on average) for Phase I testing, and Glaxo likely invested more than $30 million in a drug it sold for $10 million. (The deal also included royalties if the drug was approved.) Believe me, Glaxo knows a thing or two about this business. It has entire teams of experts who determined the risks of failure far outweighed any chances of success. That’s why the company sold the drug for a fraction of what it paid in development costs.

From late September (just before its top-line Phase III results were announced) to January, Axovant shares fell nearly 95%.

The point of this story is that this drug was never a safe bet. And every investor should have seen the writing on the wall. It’s not always easy to make these connections, especially when the CEO is taking every opportunity to sell you on the idea.

I’ve found two simple ways to cut through the B.S…

First, as is the case with any stock, you should know what you’re investing in and why. This may seem obvious, but I can’t tell you how often someone has pitched me on a breakthrough drug without knowing what it actually does. “Why” is often a question of how big the market is and how much market share the drug could win.

Second, you need to let science dictate your decisions. You can’t let a CEO smooth-talk you into an investment. They’re often compensated with company shares, which means the more investors they attract who will boost the share price, the more money they make.

Once you have this mindset, it’s easier to steer your investment.

Let me show you what I mean…

Based on ClinicalTrials.gov, a government-sponsored website that tracks experimental medicine, more than 280,000 active clinical trials are currently underway. And the odds of success are stacked against most drugs… Research firm Statista notes that nearly 85% of them fail.

That doesn’t mean we haven’t seen some huge winners out there, though. Take Humira, for example. The drug is designed to suppress the immune system. It helps people suffering from health problems like arthritis, psoriasis, Crohn’s disease, and colitis.

In 2015, Humira became the most profitable drug in history (based on yearly sales). In 2017, it topped $18 billion in sales. Total sales over the drug’s lifetime are approaching $120 billion…

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Think about that for a second.

It cost around $1.5 billion to build Yankee Stadium less than a decade ago. AbbVie (ABBV) – which owns Humira – expects to make 13 to 14 times that from Humira prescriptions next year alone.

These figures are staggering. But most drugs (including Humira) aren’t overnight successes. Consider that Humira began Phase I testing in 1997 and didn’t reach Phase III for another three years.

What’s important is that the drug proved itself time and time again during clinical testing. The data showed the drug was safe and helped patients. The evidence in patients was clear as early as 1999. It’s published in Annals of the Rheumatic Diseases, a journal that highlights the drug’s Phase I trials. Three years later, these positive results supported an approval from the U.S. Food and Drug Administration.

The point is, Humira generated a huge amount of data over many years of clinical testing. That means there was plenty of time to interpret the results and use them to guide an investment in cutting-edge medicine.

With 280,000-plus ongoing clinical trials, new data are being published in medical journals around the world every day and discussed at medical conferences. It takes work to separate the good from the bad.

Now, I’m not here to scare you away from biotech investing…

In fact, nothing is more satisfying than making the right call on an investigational new drug or technology. As I just mentioned, the amount of opportunity out there is huge. You can make a fortune if you simply learn to avoid obvious failures.

What if you don’t have the time or desire to do the background work? Well, we have an easy way to take advantage of investment opportunities in cutting-edge medicine.

As I explained, my biggest advantage when I started a career in drug discovery was tapping into a wealth of experience. My colleague Dave Lashmet, editor of Stansberry Venture Technology, has chased investigational new drugs and technology for more than two decades.

These days, I help Dave with his research efforts…

To find drugs with blockbuster potential like Humira, we read through thousands of pages of medical and science journals every year. We comb through the data on dozens of clinical trials. We talk and meet with industry experts. And we attend several conferences each year. In the last year alone, Dave and I have attended 10 conferences covering a diverse range of illnesses including cancer, heart disease, Alzheimer’s, and infectious diseases.

Our research has taken us all over the U.S. and to Amsterdam, London, and Barcelona. (By now, you should understand why.) This type of research is what differentiates Dave’s work from the rest. It’s this type of research that leads us to finding new and innovative drugs that can save lives and make investors a fortune along the way.

Dave’s track record speaks for itself. Since launching Stansberry Venture Technology in November 2014, he has made 41 recommendations. So far, 13 of those have gone on to double or more. In other words, roughly one in every three picks he recommended to his readers over this period has doubled. It’s an incredible track record.

If you want to invest in tiny biotech stocks that have the potential to double… triple… or make up to five times or more on your investment, you must read Stansberry Venture Technology. If you’re interested in learning more, click here.

Regards,

John


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Is the world’s biggest real estate market about to collapse?

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From Brian Tycangco, Editor, Stansberry Churchouse Reseach:

The world’s biggest real estate market is slowing down. And it’s not because of failing subprime mortgages or an economic crisis.

China’s property market – worth seven times that of the U.S., based on total value of new homes sold – is weakening… again.

China’s new home sales hit US$1.69 trillion last year, as an estimated 22 million Chinese moved from rural areas into cities (that’s like the entire populations of the U.S. states of Kentucky, Louisiana, Alabama, South Carolina and Kansas moving to the city).

A total of 1.44 billion square meters of apartments and condominiums were sold – the equivalent of 5.76 million new homes, assuming the size of an average American suburban house (last year, 614,000 new homes were sold in the U.S.).

But a couple of years of breakneck growth has caused the average price of developed property (i.e., condominiums and residential apartments) in China to jump 18% since July 2015. In the biggest cities of Beijing, Shenzhen and Shanghai, prices increased more than 50%.

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Adding fuel to soaring real estate prices are Chinese investors speculating for short-term gain, considering property prices in most cities are rising at least twice as fast as the 5.5% average mortgage rate.

Buyers now need to show a pile of cash up front

To curb speculation, the government started raising the requirements to purchase property in March 2017. It increased the minimum down payment on second home purchases in second- and third-tier cities from 20% to 30%.

That compares to a typical second-home buyer in the U.S., who is required to put up between 10% and 20% as down payment.

What’s more, the Chinese government also ordered state-owned banks to raise the minimum down payment for privately-developed residential projects in first-tier cities from 70% to 80%. That essentially locked out all smaller buyers in many cities, including Shanghai, Shenzhen and Beijing.

The next stage of tightening happened in September 2017, when local governments in a number of cities, including Shenzhen, banned investors from selling newly purchased homes for up to five years. Other local governments barred investors from buying a second home for up to three years.

So after growing by 16.1% in the first half of 2017, home sales growth in China slowed to just 3.3% in the first half of 2018.

The Chinese government’s year-long crusade to deflate the property market finally filtered through to developers’ sales. As a result, the shares of listed Chinese real estate developers have fallen.

The MSCI China Real Estate Index, which captures the performance of large and mid-cap segments of the China real estate market declined by 14% between May 1 and July 31. That compares with a 5.8% decline in the MSCI China Index and a 2.7% gain in the MSCI All Country World Index.

But is this a precursor to a Chinese real estate market collapse? History shows us that it’s likely not. We’ve seen this same knee-jerk reaction in Chinese real estate company stock prices in the face of Beijing’s previous efforts to deflate the hot property market.

China’s history can be a road map to profits

In September 2010, for instance, Beijing enacted measures to curb speculation in real estate after prices jumped 32% in just two years (2008 to 2010) to 4,725 yuan per square meter.

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That eventually led to a 30% decline in the MSCI China Real Estate Index by the following year, as curbs filtered through to developers’ bottom lines.

(That also opened up a terrific buying opportunity in shares of Country Garden Holdings (Exchange: New York; ticker: CTRYF; Exchange: Hong Kong; ticker: 2007), one of China’s biggest and most established real estate developers, which I recommended to my readers in February 2011. It went on to nearly double their money (95%), as government curbs were eventually lifted and eager buyers returned to the market.)

Then, in March 2013, after average property prices rose 17% to 5,850 yuan per square meter in a just a couple of years, Beijing stepped in again, slapping a 20% tax on selling a home (vs. existing 1% to 3% capital gains taxes). Beijing also increased the required minimum down payment from 60% to 70% for second homes.

That resulted in a 20% correction in the MSCI China Real Estate Index over the next 12 months, and caused total property sales to fall nearly 3% between 2013 and 2015.

(The lull in the market presented an opportunity in our Strategic Wealth Confidential newsletter to recommend shares in one of the country’s best-run real estate investment trusts (REITs). REITs are companies that hold a portfolio of income-generating property and distribute nearly all their profits to shareholders as dividends. This one in particular was paying out an 8.5% yield.)

With average real estate prices in China again up 18% in just the last couple of years, Beijing’s recent determined moves to rein in the property market shouldn’t come as a surprise. We actually welcome it.

Will the Chinese real estate selloff continue?

For the short-term, the outlook is going to be weak. The government has not given any indication that it’s willing to ease restrictions on new home purchases, and will likely add more restrictions in the coming weeks and months.

But I’ve been covering the Chinese real estate market since 2003, and the volatility we’re seeing today is nothing new.

With 600 million Chinese (40% of the country’s population) still living in rural areas, and 22 million of them moving into cities each year, the property market in China is still far from reaching a point of peak demand.

Down the road, I expect there will be a slew of profitable, well-managed and under-leveraged Chinese property developers that will once again offer up enticing value.

Good investing,

Brian

P.S. Even as China’s property market is letting off some steam, other sectors of its economy are expanding at a breakneck pace. One of these sectors is water treatment, which is growing non-stop thanks to the government’s efforts to clean up the country’s heavily-polluted rivers and lakes. It’s opening up a rare opportunity for 793% gains on a leading water treatment specialist. To find out more about this company – and two others with similar potential – go here.


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Cramer’s charts suggest it’s still worth investing in bonds

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U.S. Treasury bond yields have been on a tear this year, and with the Federal Reserve on track to continue raising short-term interest rates, it looks like the trend will continue. But when bond yields rise, prices fall, which has investors worried. “The conventional wisdom on both Wall Street and Main Street is that U.S. Treasuries are one of the worst possible asset classes to own right now,” said CNBC’s Jim Cramer.

However, Cramer thinks that investors shouldn’t be too quick to follow the crowd. The “Mad Money” host enlisted the help of technician Carley Garner, co-founder of DeCarley Trading and author of “Higher Probability Commodity Trading,” to reassess the state of the bond market. Garner believes that “the bears in the Treasury complex have gotten overconfident,” said Cramer.

Taking a look at the weekly chart of the 10-year U.S. Treasury futures, Garner’s analysis shows that large speculators, who are professional money managers, are betting against Treasury prices at never-before-seen levels.

“Not only are they holding net short positions in these 10-year Treasury futures, but they’re more bearish than they’ve ever been at any other time in living memory,” Cramer said. Together, large and small speculators are holding a net short position of 800,000 10-year Treasury futures contracts.

Garner “thinks this trade has gotten overcrowded,” Cramer said. She believes that prices are poised to rise once all of these short sellers buy back Treasury bonds to close their positions.

Looking at the seasonal price patterns of the 10-year Treasury bond, the charts show that prices tend to rise in the second half of the year. This trend is particularly reliable according to Garner’s analysis, with the biggest rally occurring from July through early October.

“Garner thinks the rally could be particularly pronounced this year given that Treasury prices are pretty depressed,” the “Mad Money” host said.

Cramer’s bottom line? The markets aren’t always what they seem. “Don’t just assume that our long-term interest rates are destined to head lower immediately,” he said. “The charts suggest that U.S. Treasury prices could actually have some upside here.”



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