Be an Artist With Your Portfolio

The final weeks of a really weird year (again)... Exactly why I repeat this mantra... All you need to know about the risk level today... '12 Charts for a Perma-Bear Christmas'... The 'Melt Up' and ensuing crash of 2021... Singing the same song – plus a new verse... My final thought of 2020... Be an artist with your portfolio...

Believe it or not, a year ago, I (Dan Ferris) didn't think the world could get any weirder...

In my December 16, 2019 Digest, I referenced "the final weeks of a really weird year."

And then, I asked you which was worse – paying $120,000 for a banana duct-taped to a wall... or $52,000 for a desktop computer?

Of course, doing either would qualify as weird in my book...

You might recall that the banana was a work of art at an exhibit in Miami. The computer was Apple's new, top-of-the-line Mac Pro desktop.

I attributed the high price tags of both items to intangibles... And I explained that intangibles are what attract folks – and allow prices to run into "stratospheric territory."

Then, 2020 happened – and life got much, much weirder...

COVID-19... the total disappearance of Clorox wipes from store shelves everywhere... the deepest economic contraction since the Great Depression... violence in the streets of major U.S. cities... people standing in line for hours to buy guns and ammo... and much more.

And of course, the financial markets reflected the chaos throughout the year as well...

The benchmark S&P 500 Index dropped 34% in just more than a month... U.S. Treasurys traded at – and still trade near – record-low yields (which also means record-high prices)... oil prices went negative... locked-down day traders are still assigning a market cap of more than $200 million to Hertz Global – a bankrupt company whose equity is worthless... gold and silver are up about 23% and roughly 42%, respectively, in 2020... and bitcoin has more than doubled this year.

At the same time, America is distinctly different than a year ago...

Thousands of businesses have shuttered amid the fallout from the COVID-19 pandemic. If you want to buy a gun, you'll still have to stand in line. And if you want to buy ammo, you can stand in line all you want, but get ready to hear that it's all gone by the time you get to the counter. That has happened to me more than once in the past few weeks.

Years like 2020 are exactly why I repeat the same mantra often...

Prepare, don't predict.

I say "don't predict" because, as 2020 proves beyond a shadow of a doubt... you can't predict the biggest events that will move the prices of the assets you own.

Re-read the last part of that sentence.

It's not just the small, random, day-to-day fluctuations in stock and bond markets that you can't hope to predict with any consistency... It's also the big ones, the ones that scare you so badly that you run to your computer and hit the sell button until it breaks. They're the market moves that can grab hold of your emotions and ruin your plans for the future.

That's why I frequently sound like I'm trying to scare the hell out of you. Because I think that's just about the right posture these days... given the hyperinflated prices of stocks, bonds, and other assets.

I felt the same way about a year ago, a little more than two weeks before 2020 turned into the year that everybody loves to hate. Here's what I told Digest readers on December 20, 2019, as we looked ahead to 2020...

The record bull run and all-time peak equity valuations suggest investors are optimistic... and not expecting much bad news. So let's entertain the opposite point of view...

Let's define a market crash as a drop from 52-week highs of 30% or more in a single year. Stock market crashes are rare events, so it makes sense that most folks usually aren't expecting one to occur. It also means a crash is always a surprise.

If the stock market crashed, it might lead to a spiral of panic selling – in turn, possibly leading to a full-on, extended bear market that could take the S&P 500 down as much as 60% over a two- to three-year period. (From its 2007 peak to its 2009 bottom, the S&P 500 plunged nearly 60%.)

For perspective, the S&P 500 is around 3,200 right now. A 60% drop would put it at about 1,275. In other words, it would plunge to a level we haven't seen since 2011 and 2012.

On March 23, the S&P 500 bottomed for the year at 2,237... 34% below its then-all-time high of 3,386 on February 19. And frankly, if the government and the firefighters at the Federal Reserve didn't step in, we might've fallen all the way down to the 1,275 level.

But I wasn't merely warning of the possibility of a crash. There was more to it than that. As I also explained in that same Digest...

A big drawdown would not surprise everybody. Data from financial-research firm Refinitiv Lipper shows that investors pulled $156 billion from U.S.-focused mutual funds and exchange-traded funds ("ETFs") in 2019, more than any year since records began in 1992.

I reconciled investors' apparently conflicting expectations by telling readers that it simply indicated that investors with real money at risk were expecting "a wide range of outcomes" in the stock market in 2020. And I said that was the "best bet" you could make at the time.

A wide range of outcomes is the definition of risk. The wider the range, the higher the risk.

(By the way, I also talked about all of this on my Stansberry Investor Hour podcast on January 2, 2020. So if you listen regularly, you might remember my warning from there, too. And if you don't listen regularly... hey, maybe you should give it a try sometime.)

And of course, now armed with the power of hindsight, we can see that...

The wide range of outcomes that markets seemed to be anticipating actually happened.

After the S&P 500 bottomed on March 23 at its lowest level since late 2016, the index turned around and made multiple new all-time highs over the rest of the year. It's now hovering around the 3,700 level – about 14% higher than it was to begin 2020.

My point is... the expectations of both sets of investors at the end of 2019 happened in 2020. The fact that folks prepared for a wide range of outcomes – and then it actually happened in just months – should tell you all you need to know about the risk level today.

It's a point that can't be made often enough as long as stocks are bumping against their highest valuations in history. And as we head into 2021, the situation is even worse today...

Stocks are riskier right now than they've ever been before...

The S&P 500 currently trades at around 2.7 times sales. That's higher than any previous peak, including the 2.1 mark for the ratio at the beginning of 2020. So in other words, we're even worse off than when I warned everyone about heightened market risk back then.

And I'm not the only one who can see that... Our friend Jason Goepfert at SentimenTrader.com can, too. Last weekend, he published "12 Charts for a Perma-Bear Christmas" on Twitter, showing...

• The most confident "Dumb Money" in history (a SentimenTrader indicator of speculative excess)

• The highest market value relative to economic output

• Nearly the highest concentration of wealth invested in stocks ever

• Massive inflows to ETFs (a favorite speculative vehicle)

• A rush into equities by overseas investors

• Mutual funds holding their lowest cash reserves in history

• Active investment managers (hedge funds) using more leverage than any time in history

• The most speculative options market in at least 20 years

• A drop in hedging activity

• The biggest concentration of indicators showing excesses in more than 15 years

• Few souls are starting to price in a potential crash

• Corporate insiders near record-low levels of buying

Now, on their own, there's no reason why any one or two of these data points means that trouble lies ahead for equity investors. But all of them together? That's different... That's one way that you can identify the biggest financial bubble in history.

As my colleague Steve Sjuggerud has observed, financial bubbles usually culminate in a massive 'Melt Up'...

That's when the markets soar straight up, faster than almost anyone could ever imagine.

But then, on the flip side, it's pretty normal for crashes and bear markets to follow Melt Ups.

Given the excesses that Goepfert noted in his "Perma-Bear Christmas" series, it appears that we could see Steve's Melt Up play out in full force in 2021. I'm talking about the S&P 500 soaring straight up in a very short time frame – maybe 10% to 20% beyond its December 18 all-time high of 3,726 in a matter of months... or maybe even higher!

If that happens, though, I believe the odds will then tilt to the other extreme... the likelihood of a fast – perhaps even in one day – correction of at least 15% to 20% (and maybe even the beginning of a one-to-three-year bear market).

What happens after that is anybody's guess.

In fact, even those two scenarios are little more than a guess. Sure, I'm looking at data and I know the pricing history of stocks, bonds, and other assets. And I also know that market crashes happen a lot more often than most people realize.

But as I've emphasized time and again (including today)... nobody knows the future.

What if the stock market goes sideways in 2021, neither up nor down very much? It could happen. Anything could happen. We can't predict what stock prices will do.

And I'm acutely aware that, by anticipating market extremes to get even more extreme, I could very well be playing right into the hands of a manic-depressive market that loves to deceive and surprise us all.

But I refuse to be unprepared for the widest possible range of outcomes for which I can prepare my wealth, myself, and my family.

Another way of thinking about my mantra is, "Since you can't possibly hope to predict, you had better learn how to prepare."

That's why I keep singing the 'true diversification' song for everyone who will listen...

And it's why I'm adding one more verse to it today... put options.

Specifically, I believe everybody should own some put options on the big stock indexes like the S&P 500, the tech-heavy Nasdaq Composite Index, or the small-cap Russell 2000 today.

Put options can help protect your portfolio from the kind of volatility I'm expecting over the next year or so. If the market crashes while you're holding puts, you'll find yourself able to raise cash by selling them – at the moment when everybody else wants cash, doesn't have any, and winds up selling in a panic.

When you buy puts at extreme market highs, you're selling stocks before everybody else.

Rather than bore you with my own strategy – which is way too emotionally difficult for most folks – I'll direct you to my brilliant colleague Greg Diamond and his Ten Stock Trader service...

Greg is a former hedge-fund trader and master of the fine art of technical analysis.

He's anticipating a big opportunity to trade put options on the major indexes I just mentioned. He sees the market very similarly to how I do right now... For example, he titled one of his recent updates, "The Warning Signs Were Everywhere... Here Is Our Game Plan."

Trading options is risky and definitely not for everybody. But if you can handle the heat, it can be rewarding. You can check out Greg's latest warning, along with more information about his Ten Stock Trader service, right here.

If you don't want to trade options, that's fine. You can still prepare for a wide range of outcomes as long as you're holding the one asset that most truly diversifies you...

Cash.

There is no substitute for cash. It's like oxygen. You need it to live, but you never think about it until you can't get enough of it.

Don't let that happen to you in the stock market. Make sure you have plenty of cash available to take advantage of market volatility when it inevitably rears its ugly head.

Once again, the basic components of my recommended "truly diversified" portfolio are...

• Stocks and bonds, a stake in humanity's relentless progress
• Plenty of cash (20% of your investable liquid assets)
• Stores of value like gold, silver, and bitcoin
• Whatever asset class you understand well (real estate, collectibles, etc.)
• For now, put options on big equity indexes

I call this "true" diversification because if all you own are financial assets, you're not truly diversified... no matter how many different stocks and bonds you own. You're only truly diversified if your portfolio includes assets inside and outside the currency regime.

Stocks, bonds, and cash are inside the currency regime. Gold, silver, and bitcoin are outside of it.

Remember, the purpose of this truly diversified portfolio is not to predict that stocks, bonds, gold, silver, and bitcoin will all go up together forever. It's quite the opposite...

The purpose of true diversification is to own assets that tend to do well at different times...

Cash protects you from big, short-term drawdowns that scare the daylights out of most investors and cause your other holdings to fall in value. Even gold, silver, and bitcoin fall when investors panic (all three sold off earlier this year as stocks were crushed during the initial COVID-19 meltdown). There is simply no substitute for having a big slug of cash after a big downturn. Anybody who had plenty of cash in late March knows what I mean.

Gold and silver help you preserve purchasing power over the long term. They've been excellent stores of value for thousands of years. And thanks to the "Lindy effect" – which I talked about in the July 19, 2019 Digest – they likely will be for thousands more, too.

Bitcoin is a burgeoning store of value that's rapidly gaining widespread acceptance. And if it continues to grow as I expect, you could make 50 to 100 times your money.

Stocks and bonds are an essential stake in the relentless upward trajectory of humanity. More people enjoy a higher standard of living than ever before... And stocks are the way to invest in the trend's endless (but occasionally volatile) march onward and upward.

If you practice true diversification, I believe you'll come through 2021 and the next several years having preserved and grown your wealth with less volatility and sheer anguish than investors who don't do it.

Don't misunderstand me, though...

Preparation is no panacea.

Preparation is inherently complicating. By preparing for a wide range of outcomes, you add to the list of outcomes for which to prepare... You must now prepare for the possibility that your preparations are inadequate to protect you from the anticipated outcome.

Is your head spinning yet?

Preparing for big risks to be realized in financial markets introduces new sources of risk. For example, if you buy puts like I suggested, you'll have to prepare for the possibility that they'll expire worthless or that you'll lose a substantial portion of their market value before you can get rid of them.

But again, the alternative to preparing for a wide range of outcomes is to not be prepared. And I'm sure you'd rather be an investor who's ready when chaos erupts than one who isn't.

At the end of every Stansberry Investor Hour interview, I ask all my guests the same question...

"If you could leave our listeners with just one thought today, what would it be?"

It's a little cheesy, but every guest embraces it and gives it their best shot. Several folks have remarked that it's a good but not easy question to answer.

Having asked that question dozens of times to others over the past few years, it's only fair that I turn the tables on myself here in my last Digest of 2020...

What one thought would I leave you with if I could only choose one?

It's a familiar one to Digest readers... The learning of life is about what to avoid.

Author and trader Nassim Taleb refers to this principle as "via negativa" (Latin for "the negative way") because it involves learning to define reality in negative terms... It's all about what not to do, where not to go, who not to have a relationship with, what doesn't yet exist, what is not being said, and what is not seen on the surface.

You can see this concept at work with some of the greatest minds in history. For example, author George Orwell implied the via negativa viewpoint in his essay, "Why I Write"...

Political language... is designed to make lies sound truthful and murder respectable, and to give an appearance of solidity to pure wind.

Put another way, learn to hear what is not being said.

Or like I told Michigan Talk Network host Steve Gruber in an interview earlier this week...

Politicians always act to maximize what's visible, and they're always not telling you something important. So you must invoke via negativa, learn to disbelieve what they say, and figure out what they're not saying.

Among other things, via negativa underscores the paramount importance of learning to recognize, understand, and avoid risk (as much as possible or desirable). Through the negative lens, risk is any condition that doesn't exist now but might exist in the future and might reduce your net worth.

It probably feels a bit weird to base your current actions on something that doesn't exist now and may never exist in the future. You're acting to avoid something that might never happen.

The thing is, though, we do it every time we buy any type of insurance... You're bringing risks forward into the present even though they might never come true in the future.

That's what preparing to face risk means... You make up a story about a risky condition that doesn't exist yet, then act like it'll come true.

You really can tie yourself in knots contemplating this via negativa stuff.

But learning to exploit via negativa just means learning to use your imagination...

Scientists do it all the time (at least they should)... They propose a hypothesis and work to falsify it. The hypothesis may or may not be true. Even if it's true, it didn't exist as far as anyone knew before the scientist pulled it out of his imagination.

Investors need a similar level of imagination, borne of a mastery of via negativa. They need to learn to see around corners and prepare for whatever dangers might await them.

By contemplating the future, via negativa is intertwined with another powerful idea I've discussed recently – time...

You want to avoid wasting time, since nobody has an infinite supply of it. So you wind up answering questions about conditions that don't exist yet – like, "How long is long enough to falsify the idea that there's a big risk of a major drawdown in the big equity indexes?"

Three months? Six months? 12 months? It's impossible for any sufficient length of time to pass when you can't say for sure that some particular risk will never be realized.

When time is a factor as it is in investing, it's hard to know whether or not you've avoided what you were trying to avoid. When a condition can happen anytime – the way a market crash can – it's impossible for the mere passage of time to make it less likely.

Via negativa's requirement that you contemplate that which doesn't yet exist and may never exist, bring it forward in time, and make it real turns investing into a pure art form. Making some potentially risky future real by preparing for it in the present is a purely creative act.

It reminds me of what author Steven Pressfield shared about what it means to be an artist in his excellent writing manual, Nobody Wants to Read Your Sh*t. As Pressfield wrote...

The artist enters the Void with nothing and comes back with something.

Her skill is to turn off the self-censor.

Her skill is to jump off the cliff.

Her skill is to believe.

It sounds a lot like what happens in your mind when you begin to imagine what might happen to drastically reduce your net worth at some point in the unknowable future.

You must possess the skill of believing risks are real or you won't take the proper action to avoid them. Since you can't know the future, you must believe – like Pressfield's artist.

Practice via negativa with your portfolio and in your life.

Learn to conjure risk from the non-existent future and make it real by preparing for its arrival.

Be an artist with your portfolio.

If you can do that, you'll make a fortune if you haven't already. And if you already have a fortune, you'll be able to preserve it no matter what happens in 2021 and beyond.

See you next year.

New 52-week highs (as of 12/22/20): ARK Fintech Innovation Fund (ARKF), ProShares Ultra Nasdaq Biotechnology Fund (BIB), BlackLine (BL), Crispr Therapeutics (CRSP), Commvault Systems (CVLT), GrowGeneration (GRWG), Green Thumb Industries (GTBIF), Innovative Industrial Properties (IIPR), Renaissance IPO Fund (IPO), Jushi (JUSHF), MongoDB (MDB), MarketAxess (MKTX), Match Group (MTCH), Cloudflare (NET), Intellia Therapeutics (NTLA), OptimizeRx (OPRX), Palo Alto Networks (PANW), ProShares Ultra Technology Fund (ROM), Silvergate Capital (SI), First Trust Cloud Computing Fund (SKYY), Square (SQ), The Trade Desk (TTD), Vanguard Short-Term Inflation-Protected Securities Index Fund (VTIP), Vestas Wind Systems (VWDRY), and Zendesk (ZEN).

In today's mailbag, feedback on yesterday's Digest about the surprises attached to the latest COVID-19 pandemic stimulus bill. Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"The 'Free Tibet' policy, like the 'Free Hong Kong' and the 'Free Taiwan' policy needs some teeth... like 60,000 mobile launch capable multi-warhead ICBMs." – Paid-up subscriber Kendrick M.

"It is surprising to see an article on war in a financial publication. But Kim Iskyan's December 15 issue [which we cited in yesterday's Digest] does instill some fear and worry in my heart.

"How can [it] not when war historian Margaret MacMillan says, 'War is deeply woven into the history of human society. Wherever we look in the past, no matter where or how far back we go, groups of people have organized themselves to protect their own territory or ways of life and, often, to attack those of others.'

"Then would the current rivalry between Country A (China) and Country B (USA) develop into a war just to prove MacMillan's point?

"No one knows for sure. However, The Thucydides Trap Project as cited in the article, may provide some clue. In 16 occasions over the past 500 years 'when a major nation threatened to displace the incumbent ruling power – similar to the US and China today,' 12 ended in war. So we have 75% chance a war will happen at some point.

"But could anyone of the 'geopolitical kindling China provides today' as Iskyan describes, whether North Korea, trouble in South China Sea, situation in Uighurs or Hong Kong, the question of Taiwan, etc. be a trigger for war? It does not really matter.

"Remember [the] last Iraqi war and massive campaign of WMD in preparation for the war? The 'geopolitical kindling' could never be the real reason for war. It is particularly worrisome for the fact that according to Iskyan, the Pew Research Center study reports 73% of Americans have a negative view of China... That is [an] all-time high. Ironically, over 50% of the Americans don't have a passport. How would 73% of Americans form their opinions on China? Through media, obviously!

"I just hope that we don't fall victim to 'Thucydides Trap' and let emotions get in the way. I sincerely pray for world peace. Humanity is larger than any nation." – Paid-up subscriber Jamin T.

Happy holidays,

Dan Ferris
Vancouver, Washington
December 23, 2020

P.S. One more thing... Our Stansberry Research offices will be closed tomorrow and Friday for the holidays, so we won't publish the Digest. We'll pick things back up on Saturday with the first of two fantastic essays from our Director of Research Austin Root in the weekend Masters Series. And then, we'll start a special "2020 in review" series on Monday.