How to Hedge Against a Bear Market

Why avoiding risk is the secret to investment success... Industries most at risk to bad debt... How to hedge against a bear market... When the facts change, change your mind... A mailbag full of questions...

For most of the last 15 years, I've focused on building tools and advisories to help you avoid risk...

You might not have thought of it that way, but that's exactly what I've been doing.

Just read almost any of the newsletters I (Porter) have written since 2001. You'll immediately see that my Investment Advisory is primarily about mitigating investment risk. We do this by focusing our recommendations on safe, capital-efficient companies. Alongside this core portfolio, we add a few non-correlated hedge-like investments (such as Fannie and Freddie, which have soared lately). And we even hedge against the market directly with a small number of short-sell recommendations that ideally will "zig" when the rest of our portfolio "zags."

Long-term studies of our results prove this approach has created the best risk-adjusted returns of any letter we publish. (That's the highest returns with the least amount of volatility.)

But today, I'm recommending the riskiest thing you can do with your money in the markets...

There's an enormous apparent dichotomy here. But... once you really understand this strategy, you're going to see that there's no divergence at all. At times, doing things that seem risky (like shorting a stock) are actually the best ways to reduce your portfolio's risk exposure. Regardless whether you follow me with this particular strategy, I want to make sure you understand why I'm advocating that you take significant steps to hedge your portfolio today.

The biggest pitfall for most investors is the tendency to misjudge risk tolerance...

Most subscribers who think they can handle lots of volatility really can't. But if you're reading this and you're thinking, "That's not me. I'm a conservative investor. I don't take big risks with my portfolio," I'd bet you're wrong. Almost every investor I talk to about risk also underestimates the volatility of his or her own portfolio.

Not you, though... right? Well, maybe. Think about your own investment experiences. What happened in your account from October 2008 through March 2009? Most people who would have sworn they were conservative investors ended up watching their life savings collapse by 50% or more. Most of them decided they weren't "buy and hold" investors after all. (They ended up being "buy and fold" investors.) Holding too much risk inevitably trips up most investors.

Risk doesn't equal reward...

I also know from empirical studies of investment results that contrary to what just about every finance department in the country will teach you about finance, risk simply doesn't equal reward.

Lots of good research out there suggests that a strategy of buying well-financed, low-volatility stocks can beat the market by a wide margin. (If you like original sources, here's a great example.)

Plenty of real-life examples guide our thinking in this area, too. Investing legend Warren Buffett is a classic example. He made nearly 25% a year in the market between 1954 and 2000 by focusing on the least risky businesses to own, like insurer GEICO, beverage giant Coca-Cola (KO), and credit-card issuer American Express (AXP).

It was a brilliant strategy. And it worked, primarily, because he avoided taking risks. He even sold almost all of his stocks in 1969 because he thought the market was too expensive. He didn't buy back in until 1974. Do you think you could avoid making any equity investments for five years just because you thought the market was too risky?

What's about to happen in the markets will be worse than anything you've experienced as an investor...

How do we know? Because of the credit cycle.

The market doesn't react well to the risk of bankruptcy, because in bankruptcy, the value of a company's equity goes to zero. You probably remember the bear market of 2001-2002. Most people assume that bear market was caused by the terrorist attacks of September 11, 2001. But it wasn't. It was the corporate credit cycle. Defaults reached a peak in 2002, when 1% of investment-grade "BBB" debt defaulted and more than 10% of all junk bonds defaulted. The growing risk of these defaults led stocks to start to decline in 2000 and 2001.

During the boom of 2003-2008, the primary driver of growth in the credit markets was mortgages. As always happens, as the boom aged, the quality of the credit being underwritten declined. And as always happens, defaults soon began to rise. In 2007, an incredible number of subprime mortgages defaulted, practically shutting down the mortgage markets and greatly impairing the market for corporate credit, too. By 2008, these tightening credit conditions led to a rise in corporate defaults and bankruptcies... and you know what happened next.

From 2010 through early 2016, we've experienced the biggest increase to credit in history. Sovereign debt has soared in size (U.S. Treasurys). Student loans have essentially doubled. Car loans – in particular, subprime car loans – have boomed, too. These are all areas that responded directly to government incentives – this was a government-directed credit boom. And finally, because the Federal Reserve manipulated interest rates so low, corporations have borrowed more money, and more of that money was "junk" (low-quality credit) than ever before.

The timing of the credit cycle is a lot easier to predict than most things related to stocks and earnings...

The reason is obvious: Debts come due at a fixed date. We know the "maturity wall" and how much money will have to be repaid or refinanced.

A substantial amount of this debt will default. We know that because default rates have already gone from almost 0% in 2014 to more than 5% this past August. As defaults grow, lenders become more cautious. That makes credit tighter and refinancing more and more expensive. Given the huge amount of debt that has been underwritten, and the incredibly low rates that prevailed at the time, not only will another credit-default cycle materialize in 2017 and 2018... but it's even more likely that default rates will end up being higher than they have been in the past.

The most knowledgeable experts are expecting more than $1.5 trillion in defaults.

You have a few choices...

You can do nothing for a long time – maybe six months... maybe a year. Nothing might happen. Or you could just wait and see if default rates really do keep ticking higher. But whether you take action, these corporate debts are coming due.

No doubt, they will be difficult to refinance, especially as interest rates return to normal. Sooner or later, something – like Hertz (HTZ) falling out of bed... or Disney (DIS) losing a bunch of ESPN cable subscribers... or Ford (F) losing money because car sales plummet – is going to put the entire stock market on "tilt." A new bear market will begin.

Your other option is to "lighten" your load. As we've been suggesting for a while, you can begin to raise cash when you hit trailing stops or take profits on positions where you have gains and you believe tightening credit conditions could lead to falling sales and profits. (A look at "The Dirty Thirty" might really help in this regard, as we've focused the list on companies that are most vulnerable to problems in the credit market.)

Or you can choose the option that's the most likely to allow you to profit from these developments: You can actively hedge your portfolio. Trying to hedge against a specific industry's troubles usually calls for shorting stocks.

For example, for a long time we've been selling short oil-sands producers and buying the best, most efficient U.S. shale firms because we believed shale production would continue to grow, while the lower prices of oil would eventually lead to losses and curtailed production at the oil-sands firms.

This kind of "paired" trading has been great for our portfolio and is a wonderful way to mitigate risk while still producing gains. However, that kind of trading isn't as effective against broad market declines. In bear market, you'll see even good stocks fall 30%-50%. How can you protect yourself from that?

You could short stocks...

We know that certain sectors of the market are encumbered by debt and suffering from falling asset prices. We've written about some of these sectors previously (autos, malls, and high-cost oil producers). But the main problem with shorting is it costs money to borrow shares (usually 4%-6% a year) and your returns are limited – you can only make 100% even if the company goes bankrupt.

In most market conditions, that's enough to provide you with plenty of protection. But what about when you know a bear market is approaching? What about when you know which companies won't be able to refinance? What about when you know the largest credit-default cycle in the history of our country – which just began in August – is going to intensify for the next 18 to 36 months, causing trillions in defaults and soaring bankruptcies?

The best way to reduce your risk...

Stansberry's Big Trade, like all of the products I've developed over the years, is primarily designed to reduce your risk. That will surely earn me a chuckle and a "come on" from some subscribers.

But remember... last year at about this time, we launched Stansberry's Credit Opportunities. We wanted to prove that, at certain times in the credit cycle, you could easily beat the stock market while investing in bonds! And it worked. All of our recommendations made money and the average annualized return was around 40%... far better than the overall market's return.

Stansberry's Credit Opportunities allowed our subscribers to make far higher returns with far less risk than investing in stocks. That was only possible because we knew which firms wouldn't default. And as interest rates rose on corporate credits (and bond prices fell), we were able to tell you which were safe to buy. It's the same database that's powering Stansberry's Big Trade...except rather than use the information to find companies that won't default on their debts, we're using the information to predict which firms will default. It's the other side of the same coin.

Taking advantage of rising volatility...

You might recall that last fall, the Volatility Index ("VIX") was elevated. Interest-rate spreads on risky corporate debt were "blowout" – many corporate bonds were trading at annual interest rates more than 10 percentage points more than similar sovereign bonds.

These conditions created an opportunity for us to buy "risk." Sure, we knew the individual bonds we were buying weren't actually risky at all, but the market perceived there to be a lot of risk, which allowed us to buy the assets at attractive prices and earn big profits as a result.

Today, though, the conditions are almost exactly the opposite. The VIX is near all-time lows. There's no "spread" to speak of in the yields between lower-quality debt and higher-quality debt. And that means this year we want to hedge risk, not buy it. The best way to hedge risk is by buying put options. And I hope you'll at least learn the best way to do so by joining us for our free live webinar on Wednesday night. (Save your seat here.)

One final thought...

Five years ago, I probably would have told you that I would never recommend buying put options – especially not far out-of-the-money put options. But then again, I would have never dreamed that for five years in a row, more than $1 trillion in corporate bonds would be issued.

And even though I've seen the numbers myself, I still can't believe that almost 25% of this total debt was "junk" rated. Judging from past cycles, at least 40% of those junk bonds will default before 2020. Not maybe default. Will default. And finally... I would have never believed we'd see the VIX this low (and put options this cheap) in the face of such clear debt-related headwinds.

When the facts change, I change my mind. What do you do?

New 52-week highs (as of 11/11/16): American Financial (AFG), Axis Capital (AXS), Berkshire Hathaway (BRK-B), WisdomTree SmallCap Dividend Fund (DES), Freddie Mac (FMCC), Fannie Mae (FNMA), iShares Core S&P Small-Cap Fund (IJR), Nuveen Floating Rate Income Opportunity Fund (JRO), Ritchie Bros. Auctioneers (RBA), and TTM Technologies (TTMI).

In the mailbag... Finally, a whole slew of questions about buying puts and our Big Trade strategy, which is designed to help you make huge gains as the next credit-default cycle develops. As you can see, no question – no matter how basic or how complex – will be ignored. Please send yours here: feedback@stansberryresearch.com.

"You talk about buying a Ford put option Jan 2018, with a strike price of $7.75, which gives me the right to sell at $7.75 anytime before Jan 18, 2018. My question is, if the stock goes down to $2.00, who will buy my option at $7.75? Am I missing something?" – Paid up subscriber Richard M.

Porter comment: If your house is destroyed by a tornado, who would pay for it? The answer, of course, is the insurance company. If you've paid your premiums, you own an insurance contract. That contract spells out exactly what your insurance company will do if your house is destroyed.

The options market works exactly the same way. When you buy a put, you're paying an insurance premium on 100 shares of stock. You're buying the right to be protected against any fall in price on those shares, below a certain point (the strike price). No matter what happens to the company, you're protected.

When you buy the put option we were discussing on Ford (F), you'll pay $0.30 per share in premium to be protected in full against the risk of Ford's stock dropping below $7.75 through January 2018. The insurance costs 2.5% of the current share price. So if nothing bad happens to the stock, the guy who sold you the insurance (the put seller) will keep the premium – just like the insurance company usually keeps your insurance premiums. But if Ford's stock falls out of bed (like we believe it will), then you can exercise your option and get paid $7.75 per share, no matter the current price of stock.

That's how your $0.30 in put premium can become worth $5 or more. (If Ford's stock is trading at $2, then the value of the right to sell Ford's shares at $7.75 is worth $5. When you exercise the options, $5 per share will end up in your account. Your broker will handle the exchange.) Thus, on the money you invested in put premiums ($0.30), you will have earned $5... or about 16 times your money.

How do you know the other side will live up to its promise? There's a clearinghouse and rules about how much capital put sellers must keep on hand with their broker. If there's any risk that the put seller can't perform, then his broker will issue a margin call. If he can't meet it, then all the assets in his account will be used to satisfy the contract.

"Porter, excellent analysis as usual re your Austrian School-based underpinnings for your Big Trade. However, there's one very disturbing non-free market element to this trade concept that concerns me, and which I think could completely undermine any chance at these trades being profitable, or at least increase risk. And that is: What about intervention by government in the form of bailouts, whether direct or indirect? Wouldn't this blow up the trades? I appreciate your thoughts on this." – Paid-up subscriber John G.

Porter comment: This is, so far, the most common question we've received. And that strikes me as pretty odd. I think people falsely believe that government bailouts help shareholders. They don't. Bailouts save creditors, not shareholders. The government acts to bailout creditors because government-insured banks eventually end up being on the hook for these losses. The government thinks it's smarter to put out a forest fire than to rebuild the whole state. But that shouldn't reassure anyone who owns stocks.

This question has its roots in a poor general understanding of corporate structure. The equity holders are on the bottom. That's who suffers losses first. It's only after the equity holders are wiped out that losses begin to affect debt-security owners. And that's when the government steps in... to protect itself.

Think about Bear Stearns. The equity holders lost 90% or more. At Lehman, the equity holders lost 100%. At Fannie and Freddie, they lost 99%. At GM, shareholders lost 100%. I could go on.

I don't believe any argument based in fact or logic would lead an investor to avoid hedging his portfolio or taking other protective measures because of the idea that the government will save him. It's a completely false belief. Even the many companies that were saved by the government's indirect efforts to reflate the banks saw the share prices of leveraged financial institutions fall by 90% or more before any of these benefits made an impact.

Or, let me put it this way... If, over the next 18-36 months, the government begins to bail out corporate creditors, that will be the "bell ringing" to let us know our strategy worked. Because for that to happen, equity investors will have been wiped out first.

"I'm a loyal Alliance subscriber and I've been picking a few long-dated puts to dabble in the Big Trade strategy. I couldn't wait, basically, for the official launch. However, I do have some concern/pause so here's my Q: The market isn't exactly logical. As some of these deadbeats start to beat even less, won't they get bought or merged with other 'less worse' companies and, likely, at ridiculous premiums? That activity could make those puts worthless. Obviously, no one knows the future. Is the answer to pick all 30 and hope it's a numbers game? Even then, while I'm still going to try your ideas, it does make me a little nervous to plow too much capital into it. Am I being too conservative?" – Paid-up Alliance member Glenn G.

Porter comment: First thing, Glenn... if you've taken action before our recommendations have even come out, you aren't being too conservative.

But getting to the point of your question (and it's a very good question)... Yes, certainly, if some company steps up and agrees to buy the equity of a Dirty Thirty stock, the chances are good that we'll lose 100% of our money on the put options we bought on that company. That kind of "single stock" risk is why I've urged everyone to trade at least a dozen of these put options. You should also diversify over time, too. So buy one or two a month for the next year or two.

However, out of the all the ways we could lose money on individual options, I think a buyout is the least likely of all scenarios.

You see, when a company is acquired, all of the debt transfers to the new owner. These companies are unlikely to be acquired for that reason. Think about it this way: If they weren't already too encumbered by debt, they could simply refinance. If they were profitable, they could simply pay off their debts.

But these companies can't do either of those things. As we showed you, they're losing $4 billion a year in cash. They're trying to support a total debt load of $300 billion. These companies aren't going to be bought out. Their competitors are standing around like vultures, just waiting for the bankruptcy auction. There's no reason to rush it. Nobody buys a big pile of steamin' bad debt.

"I have a few questions about the Big Trade... [in regards to Ford's debt burden] why can't Ford just issue lots of bonds at 'BB', wouldn't that kick the can down the road substantially? Also, you stated in one of the articles that you were looking at a particular date for the options (January 2018?) because 'traders were congregating there.' Can you explain why traders congregating was important? I would think you would choose something after a date of a large debt payment." – Paid-up subscriber Nathan B.

Porter comment: Great questions, Nathan.

First, regarding Ford... three factors drive access to capital: collateral, income, and affordability. They are the same factors, by the way, that determine whether you can get a mortgage. Ford has a big problem with trying to get more credit because it already encumbered virtually every asset it owns.

In regard to income... our scenario envisions Ford losing money on its operations next year as a collapse in subprime auto lending (and rising auto loan defaults) begins to seriously affect the prices of used cars, making new cars both relatively unattractive and unaffordable to most buyers (who won't be able to get a loan). As I'm sure you can appreciate, most lenders aren't interested in lending money to a company that's losing money and seeing its cash resources declining.

Finally, in regard to affordability, it's clear to anyone who will look closely that Ford is having a difficult time supporting its existing $140 billion or so in loans. In 2015 – its best year ever for car sales, Ford didn't even earn 3% on its assets. It's hard to imagine creditors will be eager to lend Ford even more money. And if they do, they will certainly charge a lot more. That would be terrible news for Ford's shareholders.

(Historical footnote: During the last credit crunch, Ford's assets were so encumbered by existing debt that the company had to pledge its brand name to gain access to capital. I had never seen any company pledge its brand before in a credit offering... But that's what Ford had to do in 2006. And it's the main reason why it didn't go bankrupt in 2008.)

Second question, about where traders "congregate"... We want to make sure we're trading options that are very "liquid." What that means is, you want to trade options that lots of other people are trading. In any market, whether microchips or used tires, a buyer benefits by having lots of venders selling. Lots of folks selling helps to make sure you get a fair price.

Likewise, if you decide to sell your options before they expire, you'll want lots of buyers competing for your contract. We pick "benchmark" options to track for our model portfolio and our Dirty Thirty so that we can see how changes in volatility are actually affecting our positions.

We also want to follow which segments of our portfolio are up or down on a weekly and monthly basis. So we have to pick a specific option to follow. We've chosen the options with the most trading volume and the most open interest to help make sure these prices are "real" and to make sure that there's plenty of "liquidity" for subscribers when they want to buy or sell these options.

As to why traders congregate around certain options... birds of a feather flock together. Traders in these options are looking to achieve the same goals – hedging their portfolios. They're picking options based on volatility and prices. They tend to end up in the same areas.

"I've been reading and re-reading everything you have written about the Dirty Thirty. But in you more recent article in the Stansberry Digest you clearly emphasized and stressed more than in any earlier letter to us the statement 'You'll likely see losses before you see gains.' It caught me a little off guard. I plan to follow your recommendations to the nth degree so my very elementary question is: Will you keep us informed on a daily basis or whenever necessary to keep our level of risk low?" – Paid-up Flex Alliance subscriber Don N.

Porter comment: Buying a put option is very different than buying a stock. A good stock pays you a dividend and, in theory, grows more valuable over time with increases to earnings. Put options decrease in value every day as they get closer to their expiration.

You don't want to own put options unless you have a good reason to believe that something terrible is going to happen very, very soon. And so, while we're waiting for more bad news to develop, it's virtually certain that the price of your put-option portfolio will fall.

If you saw the movie The Big Short, you'll remember that this temporary decline in price was unnerving to the clients of the fund managers involved in the trade against mortgage securities. The trade went on to make them hundreds of millions in profits... but several of the fund manager's clients sued him first because they were so afraid of the short-term losses.

Thus, it's critical to realize that we can't predict the timing of these debt collapses to the day, or the week, or the month, or even the quarter. The best we can do is target a group of companies we know is overwhelmingly likely to fail (fish in a barrel). In the short term... maybe for a month... or maybe for six months... the value of these puts is going to fall as they grow closer to expiration.

Now, we can do all kinds of things to mitigate these losses and even generate profits to offset them. For example, when volatility spikes across the entire market (like it did two weeks ago), we can take profits on any of our put options that have spiked higher. Many of our subscribers that were "beta" testing our Dirty Thirty list reported profits of 20%-40% across their portfolios. We advised them to take profits. These gains can be used to establish new positions once volatility falls back to below the 13-15 level. So trading for volatility is one way to hedge your put portfolio.

Another thing we'll do is "roll" our portfolio forward. Right now, most of the farthest dates we can trade (that have enough volume and liquidity) are puts that expire in January 2018. As the January 2019 puts become more available and more liquid, we can trade out of our January 2018 puts and into our January 2019 puts. This will extend our time periods and reduce some of the costs of holding these puts.

But the most important thing to understand about this approach is that it only takes one big move with one of these puts to make the entire approach very profitable. If you had owned out-of-the-money puts on Hertz (HTZ) last week, you could have made 10 times your money. It wouldn't have mattered how much you lost last week on all of your other puts combined.

If you don't understand this probabilistic approach to building a portfolio and trading, please don't follow this strategy.

As for your specific question about how often we will update you on our recommended portfolio, we will be updating The Dirty Thirty each month and we'll update our recommended portfolio at that time, too. If there are any significant moves in our portfolio, we'll send out an update as necessary.

"I would like to know if, as a small investor, can I participate in the Big Trade. By small I mean I have about $1500 to invest in the puts you will recommend. Is that enough? If not, what is the minimum amount I have to set aside to participate in this? Can I cherry-pick the puts?" – Paid-up subscriber Paul S.

Porter comment: Paul, my advice is that you shouldn't own any individual stocks or bonds (never mind options) until you've saved at least $50,000.

That's not because I don't care about small investors. Nobody has published more high-quality content for free than we have over the past 20 years. And of course, we publish many of our most comprehensive investment strategy letters for around $100 a year. Practically anyone can afford to educate themselves and become knowledgeable about finance, economics, and investing using our products.

That's also true with our warnings and strategies about the coming corporate credit-default cycle. Our webinar on Wednesday is free. (If you haven't reserved your spot, you can do so right here.) And we've published dozens of free essays about what's happening and how to protect yourself. Nevertheless, I don't think anyone should buy stocks or bonds until he has amassed at least $50,000.

Why not? First, until you have the discipline to save, you will never have the discipline to invest. There's a saying about not knowing the value of a dollar until you've worked for it. Well, the same principle holds true in investing: You can't know the value of $50,000 until you've saved it. Once you know that... you're going to make much more conservative (and better) investment choices. (A great book to read about this idea is The Richest Man in Babylon.)

The second reason is just math. Let's say you do a great job on your portfolio – you earn 15% a year. On a $15,000 portfolio (which is 10 times more than you have), that's $2,250 in income. If you spend 80 hours a year working on your investments, you'll have earned $28.12 per hour. I just don't think that's worth it. I think you'd be way better off working an extra 80 hours a year. The truth is, most good investors spend hundreds of hours working on their investments – reading, mostly. Until you've saved about $50,000, you're not likely to earn enough on your investments to make it worth your time.

Are there any exceptions to this rule? Of course. Truly passive forms of investing (like index funds or low-cost, highly diversified ETFs) are a reasonable way to get exposure to the stock market with small amounts of savings. One good approach is to use the strategy I recommended in the June 26, 2015 Digest.

"I have been a Flex member of yours now for several years and I love it... thank you for ALL your wisdom and hard work in getting us this great info. I have a couple of questions that I hope you can answer: 1 – Do you / [Metropolitan] Man still feel that the U.S. is heading towards negative interest rates? 2 – In light of the Trump win, do you think his 'Love of Debt' will allow banks to continue to fund these toxic loans to all these companies on the Dirty 30 list?" – Paid-up subscriber John M.

Porter comment: I haven't spoken to the Metropolitan man since Trump's election. I should check in with him and see what he thinks. My personal view is that negative rates have been off the table as an outcome in the U.S. since early October when the head of Japan's central bank began to criticize negative interest rates and explain why they weren't working (and threatened the global banking system). I think looking back we'll see the near collapse of Deutsche Bank (DB) as the peak of the negative-interest-rate outcome risk.

In regard to Trump and his love of debt, I have no doubt he's going to pump huge amounts of new government deficit spending into the system. That spending will provide some stimulus to our economy... for a while. But all of the empirical data I've seen and my understanding of Austrian economic theory tell me that it won't work – not for long. I've written two essays recently that give a lot of detail about why heavily indebted governments find that additional deficit spending results in weaker economic growth, not stronger. See the October 7 Digest and the November 9 Digest.

So no, I don't think Trump's love of debt will stop the credit-default cycle (which started in August) or prevent any of these debt-burdened firms from collapsing.

"With your recommendations to purchase long-term puts for potential large profits, you advise many will expire worthless. You suggest the few profitable ones will offset those losses. But what seems to be missing from your picture is that someone (presumably sophisticated investors/institutions) is selling those puts. On odds, those folks typically make money, so it appears that I would be attempting to 'beat the house.' Not sure that makes a lot of sense overall." – Paid-up subscriber Gary W.

Porter comment: You're right that investment banks and hedge funds frequently sell puts. I've also taught thousands of individual investors how to sell puts and I continue to recommend selling puts sometimes (when the "VIX" rises above 20) in our Stansberry Alpha strategy. Selling puts is a great way to generate income... 90% of the time.

As to your assumption that something is more sophisticated about investors who sell puts as compared with our research, I'd beg to differ. If you were right, the credit-default cycle wouldn't exist because "sophisticated" institutions wouldn't make such boneheaded loans to companies that are clearly failing. Nor would the credit-ratings agencies award an investment-grade rating to companies that eventually default. Again, that happens all the time.

Finally, if Wall Street's big investors truly were sophisticated, then why do we see so many bubbles, so many huge losses... so many times someone like Carl Icahn takes a huge bath (buying Hertz as it collapses)? These things happen. They happen all of the time. "Sophisticated" investors make mistakes – I'm writing an entire book about the obvious mistakes Buffett made in his career. And he's the best investor who ever lived.

But... even all of that stuff doesn't really explain the opportunity individual investors have when betting against institutions. The main reason big institutions tend to make big mistakes at market turning points is the "agency dilemma." What's that? It's the modern financial equivalent of "heads I win, tails you lose." Thousands of traders in the financial markets can earn a big bonus if something bad doesn't happen. If something bad happens, they lose nothing. How do you think they behave? Do you think they're particularly cautious in their approach to the markets?

I'm happy to tell you, though, that our Big Trade strategy wouldn't make sense most of the time. Our strategy only exists because two things have happened simultaneously: Companies were able to borrow far too much money – more than they've ever borrowed before and with lower-quality and lower-quality loans – at the same time that faith in central banks had become so pervasive that volatility was virtually eliminated from the stock market.

These two things happened because of the same underlying reason: The markets were flooded with liquidity, all of which was desperate for yield. A lot of the money went into junk and investment-grade bonds that are more junk than not. And a lot of the money was sold against put options.

These central-bank policies went way, way too far. As the central banks receded from the markets, trillions of dollars in loans will go bust. And that, in turn, will cause the stock market to see a huge increase in volatility and put prices.

But... for us to be right, only one thing has to happen. Either the credit-default cycle has to develop like we expect it will, or volatility has to return to the stock market. We can break even or a little better if either of those things occur. And, if both things happen, then Stansberry's Big Trade will produce a series of incredible winning positions.

Neither outcome will be predicated on the "sophistication" of the investors who choose to sell us the options. They're not half as sophisticated as you think.

"I am gratefully approaching my sixth anniversary with Stansberry Research in December. I started with a simple purchase of Stansberry Investment Advisory on December 22, 2010. Over these past six years, I have expanded my investment in Stansberry Research to the point where I am now an Alliance member. The depth of your work is outstanding and the results I am achieving are far better than anything I had done over the previous 20+ years, including several stints with 'Professional Financial Advisors' and 'Brokers'. My investment in Stansberry Research services has paid me back many, many times over. By way of specific example, my realized gains from only the Stansberry Alpha service this year of more than $33,000 have more than doubled the full investment in the Alliance membership. That is truly Return on Investment! It has not been easy. I have often errored while in trial mode on several of the Stansberry publications. However, if one becomes a student of your team's work, there is absolutely no reason that they cannot enjoy tremendous investing success. It takes time. Start small. LEARN. FOLLOW THE RULES. The results are there. Today's Stansberry Digest is simply some of the best work you have every done. Again, a very sincere 'THANK YOU' for the outstanding knowledge & services that you provide." – Paid up Alliance member Tom S.

Porter comment: What a great note. Thanks, Tom. I forwarded your note to my business partners, telling them, "This is why we're in business." Our goal is to enable investors like you to become successful in the markets. Thanks for trusting us enough to follow our advice. Your success is our success, too.

Regards,

Porter Stansberry

Baltimore, Maryland

November 14, 2016

P.S. On Friday, we published something that was obviously an error. A copy editor, seeking to make my prose more understandable, added a phrase – "during Obama's tenure'' – to a sentence about growing corporate debt loads in 2006 and 2007.

Several hundred dear subscribers wrote in to inform us that, in fact, Obama wasn't the President of the United States during those years. Many of you suggested we had made the gaffe intentionally, as though we thought we could convince you that Obama had been president then. Others assumed we had no idea when Obama was elected.

We certainly regret the error. But we were highly entertained by the responses.

One subscriber, for example, told us even if the mistake had been made accidentally, he would "never forgive us."

I couldn't decide what was funnier... the idea that we didn't know the presidential cycle, the idea that we would intentionally make a gaffe like that... or that anyone could be so upset by an obvious typo.

We hope you won't judge us so harshly.

Oh, by the way, one subscriber took pity on us. He wrote in to tell us that he was sure other subscribers were letting us have it and that he just wanted to tell us that he knew it was some kind of an error because he was sure we knew when Obama was elected. We gave that nice man a free one-year subscription to the product of his choice.