Our most controversial strategy...

Our most controversial strategy... How to time the market... Why you should become a connoisseur of value... The surest way to outperform your peers... Invest like a rich man, not a poor man...

Out of all of the things I've said or written in my career, the thing that gets me in the most "hot water" is my view that you can and should time the market. When I write "you," I don't mean some representative sample or some investor somewhere. No, I mean you... the person reading this e-mail... the person who subscribed to my newsletter... the person who is going to put his savings at risk when he invests in the stock or bond market. You.

A lot of people – even some smart ones – believe trying to time the market is a fool's errand. They argue that the best you can do is simply plow your savings, year after year, into a mutual fund or index fund. These folks make a whole range of arguments and back them up with plenty of "facts."

They'll cite academic studies and average investor results. They will say, again and again, that "no one" can beat the market, so why should anyone try?

I disagree... completely.

Let's start here. Let's say they're right. If the market is really efficient, then it shouldn't matter when you invest or what you buy. If that's really the case, then why not try to do better? As long as you're investing in something, you should do alright, according to these folks. So what's the harm in trying to beat the market?

And here's another way to look at it. The efficient-market folks love to argue that it's impossible for the average investor to beat the market because it's impossible for most people to beat the average result. At some point, it is a mathematical certainty that not everyone can beat the market. But just because something is "true" on average or across a population doesn't necessarily mean it must be true for you.

For example, I might argue on average everyone who marries will end up with a marginally attractive spouse of normal intelligence. Therefore, you're probably wasting your time trying to find a beautiful and intelligent person to marry you. In theory, that might be good advice. But was that your dating strategy? If you had dated any dog that would have you, would you have married the spouse you wanted?

In short... when it comes to a lot of important things in our lives, getting better-than-average results is a worthy goal. Luckily for investors, I don't believe beating the market is nearly as hard as trying to date a supermodel. I'm 100% convinced that anyone with normal intelligence and a modicum of emotional stability can do it. There are a few simple and logical reasons why...

The reasons come from Wall Street's irrational focus on short-term "earnings" and most investors' total lack of discipline. In today's Digest, I'm going to give you my five keys to timing the market. If you use my strategy, I guarantee you can double your average investment results over 10 years... or maybe even do a lot better.

But listen... there's an entire army of people out there whose careers depend on you never doubting the idea that the markets are perfectly efficient and you can't beat the market. If you speak to any of these millions of people in the financial services industry about my ideas, they will tell you I'm a fool, liar, or fraud. So get ready for an argument. Listen carefully. You'll notice these folks won't ever discuss the merits of my actual strategy.

You see, the financial industry can only survive and prosper if you're willing to give it your assets to manage. The industry needs you to believe that it's always a good time to put your money in the market. And it needs you to believe that you can't do it yourself. That's why when I write things like today's essay, folks in or supported by the financial industry go bananas.

As far as who is right and wrong... listen to what the oldest and wisest newsletter writer, Richard Russell, says about market timing:

In the investment world, the wealthy investor has one major advantage over the little guy, the stock market amateur and the neophyte trader. The advantage that the wealthy investor enjoys is that he doesn't need the markets... The wealthy investor doesn't need the markets because he already has all the income he needs... The wealthy investor tends to be an expert on values. When bonds are cheap and bond yields are irresistibly high, he buys bonds. When stocks are on the bargain table and stock yields are attractive, he buys stocks. When real estate is a great value, he buys real estate. When great art or fine jewelry or gold is on the "give away" table, he buys art or diamonds or gold. In other words, the wealthy investor puts his money where the great values are. And if no outstanding values are available, the wealthy investor waits. He can afford to wait. He has money coming in daily, weekly, monthly. The wealthy investor knows what he is looking for, and he doesn't mind waiting months or even years for his next investment. But what about the little guy? This fellow always feels pressured to "make money." And in return, he's always pressuring the market to "do something" for him. But sadly, the market isn't interested. When the little guy isn't buying stocks offering 1% or 2% yields, he's off to Las Vegas or Atlantic City trying to beat the house at roulette. Or he's spending 20 bucks a week on lottery tickets, or he's "investing" in some crackpot scheme that his neighbor told him about (in strictest confidence, of course). And because the little guy is trying to force the market to do something for him, he's a guaranteed loser. The little guy doesn't understand values, so he constantly overpays... The little guy is the typical American, and he's deeply in debt. – Richard Russell, "Rich Man, Poor Man"

Now... think about what Richard Russell said. Ask yourself, do you invest like the poor man or the rich man? How much do you know about the value of what you've bought? How long did you wait for the right opportunity to buy it? What's your downside? What are you expecting as your result? In a year? In three years? In five years? In 10 years?

The poor man can't even imagine a 10-year investment return. Nothing he buys lasts that long. Of course, if you want to get rich in stocks, almost everything you buy should last that long. It's the compound returns that will make you rich, not the quick trades.

What does Warren Buffett, perhaps the greatest investor ever, say? Is the market so perfectly efficient that knowledgeable and patient investors have no opportunity to earn excess returns? Buffett argues that all the value investors he knows – those who broadly followed the tenets of Ben Graham and David Dodd, authors of the value-investing bible Security Analysis – have beaten the market by a wide margin.

This isn't an accident or a coin flip. These investors all used the same principles to guide their choices. Their picks were not random or lucky. They involved all different types of securities and strategies. The only common theme was an intense focus on understanding the value of each security purchased.

The common intellectual theme of the investors from Graham-and-Doddsville is this: They search for discrepancies between the value of a business and the price of small pieces of that business in the market. I'm convinced that there is much inefficiency in the market. These Graham-and-Doddsville investors have successfully exploited gaps between price and value. When the price of a stock can be influenced by a "herd" on Wall Street with prices set at the margin by the most emotional person, or the greediest person, or the most depressed person, it is hard to argue that the market always prices rationally. In fact, market prices are frequently nonsensical. I have seen no trend toward value investing in the 35 years that I've practiced it. There seems to be some perverse human characteristic that likes to make easy things difficult. The academic world, if anything, has actually backed away from the teaching of value investing over the last 30 years. It's likely to continue that way. Ships will sail around the world but the Flat Earth Society will flourish. There will continue to be wide discrepancies between price and value in the marketplace, and those who read their Graham & Dodd will continue to prosper. – Warren Buffett, The Super Investors of Graham and Doddsville; 1984.

Step 1 in our guide to beating the market is based on the ideas of the men above. Before you buy a stock or bond (or anything else), ask yourself, "What's the intrinsic value of what I'm buying? And how does that intrinsic value compare with what I'm going to have to pay for it?" Always make sure you're buying at a good price.

There are lots of ways to estimate intrinsic value. And as with the value of a house, there's no one right answer. If I asked you to estimate the value of your home, you could give me a range based on similar sales in your area. You could tell me "replacement cost" based on what a lot nearby would cost and the construction costs. You could give me the tax basis. And I could look up what the insurance company estimates your house is worth (that's usually the most accurate).

The point is, people of normal intelligence can figure out what something is really worth. When it comes to publicly traded stocks, plenty of information is available to help you do the same.

When we look at stocks, we generally assign them an intrinsic value that's based on cash flow (how much cash this company can generate) for operating companies or a "take-out" price for asset-development stocks. In general, public companies fall into one of these two categories. They're either operating businesses (which are designed to make annual profits) or asset-development businesses (which may have many years of losses as they build out something like a gold mine, oilfield, or new drug).

Simple rules of thumb? Never pay more than about 10 times the maximum annual free cash flow for operating companies. Never pay more than half of the appraised value of an asset-development company.

The next part of our strategy to "time" the market – Step 2 – is even easier. There's not really any math involved: Become a connoisseur of value. Look around the world. What are other investors running away from? Is there a safe way to invest? Is it extremely cheap? Does this opportunity seem like one of the greatest deals you've ever seen?

Let me give you an extreme example. Remember a few months ago when trouble started brewing between Russia and Ukraine? President Obama's spokesman, Jay Carney, said on March 18: "If I were you, I wouldn't invest in Russian equities right now, unless you're going short." As a connoisseur of value, this would prick your ears...

Russian energy stocks have been the cheapest, high-quality equities available anywhere in the world for several quarters. They pay big dividends. They have valuable assets. They are dirt cheap – trading for two and three times earnings and for a tiny fraction of their asset values.

Gazprom, for example, holds assets worth more than $400 billion. Today, even after the recent increase in stock price, the company's enterprise value (the value of all of its outstanding shares and its debts) is only $144 billion. Being a Russian company means that Gazprom's stock will probably always trade at some discount. But a discount greater than 60%? And when a leading barometer of the public's thinking – the president's spokesman – makes a call about stock prices, it's almost like someone is sending you an invitation to make money.

Now, I concede... that's certainly an extreme example... but similar things happen all of the time... things that don't involve as much risk as Russian equities. And, if you're willing to focus on the areas of the market that offer outstanding value, you will come across opportunities like these frequently. On the other hand, if you're only following what the folks on CNBC are talking about, you'll never see values like this one. The key is to focus on the areas of the market where value abounds. And then... to be patient and wait for the "dinner bell" to ring.

Step 3 in our guide to beating the market is even easier. Learn to make big commitments only when other investors are clearly panicking, stocks are cheap, and extremely safe investments are available. This is what most people mean when they say market "timing." This is what I mean when I say "allocate to value." Two quick examples...

First, in the fall of 2008, investors were clearly panicking. Warren Buffett even wrote a letter to the New York Times explaining why it was time to buy stocks hand over fist – and was criticized on CNBC for doing so! If there has ever been a better contrarian indicator, I've never seen it.

Meanwhile, you could have bought shares of iconic beer maker Anheuser-Busch (BUD) – a stock I first recommended in 2006 – for around $50 for several weeks in October and November. At the time, global brewer InBev had an all-cash deal in place to buy the stock for $70 per share. I told investors the situation was so safe, they should put 25% of their assets into the shares.

It was the easiest and safest way to make a lot of money that I'd ever seen. Even if the deal fell through (and it couldn't; it was an all-cash deal at a reasonable price)... the stock was worth far more than $50 a share. In my view, there was zero downside, and an almost certain $15-$20 profit in just a few days.

A few months later – in February 2009 – shares of renowned jeweler Tiffany were trading for less than $25. The company has large inventories of gold and precious stones. Subtracting the value of its inventory from its debt load and dividing by the shares outstanding, gave you liquidation value of around $24 per share. In short, you could buy Tiffany – one of the premier luxury brands in the world – for the value of its current inventory. That means, you could have gotten the real estate, the brand, and all the future profits for free. Again, I remember the specifics of the trade because I wrote about this situation to subscribers. It's at times like these when you must be willing to make large commitments.

Fine, you might say. But what should I do, just hold cash for years or decades, waiting for a perfect situation? Stocks were only as cheap as they were in 2009 three or four times over the last 100 years.

No, I don't argue that you should stay 100% in cash until stocks crash. That is probably the biggest misunderstanding most investors have about our advice. We never advocate selling everything. We didn't sell everything in 2008, even though we knew the mortgage associations Fannie Mae and Freddie Mac were going to zero and that Wall Street was going to collapse.

And we haven't recommended selling everything now, even though we have grave concerns about the stability of the global monetary system.

We never believe that we can predict the future accurately. Instead, we want to build a portfolio that will thrive over time, no matter what happens. Today, we see that stocks are no longer great values. It's harder for us to find good opportunities. And so, we've told subscribers, begin to build cash. When you sell something, sock away the profits until better opportunities emerge. When do you sell? Well, that depends. But, no matter what, follow your trailing stop losses. And that leads us to...

Step 4: Stay reasonably diversified, use trailing-stop losses, and always maintain a large cash reserve. Here we part ways with most value investors. A lot of good value investors (including Extreme Value editor Dan Ferris) refuse to use trailing-stop losses. Instead, they hope to sell when stocks become too expensive. But in our experience, it's nearly impossible for most investors to know when to sell. Therefore, we want to focus on buying at the right time. Then we simply admit that we're not going to sell at the optimal point. We just can't predict how high stocks will go. And we want to capture as much of that upside as possible. Using trailing stops allows us to do this.

If you're not sure how to use them, please visit TradeStops.com for more information. Also, it's important to never give your stockbroker your stop-loss points. And never, ever base your stops on intraday prices. If you put your stops in the market (which is what happens when you give them to your broker)... events like a flash-crash can wipe you out.

If you remain dedicated to only buying stocks at a discount from their intrinsic value... if you become a connoisseur of value... and if you only make large investments when other investors are panicking, then you should actually find that it's easy to keep a cash reserve.

But how many stocks should you own? What's reasonably diversified? I recommend never owning more stocks than you can completely understand and follow. A good test is: Can you explain the stocks in your portfolio and why you bought them (the elevator pitch) to a friend without using notes or looking at your portfolio? If you can't, then you don't know your investments well enough to own them or you're trying to follow too many. You're not going to be able to find more than a handful of extraordinary investments at any given time. Why own anything that's not extraordinary?

Another good test for your portfolio is to make sure that there's not a single position that could cost you more than 5% of the value of your overall portfolio. Don't end up with so few large positions that a catastrophe in one stock wipes out all of your other gains for the year.

What's the last of our part of our strategy (Step 5) to always beating the market? Do everything you can to avoid the damage from fees and taxes, to maximize your long-term, compound returns. Whenever possible, keep your assets in vehicles that allow you to compound your investments tax-free. Minimize trading and fees, which enrich your broker, not you. Look for companies whose management is well-known for doing tax-efficient deals and rewarding shareholders in tax-efficient ways. And always reinvest your dividends – either in the same companies or in new ones that offer better value.

Studies show that most investors perform terribly when managing their own assets. That doesn't mean that you can't do well. It does mean that the odds are stacked against you. So print out this list. Start living by it.

Never buy a stock whose intrinsic value you can't estimate reliably – and always get a big discount when you buy.

Become a connoisseur of value. Follow the cheapest, most hated segments of the market carefully. Wait and watch for moments of maximum pessimism, like Jay Carney's statement.

Allocate to value: Wait to make major investments when other investors are panicking and truly safe, outstanding opportunities abound.

Use good money-management techniques. Follow position-sizing guidelines and trailing-stop losses. Never own more positions than you can carefully follow. Always keep a large cash reserve.

Do everything you can to avoid fees and taxes. Simply avoiding a 2% annual fee against your asset base (by not using money managers) is the No. 1 surest way to outperform your peers.

New 52-week highs (as of 6/20/14): American Homes 4 Rent (AMH), Apache (APA), Anadarko Petroleum (APC), Bank of Montreal (BMO), BP (BP), AB InBev (BUD), Chesapeake Energy (CHK), C&J Energy Services (CJES), Callon Petroleum (CPE), Carrizo Oil & Gas (CRZO), Chevron (CVX), WisdomTree Japan Small-Cap Dividend Fund (DFJ), Discover Financial Services (DFS), ProShares Ultra Oil & Gas Fund (DIG), Dorchester Minerals (DMLP), Devon Energy (DVN), Cambria Foreign Shareholder Yield Fund (FYLD), Corning (GLW), GW Pharmaceuticals (GWPH), iShares Dow Jones U.S. Insurance Fund (IAK), Integrated Device Technology (IDTI), Intel (INTC), Johnson & Johnson (JNJ), Eli Lilly (LLY), Lorillard (LO), Altria (MO), ONE Gas (OGS), RPM International (RPM), ProShares Ultra Health Care Fund (RXL), Sanchez Energy (SN), Superior Energy Services (SPN), ProShares Ultra S&P 500 Fund (SSO), Constellation Brands (STZ), Skyworks Solutions (SWKS), Triangle Petroleum (TPLM), U.S. Commodity Index Fund (USCI), Vanguard Natural Resources (VNR), and ExxonMobil (XOM).

In the mailbag... A subscriber wants to know what we mean by "market timing" and what we're going to do about all of the divergent opinions we publish. And finally, we got some vitriol, but it's merely in jest...

We're now five issues of the Digest into my nine-day run, and the mailbag is starting to run out of steam. We need your help. Don't miss this golden opportunity to give me a piece of your mind. According to the government, we're crooks. According to Google, we're even worse. Surely, we must have thousands of disgruntled and righteously angry subscribers out there. Let me have it: feedback@stansberryresearch.com.

"In the Sept 1, 2009 issue of [Stansberry's Investment Advisory] you said the number 1 secret of the best investors was to 'Time the Market... You Must Time the Market.' This market timing call seemed to be at odds with the other analysts at [S&A], most notably Steve Sjuggerud and David Eifrig. Dan Ferris seemed indifferent to any predictions of market timing for his investments. Now, one year later, Steve Sjuggerud has just written a piece in True Wealth indicating his 'market timing' call for a possible break in the market end April 2015. David Eifrig just says his indicators say the economy is in recovery mode...

"So my question to you is this: How can an armchair investor such as myself ever be able to 'time the market' if the very best investors we know have such widely held divergent beliefs about market turning points? I'm not trying to rub your nose in this. What I'm saying is that I understand the different ways people value the market. I understand the sentiment indicators and know about the flow of dollars into stocks. I get it that sectors rise and then fall...

So my real question is what exactly do you mean when you say 'you must time the market?' Some of the analysts suggest we should tighten trailing stops. Is that what you mean?

"It appears that Steve will continue to use his traditional True Wealth timing indicator of P/E + short-term interest rate. David Eifrig in Income Intelligence is saying the portfolio is positioned in a Hold to Buy area, albeit slightly less bullish than 1 month ago. You are placing short positions in your newsletter and clearly remain very cautious. If you simply read and follow one newsletter, it's relatively simple for those readers. But Alliance members who read all of S&A's newsletters are the ones mostly likely to be confused because they are getting all these different messages. Are you really expecting me to do any better than you guys?" – Paid-up subscriber Ted T.

Porter comment: Hopefully today's Digest went a long way toward describing what I mean by market timing.

In general, I feel most comfortable telling subscribers when U.S. stocks are clearly attractive. Read my October 2002 issue. Read my November 2008 issue. Read my January 2012 issue. Likewise, I feel comfortable telling subscribers when stocks are no longer clearly attractive. But getting the timing right when selling is much harder. Read my November 2000 issue. Read my February 2007 issue. Read the many warnings I've written since May/June of last year.

I believe these market-timing views are important as they relate to major commitments of capital and portfolio hedging/risk management. But you'll notice that I've never endorsed the idea of selling everything. Instead, I believe a simple focus on only buying good values, and of using sensible money-management techniques (position sizing, trailing stop losses, cash reserve) is all that's really needed to make sure you beat the market.

As to the divergent opinions among our staff members... Smart and independent analysts aren't going to agree often. Should we demand they write things they don't believe? Should we only publish analysts who agree with me? I'm curious to know how you'd handle this matter if you were in my shoes. Some of my subscribers seem almost offended that we do publish a wide range of views about the stock market and which investments are best.

That's our business. We're a publishing company, not an investment management firm. As a company, we don't have a "view" on the market. Our analysts do. And we accurately publish those opinions. What do you think we should do?

"Any update on your Warren Buffett 'Mistakes' book? And something I really would like to see is an update on your new shaving business. I hate the Gillette razors. Seriously, they are terrible.

"My wife and I run a stationery business. We were lucky to take your advice over the years and build up a nice portfolio. I like to think you are extension of my dad. He's a retired Captain Navy fighter pilot and American Airlines, and he did well for himself. My family on my dad's side is in the oil business in North Dakota. We've been there for a long time. And I am fortunate to get oil/gas royalties each month.

"I shared your newsletters that covered the shale boom, End of America, and a few others and they couldn't believe a newsletter/analyst knew that much about the business. So I they all signed up for S&A. Thanks again for your hard work." – Paid up subscriber Mike W.

Porter comment: The Buffett book is a sore subject. I'm way behind. Thanks for reminding me to get back on the horse. My new business venture – OneBlade – is doing well. We have prototypes. We're doing early beta testing now, and we're looking to launch later this year, on schedule. I'm glad you're enjoying our newsletters... and congrats on your oil and gas royalties. That's a nice income stream, I'm sure.

"You asked, and I will give you both barrels! Your nefarious, evil, stupid, egotistical, and arrogant attitude is ruining my life. I used to sit in blissful peace watching the talking heads on CNBC tell me what I should blindly do because, well, they know it all...

"Who do you think you are showing how markets work, how money goes to where it's best treated, how to identify and understand capital-efficient businesses, and how to use put and call options for income? The only options I understood before were option offenses in football! I can no longer watch TV now that my brain is engaged. I have learned more in the last two years than in my previous 30 about business and investing. With my new understanding I see through the falsehoods perpetually spouted over and over again by the news and government.

"Now I have even bigger problems to deal with! When I did nothing but lose money, the IRS ignored me. Last year alone I made approximately $30K on put-call options and now the IRS is very interested in me. Also there is the pain in the butt caused by those lousy MLPs, who continuously deposit cash in my accounts. The paperwork is such a pain to fill out! Who wants all that hassle?

"In conclusion, if you had not done these horrible things to me I could have lived in blissful ignorance totally depending on my Mother, Government, to supply my every need in life. Making all this money is a pain in the ass!" – Paid-up alliance member Keith W.

Regards,

Porter Stansberry

Baltimore, Maryland

June 23, 2014

Porter: The Fed is turning savers into speculators...

In today's Digest Premium, Porter Stansberry discusses the effect the Federal Reserve's irresponsible money printing is having on retirees... and on the rest of the global economy.

To subscribe to Digest Premium and receive a free hardback copy of Jim Rogers' latest book, click here.

Porter: The Fed is turning savers into speculators...

Editor's note: Last week, Porter offered his take on the junk bond and U.S. Treasury markets. In today's Digest Premium, he discusses the effect the Federal Reserve's irresponsible money printing is having on retirees... and on the rest of the global economy.

Nobody really knows what will happen to the world if investors lose faith in government currencies. But governments are doing everything they can to cause investors to lose faith in their currencies. It's a grand experiment.

As a result, the world's financial markets have become a giant game of hot potato: Which currency is going to blow up next? We've seen investors drop out of the yen over the last two years and into the euro. Now, European authorities are saying, "No, don't hold our bonds, don't hold our currency, you have to go somewhere else."

So investors are jumping back to the dollar. The result has been lower U.S. Treasury bond yields. Sooner or later, people with money in savings are going to say, "Enough, I'm tired of having to play this game."

Look at currency volatility following the Bretton Woods Agreement in 1944. Look at the volatility of currencies from 1971 until today, and then look at the volatility of currencies from the 1820s up until Bretton Woods. You'll notice the massive change.

Economies used to correct based on relative comparative value. Now, currency value is manipulating economies. The tail is wagging the dog. And the question that nobody knows the answer to is when the dog will turn around and just bite its damn tail. We don't know when (or if) that will happen.

But here's what we do know: There is no such thing as a "safe haven" currency. The Swiss have even decided to go ahead and start printing Swiss notes. The closest thing to a safe haven is probably the Singapore dollar or the Chinese renminbi. Singapore is such a small economy that it doesn't make sense as a global currency. There is no political transparency in China, so I don't think the renminbi qualifies yet. It could get there, but it's just not there yet.

So where should you go for safety? You should invest in well-run companies. You should go into gold, real estate, timber, and managed commodity futures. The returns on these assets over the last five years – since the U.S. banking system blew up – have been incredible. All those things have soared. Today, alternatives to the dollar are fully priced.

U.S. stocks are not cheap. By some measures, they're in very dangerous territory in terms of valuation. The Shiller price-to-earnings ratio is around 26, which is very expensive. Real estate has had a huge run. Prices in places where I shop are now back to where they were in 2005-06. There aren't any obvious safe bets in terms of asset classes anymore.

The Fed has rung all of the value out of the financial system in an effort to inflate the dollar. And inflation has ended up in stocks, bonds, real estate, commodities, and other alternatives. For example, look at virtual currency Bitcoin. Bitcoin is purely a creation of the Fed's terrible policies.

The reality is that nobody knows what is going to happen going forward. Consequently, people who want to be savers are turning into speculators. That's a tragedy, especially for people who are retired and who need safe yields. There is just no such thing to be found.

– Porter Stansberry

Porter: The Fed is turning savers into speculators...

In today's Digest Premium, Porter Stansberry discusses the effect the Federal Reserve's irresponsible money printing is having on retirees... and on the rest of the global economy.

To continue reading, scroll down or click here.