Time to buy the dip?...

Time to buy the dip?... Wall Street bullish on junk again... The dean of high yield joins us... Cooperman says bondholders are stuck with risk... A sector of the bond market we like today... The VIX crosses a milestone... Sjuggerud: The rally is still on... A reader's experience with dividends...
 

 Buying the dips has been a winning strategy this year...

 

As we've noted many times in the Digest, the S&P 500 benchmark stock index has gone nearly three years without a correction of 10% or more.

 

And the Volatility Index (VIX), the market's fear gauge, has remained depressed – signaling complacency... Though the VIX did cross an important milestone last week, which we'll discuss later.

 

 Even the selloff we've seen since the S&P 500's all-time high on September 18, which has the talking heads in a panic, has been a little more than 5%.

 

So is it time to buy off the dip?...

 

 

 In addition to stocks, we've also seen a selloff in one of the most hyped markets – high-yield (or "junk") bonds.

 

We alerted you to the selloff in junk bonds and described our current disdain for the sector in the October 2 Digest.

 

 To recap, junk bonds are the riskiest corporate bonds. The issuing companies pay higher yields to compensate for higher risk that they may default.

 

For the first time in history, the average yield in junk bonds fell to less than 5% last May, based on the benchmark Barclays U.S. Corporate High Yield Index... Today, yields have rebounded to 6.22%, but we still don't think junk bonds are yielding enough to compensate you for the risk...

 

In the June 18 Digest Premium, Porter gave subscribers a good rule of thumb for investing in junk bonds:

 

You would normally expect to see the junk-bond market yield 8%-12%. A good rule of thumb is to never buy a junk bond if it's trading at a yield of less than 10%. Another good rule of thumb is to never buy a junk bond unless it's trading at a discount to par. That's because these bonds come with such a high risk of default.   The average default rate on these bonds over time is usually around 30%.

 

 Earlier this year, Porter predicted a stock selloff, like we've recently seen, would be preceded by a correction in corporate bonds, which we've also seen. From the May 16 Digest:

 

The following chart is of one of the biggest exchange-traded funds that holds corporate bonds, the SPDR Barclays High Yield Bond (JNK). This shows you the last six months. As you can see, bonds (in black) have continued to trend higher. The fund holds nearly $10 billion in corporate bonds with an average yield of less than 6%. As long as yields on corporate paper are this low, it's unlikely we'll see a bear market develop.     Big institutional investors constantly evaluate whether to own more stocks or more bonds. Much of their decision-making is driven by what they can earn in bonds. When corporate bonds offer relatively high yields (8%-10%) annually, a lot of big institutional investors will opt to sell stocks and buy bonds. Doing so allows them to "lock in" gains and earn relatively high returns on their capital, with much less risk.   That's why I don't anticipate a significant bear market in stocks until corporate bonds begin to fall in price. Remember, bond prices move in the opposite direction from their yields. So a big fall in bond prices would send yields soaring. And that would drive investors to shift capital from stocks to bonds.

 

 Still, the world is awash in capital... and starved for yield. So we're not surprised to see some of Wall Street's biggest firms recommending buying junk bonds on the dip...

 

Morgan Stanley analysts Adam Richmond and Jeff Fong put out a report entitled "Buy High Yield." As the title implies, the investment bank's analysts are bullish on junk. They see "risk/reward as more attractive than it has been in over a year."

 

And Jeffrey Rosenberg, the chief investment strategist for fixed-income at the investment management firm BlackRock, said, "High-yield has widened out and increased in attractiveness."

 

 To be clear, we expect junk-bond rates to remain low for some time. And the junk-bond rally could well continue. We prefer to stay on the sidelines. Buying risky corporate bonds near record-low yields is not a strategy we endorse. And one can't help wondering whose best interests these firms have in mind...

 

Keep Porter's rule of thumb in mind before making a long-term investment in high yield "junk" bonds. Ask yourself if this investment is in your best interest long term.

 

But you don't have to take our word for it. Just listen to one of the best bond analysts in the world – Martin Fridson...

 

 Fridson, the chief investment officer of investment firm Lehmann, Livian, Fridson Advisors, recently appeared on Episode 185 of our weekly Stansberry Radio podcast to discuss the current environment in high-yield bonds.

 

"Right now, the yield on the high-yield index is right around 6%. The long-run average is around 9.5%," he said. "Over time it tends to move back towards that average. So if you just look at historical experience, you should actually expect a slightly negative rate of return over the next five years."

 

In other words, junk-bond prices are currently way too inflated.

 

During the discussion, Porter pointed out investors think they will be able to reap the higher yields of this risky asset and sell before the music stops. But that's not how it works. Fridson agreed: "Yeah. You don't have the liquidity to achieve that. Once it starts going the other way, the bidders disappear."

 

 Leon Cooperman, chairman and CEO of the hedge fund Omega Advisors, also thinks bond markets are risky today.

 

Cooperman appeared on CNBC's Squawk Box and said buying government bonds today is like "playing with dynamite." Remember, Treasury securities are traditionally the safest class of bonds. So you can imagine Cooperman's take on junk bonds.

 

According to Cooperman, the risk in financial markets rests "unequivocally" with bond investors right now.

 

 Cooperman said U.S. government bonds have historically moved in connection with the nominal gross domestic product (GDP), which is a combination of real GDP and inflation.

 

Cooperman said if we get real GDP of about 2%-3% and inflation of about 2%-3%, then nominal GDP will be around 4%-6%.

 

If that happens, Cooperman thinks 10-year Treasury notes (currently around 2.27%) will rise to between 4% and 6%... which means capital losses for bond investors.

 

 Mind you, we're not bearish on all bonds. For years, we've been urging subscribers to hold municipal bonds... And we're still big believers in them today. They remain a great way to collect tax-equivalent, double-digit yields.

 

"Munis" are bonds issued by state and municipal governments, often to fund large construction projects, like roads and stadiums. To encourage people to invest their money with the government, interest on muni bonds is tax-exempt.

 

And while junk bonds have a historical default rate of around 30%, the highest-rated munis have a default rate of 0.02%.

 

 Retirement Millionaire editor Dr. David "Doc" Eifrig has long been one of the strongest advocates of munis. As Doc wrote in the May issue of his Income Intelligence service...

 

Since we bought municipal bonds last summer, everything has gone right for the sector. An improving economy has led to rising tax revenues for municipalities at the state and local level, and the financial conditions of local governments has never been better. At the same time, the number of newly issued municipal bonds has dropped, keeping supply low and prices rising.

 

Doc's recommendations in municipal bonds are at new highs. Retirement Millionaire subscribers who acted on Doc's October 2008 recommendation to buy the Nuveen AMT-Free Municipal Fund (NEA) are up 93.3%. And they are up 40% on his March 2011 Retirement Millionaire recommendation of Invesco Value Municipal Income Trust (IIM). He also recommended IIM to readers of Income Intelligence, his income-investing service that was launched last year. Those subscribers are up 25% on the fund since he first recommended it to them in July 2013.

 

Even with the recent increase in share price, you can still buy some muni-bond funds at large discounts to their net asset values. And they're still paying tax-equivalent, double-digit yields.

 

 As we noted earlier, the stock market's recent selloff caused the VIX – the market's fear gauge – to shoot higher... The index rose above 20 on Friday. It crossed 22 today.

 

As we noted in the April 14, 2014 Digest, Bank of America Merrill Lynch (BAML) says 20 is a key number for the VIX:

 

"While US equities have fallen sharply, the VIX index still shows signs of complacency. Historically, most tradable equity bottoms transpire after the VIX Index trades above 20%." [According to BAML's report]   In other words, when the VIX rises above 20, we may see a short-term bottom in the market.

 

 And as you can see from the chart below, over the past two years, buying the S&P when the VIX rose above 20 has been a winning strategy...

 

 

 True Wealth editor Steve Sjuggerud said today that despite the recent volatility... he doesn't think the market rally is over. As he said in an essay published by our free e-letter DailyWealth:

 

In my opinion, money will flow into stocks (and real estate) – pushing stock prices significantly higher between now and the first interest rate hike sometime in 2015. Then stocks will have a correction after the rate hike, before heading higher again. That's our story.   So I am not too worried about the volatility we saw last week. It wasn't that exciting, in the grand scheme of things. And when you focus on the bigger picture, there's still plenty of upside ahead...

 

You can read the full essay here...

 

 And while a VIX at 20 may signal a short-term market bottom, Doc's sweet spot is a little higher...

 

As we've explained before, the VIX reflects the prices investors will pay on options that protect the value of their stock holdings. We call the VIX the "fear gauge" because when people are fearful of a downturn, they will pay more to insure their stocks... and that drives the VIX up.

 

And a higher VIX is good for selling options, as Doc does in Retirement Trader.

 

As he wrote in the April 11 Retirement Trader:

 

Remember that during the recession, the VIX soared to nearly 70%. I start to notice investors' fears when the VIX rises above 30%. And when the VIX shot up years ago, it made a great time to launch this letter and take advantage of the times. Back then, you could sell an option on almost any stock safely. Today, you need to know what to do if the times change. While a higher VIX means bigger premiums, this low volatility combined with our economic and financial analysis means we'll continue to collect safe, steady income.

 

 Our final Stansberry Conference of the year takes place on Saturday, October 18 in Nashville, Tennessee.

 

If you happen to live in the area and can still make it in person, we've got a few seats available, you can reserve your spot here.

 

 But we know most of you won't be able to join us in Nashville. That's why we've hired a world-class production crew to live-stream the entire event.

 

So if you'd like to hear from Porter, Dr. Ron Paul, Jim Rickards, Bill Bonner and many more, we encourage you to sign up.

 

It's only $199 to watch the entire show live, from your living room. You can get the full details here...

 

 

 New 52-week highs (as of 10/10/14): National Beverage (FIZZ), Invesco Value Municipal Income Trust (IIM), Pepsi (PEP), ProShares Ultra 20+ Year Treasury Fund (UBT), and WA Prime Group (WPG).

 

 In today's mailbag, a subscriber gets honest and describes his experience with dividends. Let us know what you're thinking. Send your feedback to feedback@stansberryresearch.com.

 

 "I just wanted to share with you and (perhaps) your readership a real world example of the impact that dividends plays to an account.

 

"I have taken a leaf out of your book and after 5 years of investing I have just completed a thorough and honest review of my account for the first time... and well... it is horrible.

 

"Despite reading all of the wonderful advice of your analysts, and despite enjoying one of the greatest bull runs in history, I have continued to make every investment mistake under the sun.

 

"I only have myself to blame, but it just highlights to me what a tough job you have, that despite providing all of the greatest advice that you can, clowns like myself will continue, against all rational and sane logic, to keep making the same stupid investment decisions over and over again.

 

"However, the one saving grace is that I invested into a quarterly dividend-paying stock. Unfortunately, as you will see below, I severely limited my returns on this by making horrible, horrible purchases in terms of timing and purchase price, and didn't execute an exit strategy.

 

"The stock that I purchased was an interest-rate security and covered a holding period of just over 3 years from June 2010 till Aug 2013.

 

"I bought the stock in the following way:

 

8 @ $65 = $535 on 9 Jun 2010 10 @ $79.5 = $810 on 18 May 2011 17 @ $73.70 = $1,276.90 on 2 Aug 2011 15 @ $67.82 = $1,032.3 on 14 Sep 2011 18 @ $74.5 = $1,356 on 14 Nov 11 Total purchases = $5,010.2 (Including $75 – $15 X 5 – in brokerage fees)

 

"I sold the stock the following way:

 

30 @ $75 = $2,235 on 8 Jun 13 38 @ $73.05 = $2,760.9 on 20 Aug 2013 Total Received $4,995.9 (Including $30 – $15 X 2 – in brokerage fees)

 

"Total Value $5,010.2 – $4995.9 = -$14.30

 

"Now during this holding period, I received a total of 13 interest payments, totaling $687.15, turning my account from a negative $14.30 to a positive $672.85.

 

"Despite making every single stupid mistake with chasing the price and selling at the wrong times, the magic of dividends ultimately ended up turning my account from a wretched, farcical garbage heap, to something that, on face value, was passable.

 

"I sincerely hope that you can share this lengthy example with your readership because it is firstly, a real life example (not something out of a text book or an analyst providing hypothetical advice), and more importantly I feel that I am not alone among your readership.

 

"I know that I will be lampooned and ridiculed in the feedback section, but I know that honestly, I am not alone. If your readership takes on an honest review like this (no matter how bad) of their own portfolio, if they see similar results or behaviors like I have shown, then this will be like a punch to the face that they know that they needed but have otherwise denied.

 

"I will close off with this. Dividends, even when done stupidly, are a wonderful thing." Paid-up subscriber Tim

 

Regards,

 

Sean Goldsmith

October 13, 2014

 

A valuable lesson in stop losses...

 

On Friday, Stansberry's Investment Advisory lead analyst Bryan Beach made the bullish case for the biotech firm his team recommended in the August issue.

 

In today's Digest Premium, he explains where things went wrong... and how they'll never make the same mistake again...

 

To subscribe to Digest Premium and access today's analysis, click here.

A valuable lesson in stop losses...
 

Editor's note: On Friday, Stansberry's Investment Advisory lead analyst Bryan Beach made the bullish case for the biotech firm his team recommended in the August issue. In today's Digest Premium, he explains where things went wrong... and how they'll never make the same mistake again...

 

 

 The Durata (DRTX) recommendation taught the Stansberry's Investment Advisory research team a valuable lesson about stop losses and the collective power of our readership. We got some things right – really right.

 

But we got one important thing totally wrong: We stuck to our traditional 25% trailing-stop loss. We use trailing stop losses to protect our capital when the market turns against one of our recommendations. Trailing stops help us lock in gains or minimize losses. As the chart below shows, this scenario was not a great time to use our standard stop-loss strategy...

 

 

 On Friday, August 1, when the issue hit e-mail inboxes after market close, Durata closed at $12.80 a share. When the market opened on Monday, shares surged to as high as $15.26 before closing at $15.17... a 19% spike in one day. The day after that, Durata closed within pennies of our maximum buy price.

 

That was a testament to both Dave Lashmet's compelling research and the combined market clout of our subscribers. It's not unusual for our readers to push up the share price of a small-cap stock... but within a couple of days, the market typically digests this extra interest and prices drift back down to pre-recommendation levels. Sure enough, that's what happened to Durata. A week after our recommendation, shares had settled in around $14.

 

 Around this time, Bloomberg picked up our story and began distributing its main points to a much broader audience. The headline read: "Durata Rises; 'Prime' Big Pharma Acquisition Target: Stansberry." Interest picked up and the stock ran up to nearly $17 a share toward the end of August. As shares rose, our trailing stop rose to around $12.50.

 

September came and went and Durata didn't get acquired. Impatient investors jumped ship and took profits and shares slid lower. On October 1 – two months later to the day – we hit our stop loss.

 

The next day – on October 2 – Durata announced it was being acquired. Pharmaceutical giant Actavis would pay $675 million for Durata... almost the exact buyout price we had predicted. And yet... readers who took our advice missed out on these gains. Despite nailing the buyout and the price, our official, audited track record will forever show the Durata pick as an 8% loss.

 

 This wasn't just bad luck... it was an avoidable lapse in judgment. We knew our readership was capable of causing a spike in the share price. We knew it would be temporary and that the market would go back to normal. And yet, we used the same strategy we use for $35 billion insurance firms.

 

One of the great things about trailing stops is that they minimize losses when the market turns against one of your investments. But in this case, the fall from $17 to around $12.50 wasn't the market turning against us... it was just returning to equilibrium.

 

From our recommendation on August 1 to our stop-out date on October 1, there was absolutely no news to report. No sales figures... no regulatory hurdles... nothing good... nothing bad. Nothing changed but our research and the volatility it brought to this small-cap acquisition target.

 

Clearly, a wider trailing stop – 50%, perhaps – would have made more sense given these circumstances. Given the large size of our readership and the small size of the company we recommended, we believed a price spike and descent were probable (if not inevitable)... and we should have adjusted our exit strategy accordingly.

 

Trailing stops are a terrific way to minimize volatility and avoid catastrophic losses. But every situation is different. There is no "one size fits all" strategy for stop losses.

 

 One final note... If you're a Stansberry's Investment Advisory subscriber, we would love to hear about your experience with Durata. Did you sell the day after hitting your stop loss? Did you hang on and enjoy the double? Good or bad, we want to hear about your experience with the trade. Let us know at feedback@stansberryresarch.com.

 

– Bryan Beach

A valuable lesson in stop losses...

 

On Friday, Stansberry's Investment Advisory lead analyst Bryan Beach made the bullish case for the biotech firm his team recommended in the August issue.

 

In today's Digest Premium, he explains where things went wrong... and how they'll never make the same mistake again...

 

To continue reading, scroll down or click here.