A Huge Difference Between the 2008 Crisis and Today

The worst week since 2008... Simple advice for disciplined, long-term investors... Don't bury your head in the sand... A huge difference between the 2008 crisis and today... A lesson learned amid the craziness... Singing the same, boring, old ditty...

What a horrendous week for most investors...

The benchmark S&P 500 Index peaked at an all-time high of 3,386 on February 19.

Over the next six days, it plunged 12%... firmly into "correction" territory (a decline of at least 10%). Deutsche Bank said it was the quickest drop into correction territory in history.

And the S&P 500 once again spent most of today trading deep in the red before rallying about 2.5% in the final 15 minutes to close at 2,954... down 0.8% on the day. Still, according to the Wall Street Journal, it was the stock market's biggest weekly loss since October 2008.

A steady stream of unpleasant news about the "coronavirus crisis" scares more investors every day. And who knows when the fears will calm... We're looking at another weekend with more bad news about the virus, possibly followed by another rough week for stocks.

But as we head into the weekend without the market's noise distracting us, it's the perfect time as investors to take a step back and consider the short- and long-term implications of the coronavirus concerns. And more important, what you should do about it – if anything.

Of course, I (Dan Ferris) can't know or entertain them all. But after living through many ups and downs in two-plus decades in this business, I hope I can add some valuable insights...

First things first, a piece of advice for anyone reading today's Digest...

If you're a disciplined investor pursuing an effective long-term strategy, this is a lousy time to change what you're doing.

As I'll discuss today, a lot of investors are in a trading frenzy. And that's a big mistake...

As long as your investment strategy involves good risk controls, you don't need to change what you're doing with your money right now... or at any time. You shouldn't worry just because the market is down. You shouldn't lose any sleep at night as stocks sell off.

Not worrying is the whole reason you started using those risk controls in the first place!

If you use trailing stops and you hit your stops, there's no reason not to sell. If you don't hit your stops, there's no reason not to keep holding. And on the other hand... if you find an attractive stock that meets all your investment criteria, trust your analysis and buy it.

An investment strategy that works is like a contract you make with yourself...

One of the most important reasons you make this contract – practicing good risk controls – is to handle big sell-offs like this one. Breaking it now would be a tragic error.

It's clear that many people are panicking about the coronavirus. We can't predict the future... This could be the early stages of a prolonged downturn. Or the bull market could get through this rough patch and keep marching higher... like it has done before.

But one thing is certain...

Other investors' fears about the coronavirus are not reasons to change what you are doing – as long as what you're doing is sound in the first place. All sound investment strategies employ adequate risk controls. The coronavirus is no reason to stop doing what works.

(I don't mean to sound crass, but you don't need me to tell you to protect your physical health, first and foremost. That's a given. Today, I'm focusing on your portfolio.)

With that said, it's also a mistake to keep your head buried in the sand right now...

Instead, look around for insights about the virus that could help you as an investor.

Today, I want to share one man's take with you about what's going on. I believe every investor needs to keep this in mind in the coming days, weeks, and even months. It has the potential for serious long-term damage to companies with vulnerable business models.

It comes from Charles McGarraugh, a former Goldman Sachs (GS) partner who served as the firm's head of metals trading. On Tuesday, he posted on Twitter about the coronavirus...

In short, McGarraugh discussed a huge difference between the financial crisis of 2008 and the current coronavirus crisis. As he sees it, the 2008 crisis was a "balance sheet (liquidity) crisis." But the current crisis will create an "income statement (earnings) crisis."

The difference is enormous. It could blindside millions of investors, as well as confound central bankers who believe they have the power to fix anything. As McGarraugh wrote...

Bad balance sheets can be fixed with financial engineering – monetary policy helps. Bad income statements require re-working of business models and supply chains.

I see a clear implication in McGarraugh's words... Monetary policy can't solve this one.

By that, he's talking about the Federal Reserve's interest rate cuts and other policy tools.

In 2008, companies had too much debt...

They owned assets like subprime loans, overvalued real estate, and complex derivatives securities that amounted to insurance on those mortgages.

The whole house of cards was based on the notion that U.S. housing prices hadn't fallen in decades... and wouldn't fall again anytime soon. But of course, home prices did fall... And insolvent borrowers couldn't pay back the money they never should have borrowed in the first place.

Many big financial institutions' assets were suddenly worth a lot less than they thought. And they couldn't sell because all the likely buyers had the same problem. Even worse, all their liabilities were coming due.

By 2007, Lehman Brothers' balance sheet was leveraged at more than 30 to 1. It went bankrupt in September 2008, as did Washington Mutual. Other smaller banks failed, too.

The Fed bailed everybody else out with hundreds of billions of dollars. It forced some banks to take the money, even if they insisted they didn't need it.

Problem solved. (Unintended long-term consequences notwithstanding, of course.)

But as McGarraugh points out, the coronavirus is an income statement crisis...

It doesn't attack the assets on the balance sheet like the mortgage crisis did. Instead, it attacks a company's ability to generate revenue and earn profits.

Companies like United Airlines (UAL) must pay tens of thousands of employees, maintain hundreds of airplanes, and more... no matter what happens. But if the company's planes can't fly to China because of the virus, it will have much less revenue to pay all those bills.

United recently reported a roughly 100% decline in near-term demand in China.

What if that near-term decline becomes longer term and requires the airline to radically alter the way it flies customers around the world? Can anyone guarantee it won't happen?

Of course not.

The virus could create a significant problem for long enough that it damages the business models of big companies around the world... forcing them to do a major retrenchment.

Other companies, like consumer-electronics giant Apple (AAPL), make and sell a lot of products in China. (Apple has 42 stores in the country.) So these companies might see a double-whammy of lower demand in a key market and difficulties in manufacturing the products for all the markets that they serve. As McGarraugh put it...

The problem now is too much *operating* leverage in the real economy with over-optimized supply chains, data-driven pricing management, customer acquisition funnels, etc.

Corporations have made tons of data-driven advances in the past few decades. And they all assume that the past data points they've collected can tell them enough about the future to help them serve customers better, cut operating expenses, and pick the right countries for outsourcing supply chains – among other key decisions. But as McGarraugh continued...

In a world with [coronavirus] potentially defining new on-the-ground realities, that's not a great assumption to be optimized around.

In the simplest terms... if your business depends on keeping your manufacturing costs low by making everything you need in China, you have a serious problem right now.

Now, the biggest question is: 'How long will this problem last?'...

Or as McGarraugh frames it: Will it last long enough to require companies to rethink their business models? If it does last long enough, the serious problem might become a long-term impairment that requires a significant change to your business model.

If I had to guess, I believe the coronavirus will last longer than anyone currently expects. (In case you missed it, my colleague and Stansberry Venture Technology editor Dave Lashmet detailed some of the key facts that he finds worrying in yesterday's Digest.)

In my opinion, you can't really compare the current "COVID-19" coronavirus with severe acute respiratory syndrome ("SARS") and Middle East respiratory syndrome ("MERS")...

The SARS outbreak in 2002 and 2003 only resulted in around 8,100 cases, and it was mostly all over in eight months. We've seen a higher fatality rate with MERS (roughly 35%), and it's still ongoing after six and a half years. But there are only 2,527 total cases.

Meanwhile, with COVID-19, the numbers are much higher...

To date, roughly 84,000 people have been infected. That's already more than 10 times the amount of SARS cases. And the number of deaths is rapidly approaching 3,000.

As I said on Tuesday, Nancy Messonnier – the director of the U.S. Centers for Disease Control and Prevention's National Center for Immunization and Respiratory Diseases – said this week that it's not a matter of if the coronavirus also spreads in the U.S., but when. And the bigger issue here in the U.S. is how many people will get severely ill... or die from it.

In my mind, it's also hard to compare the coronavirus with the regular flu... Yes, millions of folks get the flu each year. And it has killed many more people than the coronavirus.

But you can get a flu shot. And we know much more about the flu than we know about the coronavirus. As it stands right now, no coronavirus shot or vaccine exists. And we have no idea how many people will get it... how many will die... or when a vaccine will be available.

It's irresponsible and wrong to pretend that you know how the coronavirus crisis will play out...

No one can do that. We don't have a crystal ball.

It's reasonable to believe that the coronavirus won't ravage the Earth and kill millions of people. However, we simply can't know for sure what will happen from this day forward.

My point is, no matter what anyone tells me, we just don't know enough about the coronavirus at this point to jump to any conclusions – good or bad.

McGarraugh said this week's sell-off is justified and will continue until the uncertainty about the extent of the virus abates. Only then, he said, will we know which business models have been "reworked for resilience under the new conditions as they end up unfolding."

So what should you do with your portfolio right now? As I said at the outset, if you're a disciplined investor with a long-term perspective, you don't need to do anything different.

And for those who believe it's a good time for short-term trades, let me share a personal experience...

Heading into last weekend, I was long COMEX gold futures.

(If you don't know, futures contracts allow you to buy 100 ounces of gold for delivery at a future date. Most folks don't take delivery, though... Like me, they just speculate on the price. Or if they mine gold, they might also hedge their production in the futures market. If you don't know what futures are, don't worry about it... You're better off without them.)

I decided to stay long as the futures market closed and accept whatever happened when it reopened this week. The contract closed at $1,645.90 per ounce on Friday, and I was in at $1,646. Since each contract equals 100 ounces, that means I was down $10 per contract.

When the futures market reopened Sunday, it was obvious that the virus was still spreading and folks were getting worried. Looking for a "safe haven" asset, they turned to gold...

The April 2020 gold futures contract spiked up to a high of $1,684 per ounce in the first 15 minutes of trading. It's normal for me to sell into that kind of craziness, but I held on.

Before long, the contract fell back to $1,661, then ran up to about $1,691... at 1 a.m.! It traded in the $1,680s when I woke up, so I decided to get out. The action was so fast that, by the time I finally exited, it was in the $1,670s. Since then, it has been as low as $1,572.

My point is, the action after I exited my position was brutal and chaotic. It was nothing like what you typically expect gold to do in a crisis. This experience reminded me of a critical point that you should always keep in mind if you engage in short-term trading of any kind...

Folks are most strongly attracted to market situations that they should avoid altogether.

It's just our perverse human nature. We don't want to miss out on any opportunities.

Fortunately, I made a profit on my gold futures position. But not before I tested the waters again and quickly exited for a small loss because I realized the action was too crazy.

Lesson learned.

As long as the action remains wild, I'm out. If the market settles down, I'll think about re-entering. I want to be long gold. I believe it's heading higher. But as an investor, it's more important to sleep well at night and not lose a boatload of money in the futures market.

I've traded futures off and on for 30 years. I've been doing that longer than any other kind of investing... And I use the word "investing" lightly because futures are pure speculation.

But nowadays, the way most folks trade stocks is pure speculation, too...

As our friend Jason Goepfert at SentimenTrader.com said recently, "Retail traders have become manic," since discount brokerages cut equity trading commissions to zero last fall.

It reminds me of 1929. (No, I'm not 100 years old, but I've read about that era.)

Small investors were induced to trade after realizing they could buy stocks on margin. In other words, they could control $10,000 worth of stock with a deposit of, say, just $1,000.

The effect of zero-fee trading is the same today. The low costs and ease of trading lures novices into the market. It makes the uninitiated feel like making money is easy... at the exact moment when making money in the stock market is getting a lot more difficult.

Despite the coronavirus crisis and a brutal week in the stock market, my tune hasn't changed...

I'm still singing the same, boring, old ditty that I've been singing since mid-2017.

The markets are manic. Stocks are priced for poor long-term returns (over the next 10 years or so). Hold plenty of cash (including short-term U.S. Treasurys). Hold some gold (real gold, the kind that goes clink in your pocket). Buy value when (if!) you can find it.

And avoid stupid stuff that can wreck your portfolio... like volatile gold futures contracts.

As long as you've followed – and continue to follow – our basic advice at Stansberry Research, you don't need to change your long-term investment strategy because of this sell-off. My colleague Corey McLaughlin said it best at the end of Wednesday's Digest...

It will drive you crazy (and possibly lose you money) if you try to time any of these things, make sense of an endless stream of headlines, or predict what might happen next...

Our fundamental advice hasn't changed. Heed our advice on proper portfolio allocations, position sizing, and risk management. And as always, don't speculate with any money you can't afford to lose.

As long as you do that, you'll come out of this coronavirus crisis in good shape.

New 52-week highs (as of 2/27/20): iShares 1-3 Year Treasury Bond Fund (SHY), ProShares Ultra 20+ Year Treasury Fund (UBT), and Vanguard Inflation-Protected Securities Fund (VIPSX).

In today's mailbag, one subscriber asks a pertinent question after this week's sell-off. What's on your mind? We'd love to hear your thoughts, comments, and observations at feedback@stansberryresearch.com.

"Is Steve [Sjuggerud] still sure about the Melt Up? It seems if there is no bottom to the selling. It appears gold is no good as a chaos hedge. Bonds are the place to be." – Paid-up subscriber Matt K.

Corey McLaughlin comment: As Dan wrote in today's Digest and you have noted, it sure has been a wild week in the markets... As far as the "Melt Up," Steve sent a special update to his True Wealth Systems subscribers this afternoon with updated guidance.

In fairness to his subscribers, we can't share all the details in this space. But the short answer is "yes"... Steve says he sees a lot of opportunity after this week's sell-off. He's planning to go into more detail about why in next week's issue of True Wealth Systems.

Good investing,

Dan Ferris
Vancouver, Washington
February 28, 2020