A Lesson From the Crash of '87

The 'test' continues... What history says about the stock market now... A lesson from the crash of '87... 'Portfolio insurance' is on sale today...

Well, that didn't last long...

On Monday, we noted that the market had successfully "tested" its February lows... and that the worst of the recent correction could be behind us.

Today, that looks a little less likely...

All three major U.S. indexes reversed and closed sharply lower yesterday, and closed down again today.

This is not the type of behavior we'd expect to see if the bottom was in. Don't be surprised to see lower lows in the days ahead.

While this would be frightening, it certainly wouldn't be unusual...

The benchmark S&P 500 Index has experienced five other corrections of 10% or more since the bull market began in 2009. According to Bloomberg data, these corrections lasted an average of 200 days "peak to peak," and took an average of 14% off the market at their bottoms.

If this correction did end yesterday, it would've run for just 60 days so far, for a maximum decline of just 12%. That would make it the second-shallowest correction to date, and put it on pace to be the second-shortest as well.

But history suggests any further declines should be considered a fantastic buying opportunity...

You see, virtually every major bear market over the past 100 years has coincided with fundamental weakness in the economy. This was the case during the Great Depression, the big inflationary bear market of the 1970s, the dot-com bust of the early 2000s, and the financial crisis of 2008/2009.

However, when the market has plunged – or even crashed – without these corresponding economic troubles, the market typically rebounded quickly.

The infamous "Black Monday" crash of October 19, 1987 is the best-known example. U.S. markets crashed more than 20% that day, while many markets around the globe plunged even further. It became the largest one-day decline in history.

If you were in the markets at that time, you may recall that practically everyone in the financial media was predicting the start of another vicious multiyear bear market like the one that had just ended in 1982. Many were predicting a second Great Depression.

In reality, the economy was just fine. Stocks would bottom the next day and the bull market would resume almost immediately. Anyone bold enough to buy during the panic made a fortune over the next several years.

Regular readers know we do expect a severe recession and a major bear market within the next few years...

But we do not yet see any of the clear warning signs that have preceded these events in the past. For now, the economy remains strong, which suggests the bull market should continue.

In fact, we saw a remarkably similar market panic during the last "Melt Up" in the late 1990s. As Porter explained in the February 9 Digest, following the first leg of the correction last month...

This reminds me of what happened with Long Term Capital Management...

Back in August 1998, the market simply fell out of bed for no good reason. Sure, Russia defaulted on some debt. But that only mattered to folks like billionaire investor George Soros. It shouldn't have mattered at all to U.S. investors.

Still, the market crashed, dropping more than 500 points in one day. That was a record point fall at the time. Investors who had enjoyed nearly a decade of easy 20%-plus annual gains in stocks were in shock. But it wasn't the big one. There was a long way yet to go in that cycle's "Melt Up."

It seems highly likely that the kind of financial problems we're suffering today will end up being a lot like the muck-up at Long Term Capital. Everyone was selling because they knew Long Term Capital had to sell to cover its Russian losses. And what nobody understood was that Long Term Capital was leveraged 100-to-1... and owned $1 trillion in assets. That amount of selling triggered wave after wave of additional selling, and so on.

But the selling wasn't based on any fundamental problems in the economy. As soon as everyone understood what was driving the selling, the panic stopped. The bull market resumed. I bet that's what happens again this time around.

Of course, as we often say, the market offers no guarantees...

And even if we're correct and the bull market resumes, you'll only be able to take advantage of any additional weakness if you have capital available to buy when others are panicking.

This is why we continue to "nag" you about managing your risk today. As we've written in the Digest again and again, using tools like proper position sizing and trailing stop losses will help protect you from suffering a catastrophic loss and ensure you have plenty of "dry powder" when the dust clears.

But the easiest and most powerful way to protect yourself is simply holding a reasonably diversified portfolio. While this can mean different things to different investors, we recommend two assets in particular that everyone should own: some cash and a bit of "portfolio insurance" in the form of precious metals.

Throughout history, people have always turned to physical gold and silver during times of crisis. It's a simple and proven way to protect your wealth during a financial "worst-case scenario."

If you don't already own some physical gold and silver, you're in luck...

Earlier this week, our colleague Ben Morris noted that silver is cheaper than it has been in years. As he told his DailyWealth Trader subscribers on Monday...

For one, silver recently went through a severe bear market. From early 2011 through late 2015, silver prices fell as much as 72%. They're now up 22% off that low...

For silver to match its 2011 highs, it would have to nearly triple from today's prices.

But silver isn't just cheap relative to the U.S. dollar...

As Ben noted, it's also cheap compared with gold...

We can measure how expensive or cheap silver is to gold by looking at the "gold-to-silver ratio"...

A high ratio shows that it takes more ounces of silver to "buy" one ounce of gold. In other words, a high ratio means silver is cheap relative to gold. A low ratio means it's expensive.

Over the past 40 years, the gold-to-silver ratio spent most of its time in the 50-70 range. It peaked in 1991 at 102. (That's 102 ounces of silver per ounce of gold.) And as recently as 2011, it traded down to 32.

As you can see below, the gold-to-silver ratio climbed to 81 last week. The ratio has only stretched this high a handful of other times in the past 40 years. And when it did, it didn't stay this stretched for long.

This extreme reading suggests that silver is a better value than gold today.

Not only is silver cheap, it's also hated...

Regular Digest readers are familiar with the Commitments of Traders ("COT") report. This is a weekly report published by the U.S. Commodities Futures Trading Commission that shows what various market participants are doing with their own money.

We pay particular attention to what speculators are doing. That's because these folks are typically trend followers, which makes their behavior a useful contrarian indicator. When speculators are all making the same bet – whether they're all super-bullish or super-bearish – it's a sign that the trade is "crowded" and a short-term reversal is likely.

And as Ben pointed out, the latest COT report suggests speculators have all but given up on silver today. From the issue...

In the chart below, you can see that silver speculators' positions (the blue line) just moved into extremely bearish territory. Now, they are more bearish than ever before...

This is a historically low-risk time to buy silver (based on speculators' positions). And the bearish bets tell us that if silver starts to rise, it could explode to the upside as bears buy silver to cover their short positions.

In sum, we have lots of reasons to buy silver today. It's good financial-disaster insurance in a risky market. It's cheap relative to both the dollar and gold. And speculators – who are often wrong at the extremes – are more bearish than ever before.

Again, if you don't already own some silver, we urge you to consider buying some today.

New 52-week highs (as of 3/27/18): short positions in Sprint (S) and Simon Property Group (SPG).

It looks like Porter's response to paid-up subscriber David A. in yesterday's mailbag resonated with many of our readers. The mailbag is overflowing with folks who were compelled to write to us. Do you agree or disagree with Porter? Let us know at feedback@stansberryresearch.com.

"Porter, I've benefitted from and enjoyed your writing for several years now as an Alliance Member, but never as much as I did today when you replied so eloquently to the question about why you are 'biting the hand that feeds you,' implying that we owe the government for all the good things we enjoy in America.

"I doubt you would ever consider it, but we surely need people like you with the means, clear understanding, and ability to clearly articulate these basic precepts. It is no coincidence that those who are in favor of more and more government are also haters of the basic principles of western civilization... the very things that are, as you say so well, responsible for our success as a society. Porter for president!" – Paid-up subscriber Doug P.

"Porter, your response to today's comments from David A. were worthy of reading many times over. I sent a copy of it to our daughters, for although I do not agree with every statement equally, you articulated well so much of how I feel. Keep up the good work, and God bless you, your family, and our country (which sure needs it more now than ever)." – Paid-up subscriber S.P.

"Bravo, Porter. Your response to David A. was so clearly and logically stated. You answered with precision and humility. Your gratitude to all those who have aided you in your rise to wealth and heading a very successful company was wonderful. I loved that you turned Obama's 'you didn't build that' from being an attack on a certain segment of society into an expression of gratitude to all those who have helped you build Stansberry Research. It is a company that has helped many, many of us, your subscribers.

"Most of all I appreciated your attempt to help David see that the idea of America and the current government are not only not the same thing, they are diametrically opposed. Thank you for clarifying the difference between coercion and freedom of choice.

"This piece is one worthy of your best Friday Digest efforts. Actually, it's better than most. It ranks right up there with your farewell to your beloved family dog. Thank you." – Paid-up subscriber C.E.M.

"Bravo Porter! Well said. Very eloquent. That's a keeper to share with my young children. And there weren't just silver certificates... but Gold certificates too! I wonder what they were good for? Perhaps some other barbaric relic." – Paid-up subscriber Matt V.

"Porter, I couldn't have said it better myself, even if I took a month to write it! Thank you for doing so! I don't usually keep the Digests – unless you quote me 🙂 – but I will [keep] today's, and I'll show it to those that I speak with that think Government is the answer. Maybe I'll send it to Marjory Stone Douglas High School for their students to chew on!!" – Paid-up subscriber Carl S.

"Porter's response is a masterpiece and should be on display in the Capitol Rotunda. I took the liberty to forward it my friends, associates and family. I especially hope my grown children are stirred by his words. There is so much ill-conceived political discourse and divide in this country. I can't help but think that it is partly due to the fact that there has never been a greater divide between what our country stands for and what our government stands for than there is now. Porter, as always, I appreciate you." – Paid-up subscriber Bob B.

"Porter, as always, I'm impressed by your cogent and compelling response to David A. Thank you for writing and publishing the response. I'm sure I wouldn't be able to draft a response quite so reasoned. Wouldn't it be refreshing if our elected officials actually treated their office as a 'temp job' and covenant with the people they are elected to serve?" – Paid-up subscriber Mike T.

Regards,

Justin Brill
Baltimore, Maryland
March 28, 2018