Beware of Waterspouts

Success sours quickly... A dream-cruise nightmare... Extreme, unlikely events... 'Volatility clusters'... Preparation and experience... There's likely more volatility ahead...

British tech billionaire Mike Lynch scored big in 2011...

That was the year printer-maker Hewlett-Packard (now HP) acquired his U.K.-based search-software company Autonomy for $11.1 billion. It was one of the U.K.'s largest tech deals.

The acquisition price was a 60% premium over Autonomy's market price, which seemed absurdly large to many at the time. HP would soon come to agree...

In November 2012, HP announced an $8.8 billion write-down on its investment in Autonomy. It blamed Lynch and his team for the loss, citing "serious accounting improprieties, disclosure failures and outright misrepresentations."

The case had a lot of moving parts, but in 2018, Autonomy's former chief financial officer, Sushovan Hussain, was convicted of fraud and later sentenced to five years in prison. In 2018, Lynch and Autonomy's former vice president of finance, Stephen Chamberlain, were also charged with fraud.

In 2023, Lynch was extradited from England to the U.S. when he and Chamberlain were each indicted on 15 counts of wire fraud and conspiracy. Their trial began in a U.S. court in March 2024.

But on June 6, Lynch and Chamberlain were found not guilty of all charges.

A celebration was in order...

So earlier this month, 59-year-old Lynch took members of his family, friends, and colleagues on a Mediterranean cruise aboard the 184-foot sailing yacht Bayesian (named for the mathematics behind Autonomy's search software). Lynch's wife Angela Bacares, their 18-year-old daughter Hannah, and Morgan Stanley international chairman Jonathan Bloomer were all aboard.

But on August 19, disaster struck...

The Bayesian was moored off a small fishing village in the north coast of Sicily when a thunderstorm hit in the early morning.

The water was so violent that a nearby sailing yacht, the Sir Robert Baden Powell, had to keep its engine running full throttle just to stay upright, even though it was anchored. It likely was hit with a tornado-like waterspout, which can be just as dangerous as tornadoes on land.

Sixteen minutes later, the Bayesian sank.

Fifteen of the 22 people on board the Bayesian were rescued, including Lynch's wife. Seven bodies, including Lynch's and Bloomer's, have been recovered. All but one of the crew members survived, likely because they were awake and on deck while everyone else was asleep below.

No one would have predicted this...

The Bayesian was a big, well-built yacht made to withstand violent storms. When it disappeared, Sir Robert Baden Powell's captain, Karsten Borner, thought it must have left the area quickly to escape the weather. The ship's first mate told him it had sunk, and he said, "Nonsense. It's such a big ship. I can't believe it."

To make the story even more tragic... Chamberlain died a couple days earlier, after being hit by a car while jogging.

Lynch and Chamberlain worked hard, built a company together, and sold it for $11 billion. It's every entrepreneur's dream come true. And after finally being vindicated of any fraud, they were both killed in tragic accidents.

Statistically speaking, accidental death is an extreme, unlikely event...

Death comes for us all, but not necessarily prematurely and out of nowhere. Most of us wear seat belts and avoid ultra-risky occupations like race-car driver or Navy SEAL to avoid the risk of a sudden, violent death.

But it's impossible to avoid every risk in life...

That includes the extreme events in financial markets, like a big one-day crash or an enormous mega-bubble.

Unexpectedly large declines in markets are like waterspouts.

Even though a storm is brewing, you don't expect a water tornado to pop up and sink your yacht. It almost never happens. But that doesn't mean it came from nowhere.

Borner told one reporter, "The weather forecast included thunderstorms and that can sometimes be strange in the Mediterranean." Anyone who has spent time on the water knows extreme weather can pop up quickly, giving boaters little time to react.

Likewise, on "Black Monday," when the Dow Jones Industrial Average fell 22% in one day on October 19, 1987, it blindsided everyone... even though it had already fallen 17.5% from its August 25 high and 10% over the prior three trading sessions. At the close on October 19, it had fallen 34% in a span of just 10 trading sessions.

Most of the 10 worst one-day declines in the Dow have been like that. They were huge and unexpected, but they didn't exactly come out of nowhere. Two were in October 1987. Four were in the 1929 to 1932 bear market. Two were in March 2020. There was one in the bear market of 1899 to 1900 and one in the Panic of 1907.

The worst days arrive during bad times. As mathematician Benoit Mandelbrot once wrote, "Volatility clusters."

In other words, bad days beget bad days. So it makes sense that the worst market days tend to arrive during bear markets and crises, like waterspouts in a thunderstorm.

Earlier this month, we talked about the market's big one-day decline and volatility spike on August 5.

I (Dan Ferris) said the CBOE Volatility Index's ("VIX") jump to 65 was mostly a technical glitch... The spike was due to the mispricing of one of the options that makes up the popular fear gauge. I've since heard it suggested that wasn't the case.

Either way, it was a big move. Folks were scared, and it showed up in the options market. And if volatility really does cluster, we probably shouldn't get too complacent. It would be wise to prepare for more of it.

It's hard to think that way with the S&P 500 Index sitting around all-time highs.

But experience and preparation can help you survive storms...

The Sir Robert Baden Powell crew woke up at 3 a.m. because they knew a thunderstorm was coming. The weather hit sometime between 4:00 a.m. and 4:30 a.m.

Now, they didn't know a deadly waterspout would form. But as Borner said, these storms can be "strange." So he had all hands on deck doing everything they could to steady the ship and stay vigilant.

Borner's experience told him to be ready for anything. And in the end, his crew kept their ship afloat and helped rescue survivors from the Bayesian.

Experience and preparation seem to orbit around each other... The more experience you have, the better prepared you'll be. And the more you prepare, the better you'll survive to live another day and make use of your experience.

The best way to prepare for storms in the financial market is to have a slug of cash in a liquid brokerage account... so you can pick up any bargains during a downturn.

Now, there's nothing like cash in a crisis, but it's not the only way to prepare...

I also believe folks should hold physical gold and silver. Most of us don't expect to see a scenario where we're all using gold and silver instead of cash. That'd be a real waterspout moment. But if gold and silver are what you need and you don't have them, it would be like all the oxygen being sucked out of the room.

For run-of-the-mill unpleasantness like stock market corrections or even some bear markets, Treasury bills will also take good care of you. If you stick with the shortest-term obligations (say, three months or less), you'll likely preserve your principal... and, at today's rates, earn a decent amount of income while you decide what (if anything) you should do if there's a stock market storm.

Longtime readers know I don't make predictions...

But I'd be surprised if we don't see more volatility by the end of the year.

That's why, in my latest issue of The Ferris Report (out today), I'm adding a safe bond fund currently yielding 5.8% to the model portfolio. It's nearly as safe as a short-term T-bill, but it yields a little bit more. Plus, the principal is well-protected. (Ferris Report subscribers can check out the issue here.)

As long as the Magnificent Seven, meme stocks, and whatever speculative fare is enthralling the market keep going up, safe bond funds will look mediocre by comparison.

But don't forget... stocks are egregiously expensive right now. They also recently saw an 8.5% decline, followed by a big one-day spike in volatility. And volatility clusters.

If I'm right and more volatility arrives in the next few months, you'll wish you had prepared by buying assets that don't fall in value and issue decent monthly dividend payments.

I'm not the only one who sees more volatility ahead...

Corey McLaughlin and I recently interviewed Ten Stock Trader editor Greg Diamond for an upcoming episode of the Stansberry Investor Hour podcast.

Greg told us that he's also expecting greater volatility in the near future. That's why Greg recently went on camera to explain a big market move that he thinks will begin on September 9... and how you can prepare for it.

Greg called the market crashes in 2020 and 2022 just days before they happened. So when he gets worried about volatility, you should take notice.

If a financial waterspout strikes, taking Greg's advice could be the difference between sinking and staying afloat (and even making big gains). You can sign up to watch his presentation on August 27 here.

New 52-week highs (as of 8/22/24): Automatic Data Processing (ADP), Altius Minerals (ALS.TO), Berkshire Hathaway (BRK-B), Brown & Brown (BRO), CBOE Global Markets (CBOE), Colgate-Palmolive (CL), Coca-Cola Consolidated (COKE), Cintas (CTAS), Direxion Daily Real Estate Bull 3X Shares (DRN), Intercontinental Exchange (ICE), Intuitive Surgical (ISRG), Kellanova (K), Eli Lilly (LLY), Altria (MO), Northrop Grumman (NOC), NVR (NVR), Novartis (NVS), Omega Healthcare Investors (OHI), Pembina Pipeline (PBA), RenaissanceRe (RNR), Veralto (VLTO), and Health Care Select Sector SPDR Fund (XLV).

In today's mailbag, more feedback on politics and markets, which Digest editor Corey McLaughlin wrote about on Tuesday, and a subscriber follows up on thoughts we published yesterday... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"I agree that introducing more presidential influence on the Fed would be a bad idea. However, there is little evidence that the Fed's decisions over the years have been helpful to the economy. On the contrary, keeping interest rates low for so long has produced significant distortions in the economy. Frankly, the Fed has not done a very good job." – Subscriber Chuck B.

"That brought tears to my eyes... In print, at Stansberry Research, inflation is really currency devaluation.

"It took me a long time to finally find what I think is the truth. And there is so much real truth not being told. Instead, we get 'Fed speak' like they can really steer our market instead of being a wrecker of it.

"What we hear may be truth, but not all of the truth, some really important facts left out, or, they may have added misleading graphs or other ways of making the real truth sound like something else.

"Our Congress and [central bank] messed up our economy with currency borrowed into existence, reducing the value of each currency unit you and I own or measure our worth in. Now to reduce that falsely identified 'inflation,' they punish our economy to make it harder to purchase goods with interest rates. Once we suffer enough, they resume our currency devaluation again... " – Subscriber Bernard B.

Good investing,

Dan Ferris
Eagle Point, Oregon
August 23, 2024