Don't Get Mugged by Uncle Murphy
Don't get mugged by 'Uncle Murphy'... Your financial adviser will never tell you about this danger... A major problem for us as humans... Don't let your emotions get in the way... The exact moment when it happened with this former market darling... The difference between 'investments' and 'speculations'... Three easy steps to keep this danger from destroying your wealth...
Your financial adviser will never tell you about 'uncle points'...
But as you'll see in today's Digest, not knowing about them could crush your life savings.
Sure, these days, it might seem like the good times will never end. Perhaps bear markets are as extinct as the woolly mammoth, the Tasmanian tiger, or the West African black rhino.
After all, stocks keep screaming higher with little hesitation...
The benchmark S&P 500 Index is up about 9% in roughly a month since early October. It recently made new all-time highs on eight straight days – the longest streak since 1997. And of course, many individual stocks are doing much better than the broader indexes.
But it's important for us to have this discussion right now... That's because you must be ready for uncle points at all times. You never know what's lurking around the next corner.
With that in mind, let me (Dan Ferris) do what your financial adviser should be doing...
We'll start at the top with the most basic question you could ask on the topic...
What is an uncle point?
An investor's uncle point is the moment at which he can't take any more losses on a position. Instead, he finally decides to get out in fear of losing whatever he has left in it.
In other words, it's exactly as it sounds... It's when the investor mercifully cries "Uncle!"
It's one step beyond the maximum amount of emotional pain that an investor can stand when holding a position – or maybe even an entire portfolio – that's declining in value.
When you hit your uncle point, you're not thinking... You're just tired of feeling bad about your investment, and the only cure is to exit the position as fast as possible.
While the definition is easy to grasp, things get more muddled after that...
One major problem with uncle points is that you mostly can't tell ahead of time where they'll be...
As humans, we're a complicated bunch... We often let our emotions get the best of us.
No matter how much you tell yourself in advance that you'll be ready for anything, when the rubber meets the road and a position starts dropping, all that preparation often goes out the window. In turn, you start thinking irrationally... You start panicking, and you don't know if you'll sell out for a big loss when you're down 59%, 95%, or somewhere in between.
It's really hard to predict how you'll feel about almost anything in the future. Adding money and the uncertainties of the financial markets into the mix only compounds that problem.
You can't predict where they'll be, but it's essential that you acknowledge they exist... It's probably a good idea also to assume that nobody but Warren Buffett and a few other legendary investors can take an endless amount of pain when holding a losing position.
If you're a dyed-in-the-wool, long-term, buy-and-hold-forever investor in great businesses – just like Buffett – congratulations... You can skip this Digest, and I'll see you next week.
If you're still with me, I realize that you probably don't have all your eggs in one uncle-point-exposed basket...
Many Digest readers likely have contributed to their 401(k) plans for years. And they've likely achieved a great long-term result – including riding out bear markets without selling everything they own in panic.
These set-it-and-forget-it retirement accounts are certainly an excellent way to get past uncle points and build long-term wealth. But you surely aren't passive with all of your money...
You're actively managing at least one account, maybe more. You're looking at new trading ideas every day. You're spending lots of time logged into your brokerage account, with your hands never far from the "buy" and "sell" buttons... always thinking about what to do next.
Most folks who actively manage an account won't behave like a Buffett-style, long-term, buy-and-hold-forever investor in great businesses that they never sell for decades.
Instead, they do what human nature tempts us to do... They let their emotions influence their decisions. That's usually not good. And as a result...
They're in danger of getting blindsided by an uncle point they don't know (or admit) exists.
Uncle points explain why so many people suffer devastating losses in bear markets...
The market wears them down.
They keep promising themselves that they'll sell once they get back to breakeven... or some other fantasy that depends on their ability to predict the future (whether realized or not). They hold on to short-term positions and change their minds, trying to convince themselves that they're really long-term positions and that they can hold on through any amount of pain.
Then, one day, the loss gets too big and the pain gets too bad... At that moment – which is often the exact wrong moment to sell – they cry uncle and sell at a devastating loss.
Sadly, near the bottom of a bear market, uncle points can break more than just your brokerage account... People jump out of windows when bear markets get bad enough.
In general, managing your own money is like having a loaded gun in the house... You better grow up quickly and fully understand the responsibility you've taken on. Pulling the trigger at the wrong time and place could be devastating to you or someone you love.
If you want to see what an uncle point looks like, consider the example of Peloton Interactive (PTON)...
I reported on the exercise-equipment maker's wild market ride in Tuesday's Digest.
Peloton soared 758% from March 2020 through its January 2021 peak... COVID-19 pandemic lockdowns prevented folks from going out of their houses to their local gyms, which caused sales of exercise equipment to skyrocket.
That's mostly behind us now, though...
Peloton's stock peaked at more than $167 per share in January... And it already had fallen to about $86 per share on November 4, when the company filed its latest quarterly earnings report.
Slower revenue growth spooked investors. The company cut its annual sales forecast by as much as $1 billion. That's when scores of Peloton shareholders hit their uncle point...
Peloton's stock plunged 35% the following day to $55.64 per share. The freefall hasn't stopped... It closed today at $49.22 per share – roughly 70% below its January high.
This is a classic example of an uncle point. You can see the precise moment on the price chart. It's all the way to the right as the stock plunges 43% in six trading sessions...
One way to minimize potentially devastating uncle points is to know the difference between investments and speculations...
If you've bought any financial asset in the past year or so, it's highly likely to be a speculation than at most other times throughout history. I suspect many Digest readers own stocks or options that they're not really sure when to sell... THAT is a speculation!
Investment returns come from the intrinsic earnings power of an asset...
In stocks, that means the (hopefully growing) earnings power of the business. Bond returns come from the debt-repayment capacity of a business. Rental-property returns come from the supply and demand fundamentals of the local property market versus the cost of owning and maintaining the property.
A true investor stays invested based on the fundamentals of the business, not the action of the company's stock price.
Meanwhile, speculation returns simply come from selling an asset at a higher price than the speculator initially paid... Most speculators will exit a position based solely on the price movement, regardless of underlying fundamentals.
Many strategies fall under the basic headings of "investment" and "speculation"... But generally speaking, it's accurate enough to say that investors bet on longer-term fundamentals, and speculators bet on shorter-term price movements.
When the stock market goes up very far, very fast – like it has since March 2020 – it makes getting rich by speculating on stocks seem effortless. Investing takes a back seat as speculating causes many stocks' prices to run up well beyond any reasonable valuations.
At times like this, even the most experienced investors might not be able to tell investing from speculating...
Buffett wrote about this idea in his 2000 letter to Berkshire Hathaway shareholders...
The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money.
Buffett went on to say that "normally sensible people" behave like Cinderella at the ball...
They know that overstaying the festivities – that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future – will eventually bring on pumpkins and mice.
But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight.
There's a problem, though: They are dancing in a room in which the clocks have no hands.
Nobody knows when "midnight" – the top of a speculative frenzy – is... So in turn, nobody could possibly know when it's "just seconds before" that.
Of course, if you just made 10 times your money (or eight times, as Peloton buyers could've made in 2020), you're probably not thinking about your uncle point if the stock were to then fall 50% while you're holding it. Therein lies the problem...
The moment you find yourself holding a rapidly accumulated multibagger return on a mediocre cyclical business is exactly when you need to start thinking about how quickly it all could disappear.
In the stock market, folks seem to forget about the second half of the old saying, "Easy come, easy go."
It's all too human to feel better and better about a company's prospects solely because the share price goes up...
The market couldn't possibly be that wrong... could it?
It could. And during a speculative frenzy, the market frequently is that wrong.
I promise you... the value of Peloton's business absolutely did not rise 758% last year. And on the flip side, it absolutely has not fallen 70% and counting since earlier this year.
The truth is, Peloton probably went public for more than it's currently worth.
Efficient as the market may be much of the time, it's still subject to human foibles... And one of those foibles is the strong tendency to buy when everyone else is buying, regardless of underlying fundamentals.
Part of the problem with stocks like Peloton is that folks are betting on lousy businesses as if they're the next Amazon or Apple...
Folks think they've found the next Amazon (AMZN) any time they see an unprofitable company growing revenue fast and using whatever cash it generates to invest in more growth.
The trouble is... Amazon is one in a million. That's roughly your chance of finding the next one.
In the case of Peloton, the example of Apple (AAPL) likely influenced investors... The consumer-electronics giant makes great products whose users absolutely love them.
And so does Peloton... By all reports and appearances, the company makes products its most avid users are totally in love with.
But that's as far as the similarity goes.
Peloton is not Apple... It makes exercise bikes and treadmills. Sure, they're hooked up to the Internet, which allows users to participate in live exercise classes... But they aren't exactly iPhones, which revolutionized how we communicate, shop, work, entertain ourselves, and more.
The financial results speak for themselves... Peloton's hypergrowth is flagging, and it has failed to attain consistent profitability. Meanwhile, Apple is a huge business with the world's most valuable brand, and it gushes so much cash profit that it literally doesn't know what to do with it all.
It's not involved in a cyclical business like exercise equipment... Folks will cling to their iPhones long after their Pelotons have been sold on Craigslist for a fraction of the initial cost. Peloton will never be in Apple's league... And unless company leaders really screw up, Apple won't find itself busted down to Peloton's league anytime soon.
This isn't a new problem that investors just stumbled into, of course...
Value guru Ben Graham, Buffett's mentor, commented on the problem of getting too excited about lousy businesses during boom times in his classic book, The Intelligent Investor...
[T]he chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions.
The purchasers view the current good earnings as equivalent to "earnings power" and assume that prosperity is synonymous with safety... It is then, also, that common stocks of obscure companies can be floated at prices far above the tangible investment, on the strength of two or three years of excellent growth.
Never mind that "tangible investment" might not be a good metric for software businesses and other modern technology companies of today. The point is that Graham's comments – published decades ago – still apply very well to the current market.
Peloton is just one example of "losses... from the purchase of low-quality securities at times of favorable business conditions." A pandemic lockdown is the most favorable condition Peloton will ever see... And its wonderful effect on the company's business is officially over with the recent disappointing quarterly report.
Folks viewed the company's rapidly rising sales as something more than a temporary effect. Like Graham said, it made them feel like Peloton was a safe stock to own.
They were blind to the risks in Peloton for much of 2020... But the cracks started to appear earlier this year. And investors finally reached their uncle point en masse when the temporary nature of the company's growth was revealed on November 4.
With the stock market in full frenzy mode, it's a good bet that a lot of Peloton-like stocks exist today... Each one comes with its own band of naïve speculators totally unaware that they're holding one-way tickets to their uncle points.
A lot of folks in the market today have never seen a real bear market before...
And no, I'm not even talking about going all the way back to the last financial crisis.
These people came in after the brief bear market of March 2020... They've never suffered a drawdown of more than 10% (in September 2020). The most frenzied, overvalued, speculative stock market ever – including the dot-com era and the period just before the 1929 crash – has lured them all in...
This past April, brokerage firm Charles Schwab (SCHW) reported that 15% of retail investors started investing – speculating! – in 2020. And as regular Digest readers know, a lot of them came in through the Robinhood Markets (HOOD) trading app...
The pandemic bear market took place entirely in the first quarter of 2020. Robinhood's first report as a public company was through the end of the second quarter of that year... At the time, the company reported 10.2 million monthly active users – again, speculators! – and $33 billion in customer assets under custody.
At the end of the company's most recent quarter (third quarter 2021), Robinhood reported 18.9 million monthly active users and $95 billion in customer assets under custody.
In other words... in a little more than a year, Robinhood's monthly active users have risen 85% and its customer assets under custody have nearly tripled.
I could show you similar statistics from all the big online brokerage firms... Just know that a lot of new money has come into the stock market since the COVID-19 pandemic began.
Diving deeper into the stats, we can see that 61% of Robinhood's revenues are from users trading options...
We've previously reported on record call-option buying. And in last Friday's Digest, we mentioned how the options market is now the "tail" wagging the stock market "dog."
People buy call options when stocks rise... causing the call-option sellers to hedge their sales by buying more shares of stock. That entices more option buyers, which causes more hedging purchases. And in the end, share prices rise in a spiraling "gamma squeeze."
That's what all these millions of new investors throwing tens of billions of dollars around are experiencing today... They think it's normal to make "20x" returns in options and equities in just a few days on "meme stocks" like GameStop (GME) and AMC Entertainment (AMC). They think it's normal to make big, easy money quickly.
As Bank of America Merrill Lynch derivatives analyst Nitin Saksena told the Financial Times earlier this week...
All of these options-market phenomena are emblematic of a "momentum chase"... It seems there is a leveraged race for upside afoot... It's more of a "FOMO" trade than fundamentals suddenly justifying the almost absurd price action we are seeing.
"FOMO" means "fear of missing out"...
Market participants see other people getting rich, seemingly without effort, and they fear missing out on the fun. As Buffett might put it... many market participants "have recently enjoyed triumphs." And as a result, they've had any traces of rationality "[sedated] by large doses of effortless money."
It's nice to understand options market mechanics and investor motivations... But it's most important to realize that a whole new generation of investors – speculators! – simply don't understand the risks they're taking.
At Berkshire Hathaway's annual meetings, Buffett has occasionally spoken of the ability to "see around corners" when trying to understand risks...
All these new investors have never stepped around a corner and been mugged by their uncle point...
You, me, and every gray-haired investor who went through the last financial crisis, the dot-com crash, and any other market unpleasantness have seen this movie before...
We all know how ugly it can get on the other side of all this buying. We've all done battle – successfully or unsuccessfully – with our uncle points. We've all been that newbie investor who did everything wrong and lost money. We've all suffered and learned.
You must believe "this time is different" if you expect the current crop of newbies to avoid that painful learning experience indefinitely. That's simply not reality, though.
So therefore, it's reasonable to assume that all these folks who've never endured an extended run of falling stock prices, hit any uncle points, or taken any catastrophic losses are not ready to deal with any of those calamities in the coming weeks or months.
You must further assume that they'll deal with them in a Murphy's Law fashion...
Whatever they can do wrong, they will do wrong.
Little do these folks know that Murphy is always one step ahead of them... They're totally unaware that, by simply making a ton of money fast, they're already halfway to Murphy's house.
Maybe we should call him "Uncle Murphy"... Once they get a load of Murphy's wrath in their Robinhood accounts, I guarantee you they'll cry "Uncle!" at the top of their lungs and sell out in a massive panic. It's just what happens when folks can't take any more losses.
Uncle points and the avoidance of catastrophic losses are why every Stansberry Research editor or analyst guides folks to use trailing stops or some other risk-management tools as part of all their recommendations.
As I discussed in the October 1 Digest, the optimal way to make money in stocks would be to become an "emotionless cyborg"... You would simply hold your stocks for the long term and never blink through bear markets.
Unfortunately, you're highly unlikely to do that in your actively managed accounts... You're human, after all. Your emotions will always get in the way of sound decision-making.
That's why it's important to avoid uncle points at all costs – and in turn, keep them from destroying your wealth...
But as an investor, how can you do that?
First... hold at least some part of your wealth in a place that you rarely interact with.
For example, let's go back to your 401(k) account... If you already own shares of an exchange-traded fund ("ETF") that tracks the S&P 500, that's great. You should just keep contributing to it regularly and never look at it.
Keep the money there for 30 or 40 years (essentially as long as you can). That's how most folks will get the best returns... by putting their money into great companies and never looking at it for decades.
And of course, if you're not already doing that... there's no better time to start than today.
Second... always implement a well-defined exit strategy – and more important, adhere to it religiously for all the money that you actively manage.
You're most likely to speculate in those accounts... and get mugged by Uncle Murphy.
To prevent that from happening, decide when you'll get out of an investment before you get into it. All good traders and investors employ a well-defined exit strategy with every position in their portfolios. So if you don't do that, maybe this investing thing just isn't for you.
And third, yes... I continue to advise holding a truly diversified portfolio.
That includes long-term investments in well-chosen equities, plenty of cash, some gold and silver, and maybe a little bitcoin. By spreading your wealth around, you'll limit the chance of one uncle point wiping out everything you've worked so hard to build.
In the end, just knowing about uncle points will be a major step in the right direction for a lot of investors. I'm willing to bet that thousands of Digest readers have never even heard the term before – let alone devised a plan to deal with them. Now, you're on the right path.
And the good news for you is... every Stansberry Research editor knows about uncle points.
They all build protections against that type of risk into their investing strategies. That's true whether they operate with a short-term mindset... a long-term one... or somewhere in the middle. And if you learn to listen and trust us, you'll be far better off in the long run.
When it all comes down to it, our mission is to help you stay far away from Uncle Murphy.
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New 52-week highs (as of 11/11/21): AutoZone (AZO), Bunge (BG), CoreSite Realty (COR), Comfort Systems USA (FIX), Freehold Royalties (FRU.TO), Formula One Group (FWONA), W.W. Grainger (GWW), Liberty SiriusXM (LSXMA), Invesco S&P 500 BuyWrite Fund (PBP), and Seagate Technology (STX).
A couple of subscribers wrote in with their thoughts on our colleague Bill McGilton's warning about subprime lenders in yesterday's Digest. Share your thoughts, comments, and market observations with us at feedback@stansberryresearch.com. Remember, we can't provide individual investment advice... But we do read every note that we receive.
"IDIOT – 'I Didn't Incur Our Troubles.'
"If you're ever stuck in a deep hole, just keep digging. Somebody will pity you." – Paid-up subscriber Greg H.
"I always enjoy The Stansberry Digest but the story about Mr. Schricker and Ms. Parks was difficult to read and I am sorry for their plight.
"Since my first car, at 16, I have always driven used cars. I hunt down the cleanest, most well-maintained car I can find (nearly all are lease trade-ins) and pay a small premium to escape the 40% depreciation of a new car over the first 3 years.
"I make my own general repairs or pay a mechanic to do what I cannot. I keep the car for up to 9 years and then sell it to a friend or someone in need at a price that they can never find anywhere else. A good mechanic is as valuable a tool as a clean car lead from any good salesperson, and my mechanics have saved me thousands over the years. That transmission may cost you $2,500 to repair, however, it won't cost you $350 a month for seven years.
"It seems we lost this idea to repair rather than replace. We've come to accept monthly car payments as we do home mortgages; a necessary payment that we must endure. Do we need a new car or just WANT a new car?
"Had these folks thought about taking a lesser loan to repair their cars? Once their balance sheet is healthy, they can look for something newer. Inflation and interest rates are certainly a factor in deciding to purchase new, however, if you don't have 3 to 6 months of income set aside, your decision is already made.
"It's not our God-given right to own new things we know we cannot afford. If one is wealthy, borrowing can be a form of leverage if the asset has value from the start. New cars rarely fit this description, and borrowing from banks or against credit cards will only hand the leverage to the banks. I hope folks can find a good mechanic.
"Keep up the great work!" – Paid-up subscriber Eric H.
Good investing,
Dan Ferris
Eagle Point, Oregon
November 12, 2021