Investors Are Getting Worried (Again)

Investors are getting worried (again)... A timely reminder on portfolio 'insurance'... Sjug: This sector will lead the market higher... The 'Melt Up Millionaire' portfolio is closing forever...

The stock market's 'fear gauge' is moving higher again...

This morning, the CBOE Volatility Index ("VIX") jumped back above 20 – a level generally considered to separate market "complacency" from "fear" – for the third time this year. Prior to February's 10% market decline, the VIX had gone an unprecedented 15 months without breaching this level.

Regular Digest readers know we aren't surprised. We continue to believe the broad market could test its February lows in the coming weeks. In fact, wouldn't be surprised to see even lower lows before this correction finally ends, and the "Melt Up" resumes (more on that in a moment).

But remember... We expect significantly higher volatility no matter what comes next. If the recent market declines have been keeping you up at night, you're likely taking too much risk.

'What one of the scariest days of my career taught me'...

In the latest issue of Stansberry Portfolio Solutions – published earlier this month – portfolio manager Austin Root explained why even professional investors can benefit from a little portfolio "insurance" today.

If you're not familiar, Austin joined our team about six months ago... and his resume is impeccable. Prior to joining Stansberry Research, Austin was a partner and portfolio manager at investment adviser D.F. Dent. Prior to that, he co-founded and ran a successful hedge fund – North Oak Capital – with a strategic investment from legendary investment firm Tiger Management. And before that, he held senior investment positions at some of the best-known Wall Street firms, including Steve Cohen's SAC Capital Advisors.

And as he explained, he can pinpoint the precise day he learned the real value of proper portfolio protection: May 6, 2010. Here's Austin...

I was standing in the Columbia, Maryland, showroom of hhgregg, the now-defunct electronics and appliance superstore.

I wasn't looking to buy a new washing machine. I was checking out an investment. You see, hhgregg was a public company in the midst of a large market expansion. The retailer's hard-charging CEO had invited some investors to tour one of his new showrooms with him and other members of senior management.

I jumped at the chance to join. This level of access to management was not always easy to attain. Especially for a hedge-fund manager who was short the stock... like I was.

I was in my second year of running a hedge fund in New York. Our firm was relatively small at the time. But we had strategic investments and financial backing from some of the most legendary investors on Wall Street.

But I couldn't know as I pulled into the hhgregg parking lot... I was about to walk into one of the scariest days of my career...

As Austin explained, hhgregg CEO Dennis May met him and small group of investors on the store's showroom floor in "full-on salesman mode"...

He showed how shopper-friendly his stores were. He expounded on the benefits of his higher-paid, knowledgeable employee base. He provided invaluable details about hhgregg's generous credit programs for customers who needed help funding a big purchase. (Yikes!)

He even played down the risk from Amazon's continued push into the electronics and appliance categories. He seemed completely unfazed that we were standing in a store that just a few months earlier had been home to a Circuit City, an electronics retailer that went bankrupt in the face of heightened competition from Amazon.

Austin felt confident about his short position as the CEO directed the group to the store's 'crown jewels'...

This was its huge wall of high-definition televisions, including its newest ones that could display video in 3-D. But that's when his day suddenly took a turn for the worse...

Beyond the 3-D set he was touting, a wall of other big screens happened to be tuned into CNBC. And the headline running across the screens in bold letters read: "Dow DOWN 1,000 Points."

I was floored. I was watching the now-infamous Flash Crash on hhgregg's showroom floor.

I'd never seen the market hit an air pocket like that. Who had? That was the second-worst intraday drop in the Dow's history... almost as bad as the 1018.77-point fall that kicked off the Great Recession in 2008. But the Flash Crash had happened more quickly. About 600 points of that fall happened in less than five minutes.

Now, Austin admits he was supposed to be prepared for an event like this...

But on this day – stuck in a shopping center in suburban Maryland, hundreds of miles from his trading desk – he began to question if he actually was. As he explained...

I immediately called in to my office. I reached my fund's partner and co-founder. My fears were confirmed: Some of our long investments were getting decimated. The stocks of some world-class companies were down more than 15% in less than 10 minutes.

But... as we walked through the rest of our investments, the damage to the overall portfolio wasn't nearly as bad as the wreckage being described on CNBC. We were down, but nowhere close to the declines of the broader market. Why?

In short, we were prepared... more prepared than, perhaps, even I appreciated before my visit to hhgregg.

Austin's fund held plenty of portfolio protection, mostly in the form of short sales on stocks like hhgregg...

This didn't just buffer his losses during that day's big market decline. It also allowed him to stay calm, and take advantage of that volatility while others panicked...

Knowing I was somewhat safeguarded to the downside, I went into attack mode. To borrow Warren Buffett's quote, we were "greedy when others were fearful" and increased our holdings in a few of our favorite longs that were deeply "on sale" – only the names where we had the greatest conviction and only because we had previously invested in portfolio protection. And almost as quickly as it dropped, the market came roaring back...

But here's the thing... If I'm being honest with myself, the Flash Crash was one of the few days that I was truly happy to have been invested in such protection. On most trading days, the large potential losses that such "insurance" would help reduce were discounted in my mind... such losses could never really happen to my portfolio. Instead, like most investors, I was often frustrated by the drag they created on my portfolio, muting the gains I would otherwise enjoy during a bull market.

That's why it's important to remember days like the Flash Crash. Because those days are always around the corner. And that's when insurance serves its purpose – big time.

So how should you put this information to use for yourself?

As is often the case in investing, the answer is, "It depends." That's because insurance can take many forms... and mean different things to different investors. It can mean allocating some of your portfolio to precious metals and other hard assets... selling short shares of overvalued stocks... or investing "higher up in the capital structure" of a company, meaning buying its secured debt, rather than its stock. More from Austin...

And portfolio protection can mean simply investing more of your capital in value-oriented securities rather than in growth-oriented ones. Perhaps these value-oriented stocks pay more income. Or perhaps they trade at a much lower multiple to earnings, replacement value of assets, or book value. In this sense, these value names have a higher "margin of safety" and therefore should not drop as much as the overall market in a downturn.

In short, regardless of how you do it, be sure to hold some portfolio protection today. It won't just protect you against unexpected market declines... It will also help assure you have the peace of mind – and extra capital – necessary to take advantage of the opportunities that often come with them.

If our colleague Steve Sjuggerud is correct, we could have one such opportunity right now...

He notes the recent correction has created a rare extreme. It suggests that the "Melt Up" is set to resume, and one sector in particular could lead the next leg higher. As he explained in our free DailyWealth e-letter last week...

The Nasdaq 100 Index is historically THE major tech-stock index. It holds 100 of the largest companies listed on the Nasdaq stock exchange. The Nasdaq's top seven holdings are the largest tech stocks – like Apple (AAPL), Microsoft (MSFT), and Amazon (AMZN) – which make up nearly 50% of the index.

The important news is, traders gave up on the Nasdaq 100 Index after the recent correction. That's based on the Commitment of Traders (COT) report. The COT report is a "real money" indicator. It tells us what futures traders are doing with actual dollars.

As longtime readers know, it's a fantastic contrarian tool. You see, when futures traders are all making their bets in one direction, the opposite tends to occur. As contrarians, we want to bet against the crowd.

And right now, Steve says "the crowd" is more bearish on tech stocks than it has been in years. More from that issue...

Take a look...

When the line on the chart is rising, futures traders are bullish on the tech-heavy Nasdaq 100. The opposite is also true: When it's falling, futures traders are bearish.

As you can see, the COT report shows we recently hit a multiyear low.

In other words, the recent correction caused tech-stock traders to panic...

And as Steve explained, the last four times traders were this fearful were great times to buy...

Take a look at what the Nasdaq 100 did after these extreme levels...

It's been a bull market for the past nine years... But these are fantastic results even considering that.

The Nasdaq 100 has jumped an average of 23% in a year after similar hated extremes. History is clear: We really want to own tech stocks now.

As the Melt Up continues, I believe a similar result isn't just possible... it's likely. If you're thinking about adding tech stocks to your portfolio, this signal suggests that now is the right time to pull the trigger.

History says large tech stocks could do incredibly well as the Melt Up resumes...

But Steve has hand-picked a small portfolio of stocks – what he's called his "Melt Up Millionaire" portfolio – that he expects will do much, much better.

In fact, he's so sure these stocks will outperform that he's willing to guarantee this portfolio produces a gain of at least 50% in the next six months, or he'll work for you for free for an entire year.

This is an unheard-of guarantee... But if you're interested, you must let him know immediately. Steve will be closing his Melt Up Millionaire portfolio to new subscribers tomorrow night at midnight Eastern time... and he will not be opening this ever again at any price. Click here to learn more now.

New 52-week highs (as of 3/16/18): MarketAxess (MKTX) and Verisign (VRSN).

A quiet weekend in the mailbag. What's on your mind? Let us know at feedback@stansberryresearch.com.

Regards,

Justin Brill
Baltimore, Maryland
March 19, 2018