Party Like It's 1998... or a Post-Apocalyptic Hellscape

Party like it's 1998 – or a post-apocalyptic hellscape... The collapse of Long-Term Capital Management... From a street corner, Steve Sjuggerud called it... A lot of 1998-ness is in the air today... Why you must always get ready for tomorrow... The No. 1 rule for allocating your capital today...

I (Dan Ferris) will never forget what transpired on August 31, 1998...

It was a year or so before Porter founded Stansberry Research.

As we did most days back then, Steve, Porter, and I left our desks at our office on St. Paul Street in Baltimore around noon for lunch... We walked half a block or so up Preston Street to our usual spot, the One World Café.

Although it was a typical hot, sunny, late-summer day in the city, it was far from ordinary. As the three of us headed outside to have lunch, terror was gripping the stock market...

Over the previous six weeks, the S&P 500 had been thrown into turmoil. The benchmark index was 13% off its July 17 peak. And while we took our lunch break, the wheels were coming off... It eventually fell another 6.8% that day, wiping out its year-to-date gains.

You see, on that day, an emerging markets collapse was scaring the daylights out of investors...

Most famously, perhaps, it was causing the collapse of the Long-Term Capital Management ("LTCM") hedge fund. If you've never heard this story before, here's a basic synopsis...

LTCM had leveraged itself as much as 30 to 1 by using mathematical models to pursue roughly 100 trading strategies that involved taking as many as 7,600 different positions... Yet, as complex and highly levered as it all was, the folks behind the fund still believed their fancy math meant they were taking little, if any, risk.

And the fund hit the ground running out of the gate... Beginning in March 1994, it made 43% in its first year and 41% in its second. With two Nobel Prize winners at the helm, along with a cadre of bona fide Wall Street geniuses, investors and analysts set high expectations that the momentum would continue...

But of course, it didn't.

Without getting mired in the details, LTCM blew up in August 1998. And by the time the fund was shuttered in October of that year, it was worth less than half its March 1994 value (according to Roger Lowenstein's classic account of the episode, When Genius Failed).

That brings me back to the One World Café on the final day of August in 1998...

With other investors panicking, Steve wasn't worried at all about what was happening...

I vividly remember the moment we stood at the corner of St. Paul and Preston streets, waiting to cross. Steve matter-of-factly told Porter and I that he believed the Federal Reserve would bail LTCM out... and that the bull market still had more room to run.

It will forever be one of those "where were you when" days for me – like when the 9/11 attacks occurred or the night that Donald Trump got elected president four years ago.

That's because Steve was exactly right...

The Fed bailed out LTCM to the tune of nearly $4 billion. (August 1998 sounds a lot like the first half of 2020.) The S&P 500 bottomed the same day that we stood on the corner and Steve told us not to worry. The Nasdaq Composite Index bottomed about a month later. The S&P 500 finished the year up around 27%, while the Nasdaq ended the year up about 40%.

At its peak of 5,048 in March 2000, the Nasdaq had soared 256% above its close on August 31, 1998. The S&P 500 had risen 59% from that same date. It would retain the title of the single most overvalued moment in stock market history for nearly two decades.

Mind you, in 1998, stocks were already exorbitantly expensive – just like today...

Alan Greenspan, the Fed chairman at the time, called out the stock market's "irrational exuberance" in 1996... a full two years before that. Yet as Steve's call showed, expensive or not, stocks still had huge room to run as an epic bull market culminated in a spectacular blow-off top. (I always remind folks that valuation is absolutely not a timing mechanism.)

From the Nasdaq's peak in March 2000, it endured an epic two-and-a-half-year bear market that took the index down 77%. It didn't eclipse the March 2000 high until April 2015.

What if the COVID-19 bear market was the rough equivalent of the LTCM-induced panic?

During the COVID-19 bear market earlier this year, the Nasdaq fell about 30%. The LTCM correction in the summer and fall of 1998 featured a drop of around 30% in the Nasdaq.

So maybe we should party like it's 1998 again... Maybe we should expect another blistering "Melt Up" rally to unfold over the next 12 to 18 months before the ultimate top like in 2000.

I wouldn't bet against Steve... From the street corner in Baltimore, he nailed the 1998 setup and ensuing Melt Up. And now, he's betting that the same setup is in place again today.

Only time will tell if Steve will be right again. As I said, if I were you, I wouldn't place any wagers against it. But I wouldn't be doing my due diligence for you, my Digest readers, if I didn't share a couple of little problems that I see with this 1998 idea, in particular, and the more general idea that past episodes can help you understand present ones...

First, folks have said the same thing about 1998 many times over the past few years...

Bloomberg said it last November. Barron's said it last September. A contributor on financial website Investopedia said it about a year ago. A Wells Fargo analyst said it as far back as September 2015... as did another analyst with Zacks Investment Management.

Who knew there was so much 1998-ness floating around?

And of course, the story is much the same today... Plenty of people want to tell you how the current situation is or isn't just like the Great Depression – including the Atlantic, economist Nouriel Roubini, Harvard Business Review, CNN, and National Public Radio.

Yes, I've said that studying the era from the Great Depression to World War II would be helpful...

But I've also made it clear that I'm not predicting a repeat of that episode. I believe that it's worth studying that era for useful insights, no matter how the next several years play out.

I'm only human, of course...

If a Great Depression 2.0 happens, followed by World War III, I'm going to say, "Told ya!" while reloading my weapons and putting that black stuff on my face like Rambo (who is a personal friend of mine).

Perhaps the biggest lesson today for you, dear reader, is to remember at all times that comparing current events to the past is a dependable source of stories for storytellers.

But don't be too hard on the storytellers (said the storyteller)... They're only human, and there's a deeper issue here – an issue with the value of studying history at all.

In his must-read book, Antifragile, author Nassim Taleb calls it the "Lucretius problem." He named it "after the Latin poetic philosopher who wrote that the fool believes that the tallest mountain in the world will be equal to the tallest one he has observed."

Likewise, Taleb describes risk-management professionals who "stress test" their portfolios...

[Using] the worst historical recession, the worst war, the worst historical move in interest rates, or the worst point in unemployment as an exact estimate for the worst future outcome. But they never notice the following inconsistency: this so-called worst-case event, when it happened, exceeded the worst case at the time.

From now on, whenever you hear someone refer to "100-year floods" as meaningful limits for future expectations, you'll know it's a foolish notion. That's because the last 100-year flood proved that the one before it was not a meaningful limit on future flood levels.

What we can learn from history is limited...

Shane Parrish of the popular Farnam Street website said, "Our documented history can blind us." It can blind us to the potential range of outcomes that lies ahead.

And since range of outcomes equals risk, the markets are riskier than we can imagine.

"OK, Dan, wow... so you want me to study history. But studying history can blind me, perhaps as much as – or more than – it prepares me? Does that about cover it?"

Sort of... but not quite.

For example, I'd certainly hate to see you jump to conclusions at this point and resign yourself to the opposite end of the spectrum. That's something that we can see represented by an exchange in Cormac McCarthy's 2006 post-apocalyptic novel, The Road...

"You knew it was coming?"

"Yeah. This or something like it. I always believed in it."

"Did you try to get ready for it?"

"No. What would you do?"

"I don't know."

"People were always getting ready for tomorrow. I didn't believe in that. Tomorrow wasn't getting ready for them. It didn't even know they were there."

"I guess not."

Don't go there... You can and should believe in getting ready for tomorrow.

I'd like to believe that even if I were living in McCarthy's ash-covered hellscape, I'd still say that. As late physicist and author Stephen Hawking once said, "While there's life, there is hope."

But at the same time, there's wisdom in understanding that the future isn't getting ready for you and doesn't even know you're there.

In fact... the impossibility of knowing the future is why you must prepare for it.

Though I don't know if today is more like 1929, 1998, or any other date...

I remain confident that studying history will help you navigate the present and future. I can't imagine not studying history at all. That can't possibly be the wisest course of action.

Given the Lucretius problem, the wisest men have always known that the only worst-case scenarios you need to worry about are the ones that are worse than anything in the past.

The good news for investors is that you can study the period from 1929 to 1945, 1998, and any other period... imagine something worse (or better)... and still build a portfolio with excellent odds of seeing you through the future with better-than-average performance.

I feel like I've spent my entire career preparing for the current moment...

It's why I continue to harp on maintaining a simple four-asset portfolio as the backbone of a truly diversified investment position. As I've said before, I believe you should own...

1. Stocks purchased at discounts to intrinsic value

2. Gold and silver bullion (or proxies, like publicly traded trusts we've covered in my Extreme Value newsletter)

3. A sizeable cash position (somewhere around 20% to 25%)

4. A little bitcoin (just 1% could have a huge positive effect, with tiny downside exposure)

That isn't intended as an exhaustive list, either.

Some folks like to buy fine wine and art as a store of value. They're both fairly portable... and well-chosen wine and art can hold – and even grow – its value over time. Neither is my cup of tea financially, though I enjoy both as a consumer.

Real estate is another category you might want to explore... I've heard of land that was seized by enemy combatants during wartime, but due to long-held systems of land entitlement, it was eventually returned to the rightful owner after the war ended.

Yes, I'm still personally buying stocks today – and recommending that my subscribers do, too...

In the July issue of Extreme Value (which just hit inboxes about an hour ago), we identified a company that bears attractive similarity to my No. 1 recommendation of all time. That stock is up about 48% since the company tweaked its capital structure a little bit in May... and 12% in the past two weeks after the company changed how its shares trade.

Our newest recommendation made the same change in February. It also has a similarly brilliant management team made up of disciplined capital allocators (a must-have right now) and is looking at a massive opportunity in its industry that could generate multibagger returns for the subscribers over the next several years.

My point is, you can still find good values in a volatile market... and not knowing what the future holds. But that's also exactly why you must always diversify your assets.

I see prudent investors of all types preaching increased diversification today...

My friend and author Vitaliy Katsenelson is a classic, bottom-up, fundamental-focused, value investor. And he called me up last fall... to talk about ways to buy gold. This is the same guy who used to treat my desire to own gold as if it were a character flaw (like many diehard value investors).

Likewise, my friend and macro investor Cullen Roche told me earlier this week on the Stansberry Investor Hour podcast that the stock and bond markets right now "look about as bleak as I can ever remember."

Wow. But his solution, as you may have already guessed, is simple...

Diversification, which he nuances with this sage observation, "Patience is the ultimate diversifier. It is the thing that differentiates good investors from bad investors."

Famous hedge-fund mogul Ray Dalio has been studying the economic history of the past 500 years. And he's also preaching diversification today. As he explained in his online series, The Changing World Order, last year (emphasis added)...

Please keep in mind that even with all of this, I have been wrong more times than I can remember, which is why I value diversification of my bets above all else. So, whenever I provide you with what I think, as I'm doing in this study, please realize that I'm just doing the best I can to openly convey to you my thinking.

If you think that diversification is the last refuge of a scared investor, you're probably right in a way...

But the folks I've named are no slouches. They're some of the smartest and most successful investors I know and follow. And while our styles may differ, we've all studied some history and looked at the present from our different perspectives and arrived at the same place...

Right or not, many folks say the No. 1 rule in real estate is "location, location, location." And in the same vein, your No. 1 rule for allocating your hard-earned capital today is simple...

Diversify, diversify, diversify.

Now, um, one small thing... If McCarthy's The Road does come true, with every city on earth incinerated and food so scarce that people are eating others, diversification probably can't help you. (Maybe keep a bottle of hot sauce on you at all times... just in case.)

Have a great weekend.

New 52-week highs (as of 7/9/20): Amazon (AMZN), Alibaba (BABA), DB Gold Double Long ETN (DGP), DocuSign (DOCU), Electronic Arts (EA), Emergent BioSolutions (EBS), New Oriental Education & Technology (EDU), Equinox Gold (EQX), Fidelity Select Medical Technology and Devices Portfolio (FSMEX), JD.com (JD), KraneShares Bosera MSCI China A Fund (KBA), KraneShares MSCI All China Health Care Index Fund (KURE), MAG Silver (MAG), MarketAxess (MKTX), Microsoft (MSFT), NetEase (NTES), ResMed (RMD), Rollins (ROL), ProShares Ultra Technology Fund (ROM), Seabridge Gold (SA), Global X Silver Miners Fund (SIL), Spotify Technology (SPOT), Silvercorp Metals (SVM), The Trade Desk (TTD), and Take-Two Interactive Software (TTWO).

In today's mailbag, feedback on yesterday's Digest featuring The Gong Show and Kim Iskyan's take on the developments in Russia. Are you confident that you're properly diversified today? Tell us your story at feedback@stansberryresearch.com.

"I loved the piece written by Kim Iskyan on Putin and Russia in today's Digest. So, so true and very enlightening... Fortunately for us Americans, it is very unlikely that would occur in the US, at least I pray it doesn't. Thank you, Kim." – Stansberry Alliance member Al V.

"Corey, I can't believe you left out the Unknown Comic." – Paid-up subscriber Richard B.

Corey McLaughlin comment: My sincere apologies. Here he is.

Good investing,

Dan Ferris
Vancouver, Washington
July 10, 2020

P.S. As I said earlier, I'm still personally buying stocks and recommending that my Extreme Value subscribers buy them. They're a big part of preparing for the unknowable future...

In the July issue of Extreme Value (published today), we've found a company that bears attractive similarity to my No. 1 recommendation... which is up about 48% since its brilliant management team made changes that have put it on the radar of big institutional investors.

Our new recommendation made that same change, attracting those same big institutions. And in the next several years, we believe this high-quality business could triple your money... and it's highly unlikely to lose you any.

Remember, Extreme Value is for long-term investors only. Others need not apply. But if you think you've got what it takes to become a subscriber, you can learn more right here. (And right now, you can sign up at the absolute lowest price we've offered in years.)