Start Building a True 'All Weather' Portfolio Today... Before the Storm Arrives
Editor's note: The good times keep rolling...
After a rough ending to the previous year, stocks rocketed higher in 2019. The S&P 500 went nearly straight up in the fourth quarter, wrapping up the index's best performance since 2013. And our Stansberry Portfolio Solutions products exceeded expectations, too.
But just because everything looks sunny today, we can't expect to be storm-free forever...
Today's Masters Series essay is adapted from the May 22, 2019 and May 23, 2019 editions of our free DailyWealth e-letter. In it, Stansberry Portfolio Solutions portfolio manager Austin Root explains what you must do now to start preparing for the market's next downturn...
Start Building a True 'All Weather' Portfolio Today... Before the Storm Arrives
Will you make sure to bring your "umbrella"?
As we kick off 2020, I hope you do. Because I fear many investors will not...
In their eyes, the sky is too clear and sunny now to worry about rain. "Why lug around something I probably won't need?" they reason.
It's time to debunk such a carefree notion. I want to make sure that you pack your umbrella for the storm ahead... and maybe even help convince some of your friends and family to pack theirs, too.
Let's be clear – I don't expect a major correction right around the corner. But the storm clouds are gathering. They'll get here sooner or later. And the time to prepare is now.
In this essay, I'll show you why. But before I get there, we must start with two ways you can act now to reduce risk in your portfolio. These two steps will help protect you before the crisis – and they can even help you make money in the face of much lower prices.
So just what kind of "umbrella" am I talking about?
It starts with portfolio protection. Last May, I wrote a Digest Masters Series essay about the benefits of investing in portfolio protection such as gold and other hard assets that retain their value well.
For the sake of your long-term wealth, you must allocate part of your capital base to measures that will help protect the whole in the event of a sharp market downturn.
That isn't everything, though. To set up an all-inclusive investing umbrella that can preserve and grow your wealth, you'll need two more forms of protection...
The first is reducing your exposure to any one "factor risk."
That term is all the rage among institutional investors these days. In short, it means identifying potential risk exposures in a portfolio and then working to reduce those threats through diversification.
In theory, it's a great exercise. But in practice, most institutional investors take things too far and end up owning too many small positions... In diversifying away potential risks, they also diversify away any chance at outsized returns.
Individual investors can make the same mistake. The answer is to strike a balance... and make sure you don't place too much weight in any one bet, whether individually or in specific sectors and markets.
The second protection tool is occasionally holding more cash and "cash-like" securities.
One of the most important factors in determining how successful you can be during a bear market is simply how much cash you have on hand. This will keep you from being forced to sell good assets at bad prices because you have no safety net... And once markets stabilize, you'll be in a better position to go bargain-hunting if you have plenty of "dry powder."
When a bear market is upon us, you'll want to hold a much larger cash reserve. Of course, sitting in too much cash for too long mutes your returns... So it's important that you "tilt" your allocations further into cash rather than sell everything. And it also pays to wait until market conditions are primed for a major fall.
All this amounts to a simple change in strategy... But sadly, many investors simply won't take action in time.
Think back to 2008...
Wouldn't it have been great – even life-changing – to avoid much of the massive market sell-off? And then, with your net worth mostly intact, to buy world-class businesses like Disney (DIS) or Amazon (AMZN) at 50% discounts to intrinsic value or more... while the rest of the world was in forced-selling or panic-selling mode?
That's how I want you to be positioned ahead of the next inevitable downturn...
With your asset base protected, you'll be able to think clearly, "play offense," and buy great businesses at deep discounts... while other investors are reeling.
There's just no way your portfolio can be "all weather" without the financial equivalent of an umbrella. You must have one handy to protect your family's hard-earned wealth.
Even more important, you must have one before a storm hits because downpours can come on more quickly than you might think... And once you and your portfolio are drenched, it's already too late to take productive action.
That's why the time to prepare is right now – before the trouble starts...
Why all this talk of protection when we're doing so well?
Despite some turbulence in the markets, stocks ripped higher in 2019. The benchmark S&P 500 Index finished nearly 30% higher than where it started, good enough for its best yearly performance since 2013. And so far this year, the fresh all-time highs have continued.
So what's the problem?
Put simply, there is too much debt, monetary stimulus, and fiscal stimulus artificially boosting economic growth and propping up an aging bull market. Let's run through these one by one...
First, asset prices have gorged on huge amounts of monetary stimulus from the Federal Reserve. Fed policy has led to lower interest rates on U.S. Treasury securities. That forces savers and investors seeking yield into riskier assets (like stocks).
And after a brief stint of raising rates, the Fed resumed lowering rates again. Stocks soared on the news.
Not to be outdone, fiscal stimulus from the Trump regime is also pumping up asset prices. The U.S. government is aggressively spending more than it earns... And it registered another trillion-dollar deficit in 2019. This kind of massive spending has historically been reserved for recessionary periods. The stock market is up more than 50% since Trump won the 2016 presidential election.
Meanwhile, there's more debt sloshing around the financial system than ever before. The U.S. government owes more debt than ever (as do governments in aggregate globally)...
Corporate America is also more levered than ever...
While banks have prudently increased their capital reserves, every other major part of the economy has levered up materially. And rather than reinvesting in growing their businesses, corporations spent much of this new debt on share buybacks. Yet again, stocks have already enjoyed the benefit of this spending.
Consumers are also more indebted than ever. Home-related debts have not yet reached new highs. But all other major categories – such as auto, credit card, and student debts – have ballooned more than enough to make up for it.
Finally, even investors are more levered than ever. The amount of margin debt is near an all-time high. Investors are borrowing record amounts of cash to put into their portfolios in a greedy thirst for higher returns.
There is entirely too much debt sloshing around the system. This won't end well.
Still, as scary as that list is, I have been guardedly positive on the short- to medium-term outlook for U.S. markets for one key reason: growth. As long as America keeps growing, asset prices can move higher and the financial train will stay on the tracks. And the White House and the Fed are both laser-focused on keeping the economic growth engines running.
But I'm becoming more concerned because... growth is already slowing.
Since peaking in the third quarter of 2018 at 3.1%, U.S. GDP growth has been dropping... The most recent data for the third quarter of 2019 registered just barely 2% growth.
So we're still growing, but at a slower rate... Where does that leave us?
Well, I believe now is the time to start pulling back a little bit on the investment throttle.
To be clear, you still want to be invested in stocks. In particular, you want to lean on world-class businesses with enduring franchises and attractive returns on investment. But this is not the time to solely own those stocks.
Downshift your risk a bit. Think about trimming some of your most aggressive investments. Tilt your allocation toward safer, sturdier assets. Own some gold. Begin to raise some cash and cash-like securities (like short-term U.S. Treasury bills).
In short, keep owning those blue-chip "forever" stocks... But from here, don't go anywhere without bringing along that umbrella.
Good investing,
Austin Root
Editor's note: After two decades in this business, we've learned a scary truth... Many folks don't start to prepare for the next downturn until it's too late. Although the longest bull market in history might seem endless, things will eventually take a turn for the worst...
That's why Austin believes you must get your umbrella ready now – before it's too late. And it's a big part of the reason why he joined Stansberry Research founder Porter Stansberry, Dr. Steve Sjuggerud, and Dr. David "Doc" Eifrig for an urgent live briefing earlier this week.
During the event, Porter shared his latest thoughts on the stock market and gold... Doc revealed his No. 1 stock idea... and everyone congratulated Steve. For the next few days, you can see everything that went down at this roundtable discussion. Get started right here.