The Perfect Wealth-Building Plan for When the 'Pendulum' Swings

The 'most important Digest' of 2020 lives up to the hype... Prepare for the next big swing in investor psychology... Exploit the opportunity with these stocks... The best friend of a 'wonderful' business... The perfect wealth-building plan for when the 'pendulum' swings...

Last January, I (Mike Barrett) published 'the most important Digest I'll probably write this year'...

The essay – which ran on January 2, 2020 – detailed three ominous parallels with the late 1920s. A century ago, they conspired to turn what should have been an ordinary, run-of-the-mill recession into something so awful that it lives on in infamy...

The Great Depression.

After running through the "warnings" in last year's essay, I came to a pivotal takeaway for readers. Here's how I summarized the situation in that Digest...

No one knows when the next economic crisis will erupt of course. But if it happens while the three conditions just detailed are present – a global economy susceptible to contagion, persistent commodity overproduction, and a false sense of security – there's a good chance recession will last far longer, and be much more painful, than most can imagine.

The essay certainly lived up to the hype...

As it turns out, the next economic crisis was just a few weeks away. All three conditions were very much present. And it was indeed much more painful than anyone could imagine...

The benchmark S&P 500 Index peaked at 3,378 on February 19, 2020. Just a month later – on March 23, 2020 – it had plunged all the way down to 2,237... a roughly 34% drop.

Admittedly (and fortunately), it didn't "last far longer... than most can imagine" – at least not yet.

As regular Digest readers know, the Federal Reserve stormed in to try to save the day as the COVID-19 pandemic wreaked havoc... The central bank slashed interest rates to zero, and to this day, it still plans to do whatever it takes to keep the U.S. economy going.

Here's the deal, though... The Fed can't save the day forever.

As I'll explain in today's Digest, the "pendulum" will swing back to fear at some point. When it does, you want to be fully prepared for what's coming. The good news is, with the ideas I'll share with you below, you'll be well ahead of 99% of investors when disaster strikes...

But first, let's journey back to last year's panic – so we can see just how much has changed...

In the Digest on January 22, 2020, my colleague Corey McLaughlin wrote about COVID-19 for the first time. Back then, it was known as the "Wuhan virus" – nicknamed for the city where it supposedly originated in China. And at the time, just 17 people had died.

Before long, the virus spread to dozens of countries worldwide. And it quickly triggered "economic contagion" – one of my three warning signs – everywhere... Businesses were forced to close, abruptly sending tens of millions into unemployment across the globe.

Then, with essentially the entire world sheltering in place, years of energy overproduction turned disastrous – another warning sign. Oil prices crashed, even turning negative.

This powerful one-two punch shook investors from their false sense of security after a decadelong bull market in stocks... Many folks unloaded their positions indiscriminately, desperate to get out of stocks at any price. The sell-off was so violent that it brought comparisons with the one that touched off the Great Depression about a century earlier.

Armed with today's hindsight, I'm reminded of an old lesson from investing legend Howard Marks...

Marks likes to say that the "pendulum of investor psychology" careens from one extreme to the other. In the real world, investor psychology spends very little time in the middle.

The seven-week period starting in late January 2020 is one of the best examples you'll ever find. It started in euphoria and ended in panic as the COVID-19 pandemic became a reality.

Below, you'll see some excerpts from my daily sentiment diary, sourced from our friend Jason Goepfert's SentimenTrader.com. You can see exactly when the pendulum swung...

January 23, 2020: Stocks have one of the best 3-month returns ever, dating back to 1928

February 5, 2020: Cash hits the 2nd lowest level in 40 years, signaling major complacency

February 13, 2020: S&P 500 hits 36 all-time highs in 4 months; 5th most since 1928

February 19, 2020: Confidence in stocks has never been higher

February 24, 2020: Dow Jones Industrial Average dives 1,000 points on pandemic fears

February 25, 2020: Most lopsided selling pressure in 60 years

March 5, 2020: Risk appetite the lowest it can go

March 9, 2020: Worst day for the energy sector since 1926

March 12, 2020: Pure, unbridled panic

We all know what happened next...

In addition to the Fed's rescue efforts, central banks around the world slashed interest rates and unleashed colossal stimulus programs to support financial markets. And then, on cue, the stock market roared back to life... It has been on fire ever since, even hitting new highs.

Importantly, just 10 months after 'pure, unbridled panic,' we're back in the danger zone today...

The pendulum of investor psychology has swung completely back to the other side.

Investor sentiment has climbed back to where it was last January. It seems like everyone forgets just how fearful they were during the COVID-19 panic. To see what I mean, look at some recent entries from my sentiment diary, again using SentimenTrader.com...

December 11, 2020: The most companies since 2000 have gone public without first being profitable

December 14, 2020: 15-year high in percentage of indicators exhibiting extreme optimism

December 16, 2020: Only 32 days have been part of back-to-back losing sessions, the fewest since 1928

December 21, 2020: A multiweek or multimonth decline from here wouldn't be all that unusual

December 22, 2020: Never been more "severely overvalued" companies in the S&P 500 (i.e., P/E ratios > 30x) over the past 40 years

January 13, 2021: Massive spike in speculative activity

In short, with the stock market sporting rarely seen valuations and sentiment again hitting optimistic extremes, it's time to prepare for the next big swing in investor psychology...

At some point, the pendulum will rocket back toward extreme fear.

Back in November, I argued that the conventional '60/40' portfolio is now obsolete...

In a world of permanent near-zero interest rates, investors simply need a new playbook.

That's what my colleague Dan Ferris and I are doing with our Extreme Value service. We're following a revised plan to make sure our subscribers get the most out of their money...

1. Add exposure to stocks, but only when the risk-reward trade-off is clearly in your favor

2. Sleep well at night by holding plenty of cash

3. Own precious metals to protect your wealth from inflation

4. Own bitcoin, the world's best managed currency

5. Have a plan to manage market volatility

The last element of our new Extreme Value playbook is the most critical...

We can't know exactly when the pendulum of investor psychology will careen back to extreme fear. But it will happen at some point... Markets don't endlessly go up forever.

However, if you wait until then to put your plan together... it will be too late. You must decide now, well in advance, how you're going to exploit the next episode of extreme fear.

When you're putting your plan together, here's where I suggest you start...

Focus on companies that pay growing dividends (or those likely to in the future).

The reason is simple... Over the past five decades, these stocks have generated the highest returns – and done so with the least amount of volatility.

According to a research report from the Hartford Funds titled, "The Power of Dividends, Past, Present and Future," an initial investment of $100 in dividend growers and initiators in 1972 would have become $9,568 by 2019. But the same $100 investment in a portfolio of companies that never payed dividends turned into just $388 over the same period.

That's a remarkable difference.

Companies not currently paying dividends but likely to eventually initiate them tend to be smaller and growing fast. When they're still developing, it makes sense for these companies to deploy all of their surplus cash back into the business rather than pay a dividend.

In short, if you're a serious long-term investor, you simply can't afford to miss out on the kind of performance that dividend growers (and future initiators) generate.

As Berkshire Hathaway founder Warren Buffett told his shareholders a decade ago...

Time is the friend of the wonderful business.

With that quote in Berkshire's 2010 annual report, Buffett was talking specifically about his investment in Coca-Cola (KO). By looking at the numbers, you can see what he meant...

Between 1988 and 1994, Berkshire accumulated 400 million shares of Coca-Cola at a total cost of $1.3 billion.

In 1995, Berkshire received $88 million in Coca-Cola dividends. That works out to a dividend yield on Berkshire's original cost basis of about 7% ($88 million divided by $1.3 billion equals 6.8%).

Today, 25 years later, Berkshire still owns those 400 million shares of Coca-Cola stock. But now, they're generating $652 million of dividend income. That equates to an incredible yield of 50% on Berkshire's cost basis ($652 million divided by $1.3 billion equals 50.2%).

Think about that...

Berkshire's Coca-Cola position is now earning half of what it originally cost each year in dividends alone. Time has indeed been a friend to this well-bought, wonderful business.

This is why you want to own elite businesses that pay growing dividends...

Over time, the rising payouts greatly enhance your investment returns. And when you reinvest those dividends into additional shares, the outcome is even better...

According to the Hartford Funds' study, 78% of the S&P 500's total return over the past 50 years can be attributed to dividend reinvestment. And as the graph below makes clear, to maximize your returns, you absolutely want to reinvest dividends on long-term holdings...

Let's quickly summarize what we've covered so far...

The pendulum of investor psychology swings continuously between extreme fear and extreme greed. It's currently in extreme greed mode, and that means we must start preparing today for the inevitable swing back toward extreme fear. And when that happens, you'll want to load up on dividend growers (and businesses likely to initiate them).

Taking it a step further, you also want to make sure...

You're focusing on the rate of dividend growth.

Let's go back to Buffett and Coca-Cola to show you what I mean...

A decade ago, Buffett predicted that Berkshire would earn about $752 million in dividend income from its Coca-Cola shares in 2021. But in reality, that's about $80 million too high.

Why?

Because Coca-Cola's revenue growth has dramatically slowed since Buffett's forecast...

In 2010, the company's sales totaled $35.3 billion. But by 2019, its sales were just $2 billion higher ($37.3 billion). And over the past 12 months, the company's sales of $33.4 billion are actually lower than they were a decade ago.

With top-line growth slowing, Coca-Cola's dividend growth is slowing, too...

When Buffett made his $752 million prediction back in 2010, the company's dividend was growing at 7% per year. Now, it's growing at just 2.5% per year. That's roughly in line with the overall S&P 500's current dividend growth rate of about 3%.

Fortunately, at Extreme Value, we've found a group of 'crown jewel' stocks doing far better than that...

In October, as part of our revised plan to prepare in advance for the next wave of volatility, we separated our Extreme Value model portfolio into two buckets...

The first one includes "crown jewels" – positions we're holding indefinitely. The second bucket includes stocks we like but would part ways with if they trigger our hard stops.

And again, it's important to start planning now... before the pendulum swings back.

The S&P 500 is currently about 14% above its 200-day moving average. If the next leg down takes it back to that level, I believe you'll be able to buy nine of our 12 dividend-paying crown-jewel stocks below our maximum buy prices. (Three of the nine are currently within buy range, and two are within $1 of our recommended "buy up to" price.)

That would give you the opportunity to build a great portfolio of world-class businesses...

Their year-over-year dividend growth rates range from 6% to 15%, and the average for all nine companies is 10%. That's three times better than the S&P 500's current dividend growth rate. And keep in mind... four of these crown jewels are in the S&P 500.

As a quick aside, this perfectly illustrates why we advocate owning individual stocks rather than exchange-traded funds benchmarked to an index like the S&P 500. Why would you want to have exposure to all of the lower-yielding, slower-growing constituents... when you can simply cherry-pick the best businesses?

Now, let's see what the faster dividend growth can actually do for you...

Let's assume these crown-jewel stocks' dividends will continue to grow about seven percentage points faster than the S&P 500 (10% versus 3%)... That's a conservative estimate, given the quality of these businesses and their bright prospects.

If that happens, then in five years, this collection of crown-jewel stocks will be generating almost 40% more income than the S&P 500. A decade from now, they'll generate twice as much income.

With interest rates expected to remain near zero for years, that's a substantial return boost that you simply can't ignore today... particularly if you intend to reinvest your dividends.

Of course, we can't guarantee that these stocks will continue to grow their dividends at above-market rates. But the prospects are excellent that they will...

As a group, they're providing key products and services, consolidating fragmented industries, raising prices, and developing new products. These are the attributes of businesses that consistently grow revenue and profitability, then translate it into above-market dividend growth. That's a big part of the reason why we call them "crown jewels."

Thousands of stocks compete for your hard-earned investment capital... But in reality, a vastly smaller subset of this universe is actually worthy of it.

Through years of in-depth research, Dan and I have identified some of the best ideas available for your long-term capital. Remember, a great business isn't just one that grows... It's one that shares its rising cash flows with the rightful owners through rising dividends.

Our conviction in these "wonderful" businesses across the cycle is perhaps the greatest benefit of a subscription to Extreme Value. We break down exactly why you should buy them when most other investors are scared... then hold them indefinitely to take advantage of their growing dividends.

Consider Automatic Data Processing (ADP)...

It's a crown-jewel stock we recommended during the depths of the Great Recession in October 2008. And today, more than 12 years later, it's still in our model portfolio... though well above our maximum buy price nowadays. Subscribers who took our initial advice paid about $35 per share back in 2008. It's now trading at about $165 per share, an increase of 371%.

But when you include dividends – which compounded about 10% between 2008 and 2020 – our total return soars to an incredible 643%. And consider this... The position has now earned more dividends per share ($43.12) than it cost back in 2008 ($34.80), including the spin-off of enterprise software company CDK.

This is exactly how you build long-term wealth in the stock market.

A year ago, I wrote what proved to be my most important Digest of 2020. And while I can't know what the future holds, I hope you'll take the advice I'm sharing in my first Digest of 2021... This lesson will turn out to be even more important for your long-term wealth.

And when the pendulum swings back to extreme fear, you'll be prepared better than most.

Plus, we've just uncovered the latest worthy addition to our crown-jewel bucket...

In the January issue of Extreme Value, we introduced subscribers to a mid-cap stock poised to exploit not one... not two... but three big infrastructure-related growth opportunities.

The fact that this company has accumulated the necessary expertise, national presence, and scale to capitalize on all three simultaneously speaks volumes about its special status. And even though it doesn't currently pay a dividend, that's OK with us... Shareholders are better served by the company investing any free cash flow back into growing the business.

The company's stock price surged last week, once it became clear that the Democrats would control the White House as well as both houses of Congress. And it has been bouncing around within a dollar or two of our maximum buy price since then.

This political shift in Congress means President-elect Joe Biden's plan to make a $2 trillion accelerated investment in the U.S. economy is more likely than ever. The good news for Extreme Value subscribers is that there's absolutely no doubt our latest recommendation will be one of the big beneficiaries of that spending surge, if and when it materializes.

Like I said, you still have the opportunity to get in below our buy-up-to price today...

And we estimate this company's "intrinsic value" – the highest expected price a knowledgeable buyer would pay for the entire business – at about $114 per share. That's about 45% higher than the current share price.

If you're not already an Extreme Value subscriber, you won't find a better time to join than right now. You can get a one-year subscription at the lowest price we've ever offered. Get started right here. (Current subscribers can find this latest research right here.)

New 52-week highs (as of 1/13/21): AbbVie (ABBV), ARK Fintech Innovation Fund (ARKF), Asana (ASAN), Bunge (BG), Berkshire Hathaway (BRK-B), Cerner (CERN), Cresco Labs (CRLBF), Curaleaf (CURLF), Green Thumb Industries (GTBIF), Harrow Health (HROW), JPMorgan Chase (JPM), Jushi (JUSHF), KraneShares CICC China Leaders 100 Index Fund (KFYP), ETFMG Alternative Harvest Fund (MJ), Sea Limited (SE), Trulieve Cannabis (TCNNF), TerrAscend (TRSSF), Travelers (TRV), ProShares Ultra Semiconductors Fund (USD), and ProShares Ultra FTSE China 50 Fund (XPP).

In today's mailbag, feedback on yesterday's Digest about the need for tougher cybersecurity. What's on your mind? As always, you can e-mail us at feedback@stansberryresearch.com.

"Since the pandemic hit, there have been a dozen or more states unemployment divisions that have been hit hard with fraudulent unemployment claims. A fraudulent claim was just filed on my Social Security number along with numerous other employees of our company...

"We use a subsidiary of Equifax to handle all of our unemployment claims and the state of Colorado recently told them that 90% of all current unemployment claims being filed have deemed to be fraudulent. They also released a report indicating that the fraudsters were filing on people with higher incomes and full unemployment benefits available.

"I've confirmed with Equifax that my Social Security number was not a part of the major 2017 data breach. Based upon that and the volume of fraudulent claims I can only assume that the State of Colorado's Department of Labor and Employment database was hacked. How else would they know who had benefits available and the benefit amounts? In fact, the state of Oklahoma indicated that their department of labor database was hacked and breached and they are experiencing the same high volume of fraudulent unemployment claims.

"All of these attacks are real. Thanks for the article." – Paid-up subscriber Rick R.

Regards,

Mike Barrett
Orlando, Florida
January 14, 2021