This idea is far more important than any single stock pick... Could you tolerate a 74% loss?... The most important kind of diversification... The safest stocks you can buy...
Porter note: I believe that Stansberry Research is a formidable and valuable resource for investors who are interested in managing their own investments. I'm proud of our research and the quality of the analysts I've been able to recruit and retain.
When it comes to independent financial research, I don't know of any firm anywhere in the world that puts out products that match ours when it comes to thoroughness, insight, or value. The proof of this value and the genuine quality of our work shows up year after year in our careful evaluation of our track records and, of course, in the tens of thousands of Alliance members who continue to use our work as we enter our 20th year in business.
But no matter how much I trust our products and admire our analysts, I would advise every single subscriber of Stansberry Research to hire a money manager...
Investing successfully is extremely time-consuming work, and it can be emotionally challenging – even confounding. At every turn, your most basic human instincts will prevail upon you to do the very worst thing, at the very worst time.
That is how extremes in markets are made. Fighting those emotions – successfully – is how great investors can far outpace the market's average returns.
Unfortunately, I know that most of our subscribers won't be able to do that. It's not that they won't have the right information... It's that they won't be organized or disciplined enough to put those strategies into action effectively.
That's the difference between ideas about investing and the reality of being an investor.
Erez Kalir, as many readers may recall, is an old friend of mine. He is a Stanford and Yale graduate, was a Rhodes Scholar, and has been in the hedge-fund business for many years as both an analyst for some of the biggest fund groups in the world and as a principal manager of his own funds. Erez is a highly experienced investor who worked in one of the toughest and most competitive arenas of all, Tiger Management.
Today, Erez and his firm – Stansberry Asset Management ("SAM") – use the investment research from Stansberry Research and employ our basic investment strategies.
I want to provide you with the opportunity to hire an investor who will guide your assets using our research to manage what I believe is the single most important challenge you face – managing your assets in a world of wild volatility, technological upheaval, growing social unrest, and incredibly unstable currency values.
I am happy to welcome Erez for today's Digest, where he will show us the importance of a time-diversified mix of long- and short-term investments.
Erez, the floor is yours...
We're now more than a decade into the great bull market that began in March 2009...
And while we can't know exactly how long the good times will last, I (Erez Kalir) think most investors realize that we're closer to the end of this bull market than the beginning.
As the saying goes, "Everyone is entitled to his own opinion, but not to his own facts." And right now, the facts tell us that U.S. stocks are more expensive than they've been at almost any time in history.
Legendary investor Warren Buffett's favorite stock market gauge is the ratio of a country's total stock market capitalization to the overall GDP of the country. When the so-called "Buffett Indicator" is less than 50%, it's too low. It's about right when it's between 75% and 90%. And a market is relatively overvalued when it's more than 115%.
In the U.S., the Buffett Indicator is now more than 140% – the second-highest in history, behind only the twilight of the dot-com era in early 2000. Any number of other valuation measures tell a similar story. With stocks so expensive today, what should investors do?
Porter and his team offered an answer earlier this month when they unveiled The Defensive Portfolio...
This portfolio – the newest Stansberry Portfolio Solutions product – uses six specific strategies to create the kind of resilience investors will want when the next bear market arrives.
At Stansberry Asset Management ("SAM"), we've already been using all six strategies to guide our "All-Weather Portfolio" for several years. The All-Weather strategy is designed for investors seeking a portfolio with less correlation to the stock market that aims to produce gains through the full investment cycle. This type of strategy can be particularly useful during steep market declines like the one last December, when the market plunged more than 15% in just a few weeks.
Sharp market declines like that can be difficult for investors to navigate if they don't already have a defensive strategy in place. To show you the impact of a defensive strategy...
During the benchmark S&P 500 Index's five worst months since SAM launched in April 2016 (October 2016, February 2018, March 2018, October 2018, and December 2018), SAM's All-Weather Portfolio saw less than half of the market's decline, on average.
The idea I want to share with Digest readers today is the bedrock of our All-Weather Portfolio...
It's an idea I believe is far more valuable than any one stock pick or strategy.
It's an idea that runs directly counter to the gospel preached by Wall Street and the financial establishment. It also runs counter to what most of us have been "taught" about investing since we were kids.
But I believe it's the most important idea I can share with you about how to protect your portfolio against the kinds of devastating losses so many people suffer in a bear market.
The idea is diversification across time.
How often have you heard the 'buy and hold' mantra?
This canard gets hammered into us by Wall Street and others in mainstream financial circles from the first moment many of us get introduced to stocks. Of course, what "buy and hold" really means is that we're supposed to own stocks with only one time horizon in mind: the long term.
But building a portfolio in which every holding is meant to be for the long term presents one big problem: You're likely to get crushed during a severe bear market.
Consider a portfolio with only high-quality businesses that are capital-efficient and possess significant economic goodwill...
These are the kinds of companies Porter and his team of analysts love to write about in Stansberry's Investment Advisory.
Porter presented an illustrative portfolio of such companies at the Stansberry Conference in Las Vegas last October. The chart below is borrowed from his presentation...
As shown in the last column of the chart, the average maximum peak drawdown during the applicable bear market in this list of high-quality, capital-efficient stocks was 74%.
While these numbers are a worst-case scenario – reflecting maximum drawdowns for each individual stock over its worst-performing period – they can still serve as a cautionary tale for "buy and hold" investors. Think about this for a moment...
How many of us could tolerate an average 74% loss in our portfolio?
My oldest daughter, Daphne, who is nine years old, possibly could. That's because she still has the rest of her life ahead of her... We're likely talking about another seven decades or so. And the earliest she would need to use the funds in her stock portfolio is 10 years from now when she's in college.
But what about those of us who are already in or nearing retirement and who don't have the luxury of waiting and hoping for our stock portfolios to recover? For folks in that category, "buy and hold" would likely spell disaster.
For all his talk about patience, Buffett himself understood this early in his career...
When he managed money for other people through the Buffett Partnerships from 1956 to 1969, Buffett did put some of his portfolio into long-term investments in high-quality companies. He later became famous for these investments, such as property and casualty insurer GEICO.
But crucially, he didn't put all of his portfolio into such long-term investments...
Instead, Buffett had a second category in his portfolio designed for opportunities he expected to pay off in a shorter time frame – from a few months to a year. This category included investments in merger arbitrage, liquidations, bankruptcy workouts, and corporate spinoffs. Buffett also made sure that he always held some "dry powder" in cash.
Carving out a piece of your portfolio for shorter-term opportunities gives you two powerful advantages...
First, shorter-term opportunities are often significantly less correlated to the overall market.
At SAM, one of the most important short-term strategies is merger arbitrage. As Porter's team defined it in the March 2017 issue of Stansberry's Investment Advisory...
As its name indicates, it's a strategy based on merger and acquisition (M&A) transactions. Last year, there were around 400 announced M&A deals involving publicly traded takeover targets in the U.S... So lots of opportunities to pursue this strategy crop up.
When a company (the "acquirer") announces that it intends to purchase a public company (the "target"), the acquirer typically has to offer a premium above the target's market price. This premium (or "spread") is intended to convince the target's management and shareholders to accept the deal.
Merger arbitrage is an investment strategy that seeks to profit by betting that the spread will collapse and the target's stock price will converge to the offer price.
How does merger arbitrage tend to perform during periods of market duress? It's often entirely uncorrelated...
For instance, during the height of the last bear market, the S&P 500 fell more than 50% from October 2007 to March 2009. But over the same period, the HFRX Merger Arbitrage Index – a basket of merger opportunities – actually gained around 3%.
The second advantage of a portfolio category dedicated to shorter-term opportunities is that it recycles capital quickly. That allows you to buy high-quality, capital-efficient stocks and "trophy assets" at a discount to their true value in the event of a market crash.
Let's go back to the portfolio in the chart above that consists only of world-class businesses that you plan to hold for the long term...
If the stock market crashes, you'll want to add to the portfolio by buying those elite businesses at substantial discounts that could be more than 50% of their true value. But you'll be stuck... With your whole portfolio already deeply underwater, what would you sell to free up the needed cash to buy?
Now, imagine instead that you've allocated, say, a third or a half of your portfolio to shorter-term opportunities today...
As we see it, these opportunities will naturally "close" within a matter of months, recycling your capital back to you and providing the ammunition to add to long-term holdings in a "fire sale."
Is it ever safe to be entirely invested in high-quality, long-term holdings?
I think the answer is "yes."
It works if you're still young – like my daughter – and have decades left to invest. And I believe it also works for the rest of us immediately after a stock market bloodbath, such as in early 2009.
But in the late stages of a bull market, when valuations are stretched, I believe a time-diversified mix of longer-term and shorter-term investments offers a far superior risk-to-reward setup than a standard "buy and hold" strategy.
If you're interested in learning more about these strategies and others we use at SAM, I urge you to reach out...
Our team would be delighted to speak with you. We're always happy to help Stansberry Research subscribers. You can reach us by phone at 646-854-4370 or e-mail at info@stansberryam.com.
If you'd simply like to start by reading more about time diversification, merger arbitrage, and the single biggest risk we see in the market today, I invite you to download our latest report, "The Most Dangerous Investment in Your Portfolio."
Even if you're not interested in working with a professional manager this year, this must-read report has insights and ideas you can use to help protect your own portfolio today. Click here to download your copy now.
New 52-week highs (as of 5/28/19): iShares iBoxx Investment Grade Corporate Bond Fund (LQD), Nuveen Municipal Value Fund (NUV), and Vanguard Inflation-Protected Securities Fund (VIPSX).
The mailbag will pick back up tomorrow. In the meantime, send your thoughts, comments, and concerns on the markets to feedback@stansberryresearch.com.
Regards,
Erez Kalir
New York, New York
May 29, 2019
IMPORTANT DISCLOSURES
Please note that the past performance of any investments, strategies, or portfolios discussed in this article is not necessarily indicative of future results. All investments involve risk of loss, and a loss of original capital may occur.
About Stansberry Research and SAM
Stansberry Research is a subscription-based publisher of financial information and is not regulated by the SEC because it is a publisher. Stansberry Research and SAM are separate corporate entities that are separately operated and are overseen by different boards and different management teams. SAM's management team is responsible for the investment decisions of SAM. No member of SAM's management team nor any other officer or employee of SAM is an officer, editor, writer, or other employee at Stansberry Research. Similarly, neither Porter Stansberry nor any other officer, editor, writer, or other employee at Stansberry Research is an officer or employee of SAM. Although SAM will utilize investment research published by Stansberry Research, SAM has no special or early access to such research. It receives information from Stansberry Research just like any other subscriber does – after the issues are published.
Stansberry Research officers, editors, writers, and other employees are prohibited from controlling SAM by any means, including through ownership, contract, or otherwise. Members of SAM's management team and SAM officers and employees are prohibited from controlling Stansberry Research by any means, including through ownership, contract, or otherwise. Stansberry Research has an arrangement with SAM under which it is compensated by SAM (on a flat dollar amount per solicited client) for its solicitation services.
About the facts mentioned in the Digest:
A measure of total market cap relative to the U.S. GNP is known as the "Buffett Indicator," which is described by Warren Buffett as "probably the best single measure of where valuations stand at any given moment." For more on the indicator and how it is used to gauge market valuations, see www.gurufocus.com/stock-market-valuations.php. Buffett's strategies related to a mix of short-term and longer-term investments are detailed in his January 18, 1964 partnership letter. Source for market performance mentions: Bloomberg. December market decline details: From 12/3/2018 to 12/24/2018 the S&P 500 Index dropped 15.7%. 2007-2009 market decline details: From 10/9/2007 to 3/9/2009 the S&P 500 Index dropped -56.8%. HFRX Merger Arbitrage Index monthly numbers can be seen at www.hedgefundresearch.com.
Important information related to the market performance of SAM's All-Weather Portfolio:
Performance in different market environments or over different time periods could result in different absolute or relative returns. The performance for the All-Weather strategy model portfolio is calculated net of SAM management fees. The All-Weather model portfolio performance cited in this article represents a $500,000 account that started on the date of SAM's first trade, which was April 1, 2016. As described in the article, the average All-Weather portfolio performance as measured against the S&P 500's five worst months is calculated as a straight average of the SAM All-Weather strategy model portfolio performance decline for each applicable month as a percentage of the S&P 500 performance decline for the same month.