Tag Archives: money

How To Survive The Coming Market Crash

If we have an atom that is in an excited state and so is going to emit a photon, we cannot say when it will emit the photon. It has a certain amplitude to emit the photon at any time, and we can predict only a probability for emission; we cannot predict the future exactly. —Richard Feynman This week, the S&P 500 finally broke through its 2,100 level, despite a huge influx of negative earnings reports . Though it failed to hold, the resistance has been tested. We ask whether the fundamentals of the stocks in this index could justify a true breakthrough of this resistance level. Much of this 7-year rally has been bolstered by central bank stimuli and stock buybacks. Both of these catalysts are coming to their ends. Most notably, as pointed out by Seeking Alpha contributor Gary Gordon, corporations are abandoning their buyback programs as a result of debt concerns. The next market crash will inevitably be labeled a “debt” or “balance sheet” market crash – allow me to explain: The Japanese market crash of the 1990s was caused by companies selling their assets to pay off debt. Individually, each company was doing the logical thing: Cleaning its balance sheets. However, when the majority of corporations engage in this action at once, you have a situation in which no companies are borrowing – despite ZIRP. The quiet liquidation of assets to pay off debt leads to a market crash that is stealthy at first but quickly turns into a landslide. The problem in the current market is investors’ ignorance of such an activity in favor of the go-to data, such as strong nonfarm payroll reports and interest rates. When we see such positive data, we feel the equity prices are justified. The problem is that if the economy really does look good, the Federal Reserve (the Fed) will have no choice but to “slow things down” by raising interest rates; and we all know what happened last time the Fed raised rates. That is, we are in trouble either way. On the one hand, if the fundamentals as per company activities and earnings look bad, the market should react negatively. On the other hand, if economy data supports a strong economy, the “data-driven” Fed must raise rates, which will cause a market correction. It seems that in either case, the 2,100 level of the S&P 500 should not hold for long. From a technical standpoint, the S&P 500 is stuck between 1,810 and 2,134. If this condition holds, we have much more downside at the 2,100 level than upside; i.e., a downward movement can bring us down 300 points but an upward movement is unlikely to bring us up more than 30 points. One problem with earnings being so poor is that the drop in earnings necessarily raises the P/E of stocks in the S&P 500. We are looking at an average P/E of 25. Falling earnings should be seen as a warning sign that the P/E is on the rise – that stocks are becoming increasingly expensive. The natural – logical – reaction would be to sell stocks and instead short stocks or buy bonds and other non-correlated investments, such as gold . Still, the market could continue to rise, as a result of short squeezes and algorithmic trading, which makes up 50% of the market’s trades. A new all-time high could be on the horizon, but it would be historical: The first all-time high created by a short squeeze, not by fundamentals. The question we must ask now is whether a reversal is also on the horizon. Thesis Corporate debt will be the catalyst for the next market crash. This market crash will be the result of balance sheet recession, which was the same type of recession that caused the Japanese market crash. This type of crash is fueled by debt: Corporate debt reaches all-time highs Companies begin to default Other companies begin paying off their debt out of fear To pay off this debt, assets are sold (this is where the crash begins) Borrowing slows The government lowers interest rates to attract borrowers Monetary policy fails because it relies on the assumption that borrowers always exist The economy grinds to a halt Investors move their capital into savings and precious metals, as bonds and equities no longer pay off Food for Thought Balance sheet recessions are basically invisible because only two groups of people look at balance sheets: fundamental investors and creditors (banks). The latter group only wants to know the probability that a company will default. The former group only sees the trees – not the forest. To put it more clearly, think of it this way. If you’re an investor looking at company ABC and you notice ABC paying off debt, you’ll think of this as a bullish indicator. After all, paying off debt is the responsible thing, especially when the company’s debt is at record-high levels. However, the point of a company is to invest your money better than you can. If that company is not investing but paying off debt, it is ignoring its main duty. In addition, paying off debt is not part of the growth cycle of a business, and a company spending its money to reduce debt is therefore not a worthwhile investment. As for how this relates to a market crash, investors look at companies individually. Rarely would an investor note that the result of a massive number of companies engaging in debt reduction equates to a lack of borrowing, which equates to the government engaging in new fiscal and monetary policies – the latter of which fails during the beginning stages of a balance sheet recession, and the former only softens the blow, delaying the inevitable. When we step back and look at company behavior as a whole, we begin to see the forest: Paying debt when interest rates are near-zero is the sign of a recession. What spurs debt reduction? Defaults, exposure to debtors at risk of default, and heightened overall default risk. Food for thought: Click to enlarge The Contrarian Strategy We should always be hedged against a Japan-like market crash. But going short on the S&P 500, such as via the SPDR ETF (NYSEARCA: SPY ) could be dangerous during a phase in which government intervention and short squeezes could bring us to new highs. Instead, I recommend a ratio back spread: Click to enlarge Here, we short an out of the money (OTM) put option with a near strike price and buy two OTM put options with a far strike price and long expiration date. This position is taken when we think a large downward movement will happen in the future for SPY but simply cannot pinpoint when. Here, we are delta neutral and theta positive, which means that the small, daily fluctuations of the SPY will only help us profit via time decay. However, once a large downward move takes place, we will see the profit of the above option strategy skyrocket, as the delta for the bought put will increase much more quickly than that of the sold put (note how gamma is negative). Vega is high, implying that any volatility change in the SPY will lead to an increase in the above spread. With market volatility at a relative low, now is a good time to open such a spread. We only need to do one thing to manage the spread: Roll over the front-end put every month. That is, every month, sell a monthly put option that is roughly $10 out of the money. In this way, we keep the strategy delta-neutral and theta positive. Happy trading. Learn More about Earnings My Exploiting Earnings premium subscription is now live, here on Seeking Alpha. In this newsletter, we will be employing both fundamental and pattern analyses to predict price movements of specific companies after specific earnings. I will also be offering specific strategies for playing those earnings reports. In our last four newsletters, have accurately predicted earnings beats 100% of the time. In the most recent newsletter, we predicting how Microsoft (NASDAQ: MSFT ) will react after its upcoming earnings report. Request an Article Because my articles occasionally get 500+ comments, if you have a request for an analysis on a specific stock, ETF, or commodity, please use @damon in the comments section below to leave your request. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Preserve Your Capital By Including Precious Metals In Portfolio

We are witnessing a horrible run in stock markets across the world. January was terrible, with all leading global indices ending in red territory. China’s benchmark Shanghai Stock Exchange slumped about 25%. The tumult has continued in February as virtually every sector, from biotech to energy and from banking to tech-has struggled. With stock markets getting hammered on daily basis, it will not be surprising to find majority of investors’ portfolios may have taken a big blow. Nouriel Roubini, noted American economist, in a recent interview ruled out that the global economy is in danger of confronting 2008 financial crisis-like situation. Nonetheless, there are not many good signs for a healthy global economy. The oil market is witnessing a carnage, emerging markets are in doldrums as a result of sliding commodity prices and capital flight, and China is slowing down. German economy, Europe’s growth engine, faltered significantly in December as industrial production lost momentum. The U.S. economy, by and large, is chugging along nicely but ambiguity over the Federal Reserve’s next round of interest rate hikes and anxiety over the run up to Presidential elections, should keep markets under tight leash. Against this backdrop, it is very likely that market participants will have a very low risk appetite. As a result, the market sentiment could remain bearish for most part of the year. Still, investors can safeguard their capital and minimize risks by including safe-haven assets such as precious metals ETFs in their portfolios. For instance, consider, Physical Precious Metal Basket Shares Trust ETF (NYSEARCA: GLTR ). The ETF, in the backdrop of the meltdown in precious metals markets as a result of stronger dollar, slumped about 20% in 2015. The situation, however, has changed dramatically this year. The ETF is up about 10%, year-to-date, performing almost on par with gold and silver and way better than other assets. The investment objective of this fund is that the shares should reflect the value of physical gold, silver, platinum and palladium in the proportions held by the trust. As of February, physical gold constitutes about 60% of the portfolio, silver accounts for about 28% of total assets, while platinum and palladium make roughly 12% of total assets. Barring palladium, which is still struggling, all other precious metals are expected to perform reasonably well this year. Gold, as I discussed earlier, stands to gain for many reasons. Firstly, the slump in oil prices amid supply glut would keep investors wary of riskier assets and create demand for safe-haven bets. Earlier this month, gold vaulted to a 7 ½ month high as investors moved their money towards safer assets. Besides, there is growing speculation that the pace of rate hike will much slower than previously anticipated. Lower interest rates would encourage investors to shift their money towards non-interest yielding assets such as precious metals. And finally, although, physical gold market has relatively low influence over prices than paper gold market, drop in mining activities, due to years of low-price environment, should also propel gold prices. Silver, meanwhile, should continue to march ahead, as the white metal, typically tends to have a positive price correlation with gold. Platinum performed badly last year. It sunk about 27%. However, it has begun the year strongly. Gaining about 4.75%, year-to-date, the metal should perform better this year as the demand from the automobile sector is likely to remain robust. Also, as I discussed earlier citing the World Investment Council report published in September, platinum mining activities in South Africa are expected to halt for next two years. This is because; an extended period of low-price environment has forced miners to drastically cut down CAPEX. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Trounce The Market With Less Risk

Over a lifetime, stocks trounce bonds more than 800-fold. Contrary to conventional thinking, LESS risk taking can lead to HIGHER returns. Active investing can significantly outperform balanced, buy-and-hold strategies. Most of us tend to think of investing in terms of the experiences of our lifetime, and in fact, of that limited span during which we were vaguely aware of economic events in the world at all. (Nope, you can’t count those teenage years…) But it is important to view things in a greater historical perspective. The chart below does that. (click to enlarge) Source: Stocks, Bonds, Treasury Bills and Inflation 1926-2010 If you zoom in on the graph, you’ll quickly grasp one salient fact: over the long run, if you can stand a bit of risk, you’ll certainly be richly rewarded for that risk. From 1926 to today, an investment in the lowest risk strategy, short term government bonds, grew your money 19-fold, but barely outpaced inflation which eroded the value of the dollar 12-fold over that same period. In stark contrast, investing in small caps grew your money 16000-fold. Yes, you read that right! Put another way, a $1000 investment grew to just over $16 million. Here are a couple of other important observations: If time is on your side, you are seriously shortchanging yourself by not investing in the stock market. A small increment in your yearly return makes a huge difference over time. Look at how a 4 percent difference between large cap stocks and long term bonds increases returns by more than 40 times over that period. Thanks to the incredible magic of compounding, the earlier you start the better off you’ll be. The more you depend on your investments for income today, the less you can (safely) earn, ironically enough. (The corresponding corollary to that in the banking sector is that the more you need a loan, the less likely you will get one. Oh well…) It may take you 20 years to recover from a market break! If you invested in the market in late 1928, you were not back to square one until 1946 !!! (If you think we have that problem solved, just talk to some Japanese investors. Or view this article on my blog.) Even government treasuries can be a poor investment. See the period from 1965 to 1970, when treasuries dropped, yet inflation was raging. Faced with the complexities of investing, sticking your head in the sand and your money under your pillow just ain’t the way to go! Just look at that inflation line. It means your $1.00 invested in 1928 buys you about 8 cents in 2015 prices. So you cannot afford to be on the sidelines. In fact, if you are not investing, you have almost a complete certainty of seeing your assets shrink. So given all of these conclusions, how should you invest your hard-earned money for the best results? Or if you’re among the fortunate few born with a silver spoon in your mouth, how should you protect your leisurely-inherited millions? The short answer is: it depends… For those of you not quite happy with that decidedly hedged answer (Ever wonder what the word hedge funds really means?), please read on. I promise to give you a more concrete response. A traditional approach would be to spread your assets widely among several groups of investments. Take a look at the following graph showing how several different categories of exchange traded funds performed in the last big stock market crash in 2008. (click to enlarge) As the graph makes clear, while the stock market was plunging, other market sectors (mortgage-backed securities, short and long term treasuries, corporate bonds and government backed securities) were rising. So by mixing your asset classes, you can significantly smooth out the volatility of your portfolio. This is particularly important for retirees, since you can choose to withdraw only from areas that have risen in value, as opposed to selling at the worst possible moment, when asset values are at all time lows. A number of mutual funds and ETF’s already subscribe to this strategy. The chart below shows the performance of the Janus Balanced Fund, plotted against the SPDR S&P 500 ETF Trust ETF (NYSEARCA: SPY ), which is a proxy for the S&P 500 index. This has averaged a 9.85% return over 20 years, with fewer big drawdowns than the S&P itself. (click to enlarge) (click to enlarge) If you pay close attention to the percentage comparison, you will note that the balanced approach actually beat the S&P 500 in overall return with less volatility along the way! Some people mistakenly assume that this “spread your marbles out evenly” strategy argues against an actively managed approach. Nothing can be further from the truth. The next two graphs show an active approach that picks the best stocks in the US stocks universe (according to our proprietary formula), times the buys according to certain technical criteria related to momentum, and rebalances the portfolio on a weekly basis. Here is a relatively low-beta (low volatility) approach, that still wallops the results of the JANUS fund shown above, as well as the S&P. (click to enlarge) And for those of you willing to sit tight through a little more volatility, how does a 16 fold return on your money over a 12 year period grab you? But don’t complain about the 50% drawdown… (click to enlarge) Source: quantopian.com Strategy back-testing based on universe of 8000 plus US stocks from 1993-2015. Graphed results are NOT based on historical performance. Real results may differ significantly from back-tested results. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: The author currently holds positions using some of these strategies. We do not currently hold position in the Janus fund. The active strategies mentioned require margin accounts and the ability to short stocks at certain times.