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When the Market Crashes, There is Only One Place to Hide

Here’s the short, simple reality to understand: in powerful down markets, every asset class gets clobbered.

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“This is Wall Street, Dr. Burry. If you offer us free money, we are going to take it.”

-Smug, Know-Nothing Goldman Sachs Chicky in The Big Short

My firm didn’t operate too differently from the above statement, frankly. but there was that one time we said no…

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In 2007 or 2008 – I don’t recall exactly – a mutual fund client asked us to create a defensive portfolio they could launch as a new product.

Sounds simple enough, right? Except, they weren’t looking for a portfolio loaded with utilities, healthcare and consumer staples.

What they wanted was a portfolio of stocks that would rise when the market was falling (it already was falling, but Wall Street is just as good at closing the barn door after the animals have left as are elected officials).

I suspected this would be tough to create. Once we ran our studies, indeed we realized this was an impossible request and for the first time ever, we declined the portfolio request.

Here’s the short, simple reality to understand: in powerful down markets, every asset class gets clobbered. *

Put in a more fancy-pants sounding, Wall Streety way: during crashes, correlation skyrockets. In this case, it was effectively impossible to create a portfolio of stocks that would rise in a crashing market; all stocks crater in that environment.

Correlation is measured on a scale of -1 to 1. A reading of 1 defines perfect correlation, -1 is perfect inverse correlation and 0 means no correlation at all.

A reading of 1 is easy to understand but think of the others this way. The correlation of wearing surgical masks and the spread of covid almost certainly resides near zero. Jen Psaki’s relationship with the truth? Probably a -.9 or so.

As an aside, both high and low correlations have value. For instance, we had a good friend in college who we came to realize had a sense of direction that had to be very close to a full negative 1. If he were in the car and thought we should turn left, the rest of us knew with total certainty to go right.

With correlation, readings at or near 1 and -.1 are rare in anything that actually requires study, so measurements above .4 already start to imply strong correlation.

When we looked at the historical track record we found that in severe downturns, all asset classes fell with the market at correlations above .5. It was eerie.

What about foreign stocks? Um, no… that’s actually a double whammy of bad news. Not only do their markets get hammered at least as hard as ours, currency declines magnify those losses. We can all appropriately hate what our leaders are doing to destroy the U.S. Dollar, but in a world of fiat currencies it is ours the world runs to as the safe haven. Most foreign currencies decline in value as a result.

Cryptos? Who the hell knows, but why would they be spared if gold isn’t?

Wait, what about gold? Yeah, it will probably act like a safe haven in a down market but in this case that probably means it will just decline less than stocks overall. For instance, while the Dow literally got cut in half from October, 2007 to February, 2009, gold’s peak-to-trough decline in 2008 was fully 25%.

By being down “only” 25%, did gold perform better than the market? Yes, but correlation of the direction of the movement skyrocketed even in this safe-haven asset class.

Quick disclaimer: I currently own gold and silver and will be holding these positions. But I hold them in the proper size and I am also expecting them to initially decline when the market really tanks.

Important note: if you’re holding gold and silver mining companies – which, after all, are just stocks – you can expect them to get hammered just as hard as all the stocks around them. The relative outperformance of bullion itself won’t save them; again, just go look at 2008.

Okay, so what the heck should someone do right now?

Well, I don’t like giving “right now” investment advice so I’ll say what I have been saying all year to close friends and family: if you’re fully invested, raise at least some cash in your portfolio. I’ve been advising a minimum of 20% but that figure will vary depending on your personality.

As I’ve been telling them, think of it this way: if I’m wrong and the market keeps ramping higher on the back of all this stimulus – and that indeed is the only reason the market has continued its 2021 surge, btw – and you’re still 80% invested, you’ll still be making a lot of money and you’ll feel okay about it. Sure, you’ll mutter that I was early with this advice – I have been all year and still could be depending on central bank responses to this decline – but you won’t resent me for the input.

If you stay fully invested, however, and the market tanks by 40%, you’ll feel ill. Having some cash on the sidelines provides for a rainy day, keeps something available with which to buy stocks near future lows and, most importantly, will do wonders for both your decision making and your psyche.

When people get stuck for cash – margin calls, mortgage payments, whatever the need may be – they make all sorts of bad decisions. They’ll sell whatever they have to and often, it’s psychologically easier to sell their “winners” along the way than it is the stocks that have been crushed the most. What many people end up with at bottoms is a portfolio full of the crappiest individual names.

‘Oh great,’ you may be thinking, ‘you’re telling us this on a day when the market is already down 500 points. Thanks a lot.’

True. Actually, I’ve had this post 80% drafted for the last 10 days or so, it just felt like that this might be the jarring market day in which readers would take it seriously. Let me explain by doing a little mind reset with you:

You may have a 401k that had risen, say, from $200k to $500k over the last three years (until 2 weeks ago). Awesome! But unsustainable.

After the market weakness of the last couple weeks, maybe its value has declined to $450k. If you’re the type that thinks my advice makes sense, but you don’t want to sell any stocks or mutual funds because they just fell from $500k, your mindset is all wrong. Sorry to be so blunt but it’s true.

Here’s what you actually have on your hands: a 401k that has risen from $200k to $450k over the last three years. Still awesome, also unsustainable.

If you think you’re the one genius who can nail market tops perfectly and you’re now certain that the market will soon regain its recent highs, re-read my last sentence and get your head on straight.

That said, at this moment I do have to admit that I don’t know if this is the start of the big correction. On the one hand, a few too many people for my taste are looking for that crash. On the other, how insanely optimistic did the market have to be that only now it is noticing the slow-moving Evergrande disaster in China that has been known for a year and plainly visible for nearly a month?

Regardless, the point is this: if this is the start of the big correction – or even a true bear market – then this is only the beginning.

We’re at such stratospheric valuation heights – the highest in history, generally – that the next big correction will take stocks down 30, 40 or even 50%.

So yes, it’s still okay to be raising at least some cash today. Even today.

Tighten up stop losses. Raise cash right now from zero to 5% if your end goal is 20%. Redirect future 401k deposits to the money market fund rather than the high-growth stock funds you’ve been riding.

In short: take action. Don’t be paralyzed and again keep in mind this simple reality: in powerful down markets, nothing gets spared. The only place to hide is in cash.

This post has me re-awakened. More soon…
FDG

*Historically, there has been one other place to hide in down markets: high grade, U.S. bonds. That will likely still turn out to be the case – indeed, bonds are rallying today – but what’s the point? The rates offered by today’s bonds are so meaningless as to be roughly equivalent with cash so my preference at this moment in time is for cash.

 

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Americans sense things are on the wrong track, and have been for quite some time. Among our many challenges, for example: It can no longer be denied that income inequality is skyrocketing. But it is not capitalism that is enriching the few while slowly impoverishing the many. It is America’s long, slow turn away from free markets -- and the vital medium of exchange that underpins them -- that’s doing us in. This pseudonym is a nod to a somewhat-fringey, indulgent personal suspicion I hold with a 1% probability of being accurate: Alan Greenspan never ceased being Ayn Rand’s “man in Washington.” What if the well-known central bank chairman put on the show politicians wanted from him for years, all while secretly trying to return this world to rationality? Instead of destroying copper like D’Anconia, however, Greenspan destroyed money. Without realizing it now, some of you know me but I write under this pen name for two reasons. First: Of all the potential tyrannies we face today, by far the greatest threat to America is the misunderstanding, and therefore the ongoing destruction, of the U.S. dollar. Second: I write with the hope my ideas will stand on their own, aside from any political party, even apart from my own considerable charm and personality. Love me for my ideas, not because I'm beautiful. Politics, markets, more ... the things on which I’m qualified to opine will be unveiled here over time.



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Business

America Needs a Reboot

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There is a sign outside of Needville Feed that reads: “Has anyone tried unplugging the United States and plugging it back in?” Let the painful laughter ensue! It’s confession time. How many times have you been unable to figure things out on your computer and just decided to start over by rebooting in hopes of a new beginning. Sure, no one wants to lose the current good work, so you save what you can and hope for the best.

But America does need a reboot? Something is not right with America today. Some are working to get the 34 states needed to convene a National Constitutional Convention. Others are clamoring for term limits for all politicians. Unfortunately, every radical answer unleashes radical fears that such plans could create more problems than viable solutions. We seem stuck in stupid!

They want clean energy with wind and solar while they work to shut down natural gas and nuclear energy, two clean energy sources. Due to our clean energy efforts, our coal and oil resources are cleanest in the world. But they want to buy oil from questionable countries while limiting production here. Does it make sense to move from energy independence to energy dependence before we have proven clean energy alternatives that can supply the energy we need? Of course not! We’re stuck on stupid. Time to reboot expanded energy options to reclaim energy independence!

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How can you have true freedom of speech and not occasionally offend someone along the way? The answer to hateful or offensive speech, is more speech and thicker skin. People throw around the term “snowflakes” for people who want freedom for themselves but can’t handle that freedom for those who would attack their own views. Freedom is messy. Freedom is loud. Let people say what they want and experience the consequences for their comments. If you offend enough people, don’t expect to win many votes or popularity polls! It’s time to reboot freedom of speech for all!

I always thought that government was established to protect their citizens from enemies and from criminals. Why are people buying guns? Citizens want weapons to protect themselves. They are seeing far too many criminals let go without being prosecuted or punished. Government wants to take guns away from citizens, and everyone knows that criminals will keep theirs! In America today, crime seems to pay pretty well for the growing number of flash mobs, carjackers, and rioters taking what they want! Few big city DAs are doing their jobs. If you riot in the streets, rob small businesses, and attack bystanders, you should go to jail and serve time! We’re stuck on stupid! It’s time to unplug and reboot America’s law and order program!

Immigration has made America a better country, a melting pot of people who value freedom and the opportunity to earn their own dream. But people playing by the rules to immigrate to America keep waiting and never get the welcome illegal aliens receive by just crashing our Southern borders. By not having a secure border, we are advertising for more illegals to come. The Biden administration will provide transportation, let you have benefits, and work to get you housing and an eventual path to citizenship. Why immigrate legally, when doing so illegally works so well? Time to reboot. Time to finish the wall and secure our Southern border!

Martin Luther King, Jr. paid the price and rallied the country around a dream that one’s character would mean more than the color of a one’s skin. And yet today, calls for racism are encouraged. To many, you’re celebrated for saying that all whites are racist. Many blacks call for special reparations for the racism of a distant past. There is one sure result of such calls for special racial treatment-renewed racism! Reverend King would have surely affirmed that “All God’s children matter!” Under democratic leadership, America is backsliding into more racial animus. It’s time for a reboot. It’s time to reaffirm that “All men are created equal” is a value and a promise worth fighting for.

Personal responsibility for one’s choices is a critical American value. If you commit a crime, you do the time. You borrow money for something you want, you pay your debt. President Biden executive order to “forgive” student debt is not “free.” That debt isn’t “canceled;” it’s transferred to every tax-paying American. Many of those taxpayers have already worked and sacrificed to pay off their own student debt. This is not only stupid; it is an assault on basic fairness and a blatant attempt to buy votes. Reboot required! Reinstall personal responsibility programming!

In a recent interview on Jesse Watters’ Fox News show, Victor Davis Hanson of the Hoover Institution confronted the extreme actions of the left in transforming America. They are attacking and overthrowing America’s time-tested values.

To Hanson, the left is governing exactly the way they accuse the right of acting: “I mean, nobody on the right said let’s junk the 233-year-old Electoral College; [the] 180-year-old filibuster; the 150-year-old, nine-person Supreme Court. Nobody [on the right] said let’s bring in two more states and end the idea for 60 years of a 50-state union.”

It’s only left that has no problem stalling protection for right-leaning Supreme Court Justices facing demonstrations outside their homes. It’s the left that wants to radically federalize the voting laws to ensure that 70 percent of the votes would not be cast on Election Day. It’s the left that has radically weaponized the IRS with excessive increases in personnel and funding. The left calls January 6th an insurrection, but as Hanson notes: “Remember in 2021 when they had barbed wire and 30,000 troops in Washington, D.C. in the greatest weaponization since the Civil War?” Do you remember?

When Fascism comes to America, it will be wrapped in government entitlement programs that take from your neighbor to give you the things you ought to be forced to earn for yourself. It’s time to unplug this radical administration before it is too late. In November, it’s time to reboot by booting out the politicians who have played so loosely with America’s time-tested recipe for freedom and opportunity. It’s time to send the left home!

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Business

Redirect Yourself to Be More Productive

At any moment you have the opportunity to make a choice

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When you feel as if you’re not being as productive as you could be, or that you have strayed from your desired path, ask yourself: “What is the most effective use of my time?”

Suppose you face a variety of unrelated tasks, and what day does that not happen? Or, you face a variety of related tasks on the same project. Asking yourself what is the most effective use of my time invariably helps direct you to that task, which at present, merits your attention.

What Is the Most Effective Use of My Time

At any given moment you have the opportunity to make a choice, even if a task or project has been going well, you have the opportunity to make the choice as to how to use your time starting at that moment.

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Generally, speaking, when the self-directed question arises, it’s an indication that you’re facing some sort of quandary, and probably need to redirect your efforts. So ask yourself the question anytime you feel the need.

Will It Be Any Easier Later?

When faced with a situation I would prefer to put off, I ask myself another type of question: “Will it be any easier later?” If the task will be easier later, then I have rational justification for not proceeding on that particular task.

For example, if I have to organize all the receipts related to a certain project that will be in progress for another week, I can readily put off this task for another week. Then, with all the receipts collected, I can organize them accordingly, knowing I can do the job until its ultimate completion.

If the task won’t be any easier later, then it largely makes sense to proceed now, particularly if it might be more difficult later. Preparing for a speech, an interview, or a test or exam several days beforehand is a wiser approach to studying rather than cramming the night before.

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