by John Persinos, InvestingDaily.com
Article of the Week from Investing Daily
Back in 2008, global capitalism came within a whisker of collapsing. That year, the S&P 500 fell about 40%. I had a child in college and a home mortgage. I managed to stay employed, but millions of my fellow Americans weren’t so fortunate.
Observing the news lately, I’m getting flashbacks to that traumatic time. Despite terrible economic fundamentals caused by a deadly pandemic, we’re in the midst of an asset bubble. At the same time, Washington is aggressively deregulating the financial system, perhaps laying the groundwork for another 2008-type catastrophe.
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You might wake up one morning, as I did 12 years ago, to find that a blue-chip institution like Lehman Brothers has failed. Below, I’ll steer you toward ways to make money with downside protection.
It’s clear that federal officials are pulling out all the stops to keep the stock market afloat. Latest case in point: stocks were sinking Thursday, due to soaring coronavirus cases in the U.S., when reports about banking deregulation cheered investors and stocks reversed direction late in the session. The Dow Jones Industrial Average rose 1.18%, the S&P 500 rose 1.10%, and the NASDAQ composite climbed 1.09%. In pre-market futures trading Friday, stocks were set to take a breather and open lower.
News emerged Thursday that the Federal Deposit Insurance Commission (FDIC) and Office of the Controller of the Currency intend to loosen restrictions imposed by the so-called Volcker Rule, making it easier for banks to plow big investments into venture capital and similar funds. The change also would allow banks to avoid setting aside cash for derivatives trades between different affiliates of the same firm.
The announced rollback of the post-crisis crackdown on banks focuses on “proprietary trading,” a transaction initiated by a financial firm for direct gain instead of investing for the benefit of clients. These reforms were named after then-Federal Reserve Chairman Paul Volcker. Implemented as part of the Dodd-Frank Wall Street Reform and Protection Act of 2010, the Volcker Rule restricts banks from proprietary trading and from investing their own money in hedge funds and private equity funds.
Wall Street is getting the deregulation it craves, but we might all come to regret it. No one likes onerous red tape. However, without sufficient policing of complex technical processes, the average retail investor is left to the mercy of market insiders who make highly speculative bets.
The stripping away of financial safeguards is occurring during the worst economic downturn since the Great Depression.
In the words of legendary investor Jesse Livermore, who lost his massive fortune during the 1929 stock market crash: “There is nothing new in Wall Street. There can’t be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again.”
CDOs: they’re baaack….
Remember collateralized debt obligations, aka CDOs? They were the villains of the financial crisis of 2008 and helped trigger the global meltdown. Well, they’re coming back into vogue. The re-emergence of highly risky CDOs doesn’t seem to bother anyone in government, but it should.
The Federal Reserve and other government entities have been systematically dismantling the reforms and buffers that were put in place to prevent another 2008 meltdown. It’s not just the Volcker Rule. A slew of other regulations and capital requirements have been loosened.
A debt crisis could be the pin that bursts the stock market bubble. The coronavirus-induced recession is putting new strains on already indebted companies. Diminished demand and supply chain turmoil are creating a cash flow crunch for many businesses, making it difficult for them to service their debt burdens.
This dynamic especially hurts smaller companies in the hard-hit travel and lodging industries. Banks could face a wave of creditor defaults, possibly triggering a domino effect similar to the 2008 meltdown.
According to the Organisation for Economic Co-operation and Development (OECD), between 2008 and 2019, the average global issuance annually was $1.8 trillion, which is double the average annual amount of $879 billion between 2000 and 2007 (see chart).
During the era of ultra-low interest rates that followed the Great Recession, corporations loaded up on debt. But instead of using that money to invest in organic growth, most of these borrowers launched share buyback programs or funded mergers.
Financial contagion could easily spread at any time, sparked by a host of factors ranging from coronavirus to trade war to poor economic data, pulling down overpriced but fundamentally weak stocks that are living on borrowed time.
Sure, some states are ending lockdowns, but businesses don’t automatically make money by opening their doors. They require actual customers to spend money. The social interaction that makes restaurants, bars and sporting events appealing also makes them coronavirus hot zones. As COVID-19 cases soar across the country, we’re already witnessed re-closings.
Several states set single-day coronavirus case records this past week, including Arizona, California, Nevada, Texas and Oklahoma. Anyone who’s still betting on a V-shaped economic recovery is living in fantasy land. Another market sell-off this year is likely.
The Great Recession of 2007-2009 erased nearly 57% of the value of the S&P 500, before the market bottomed out in March 2009. Are you prepared for another crisis? My latest video provides time-proven defensive measures.
Here is a transcript of the video:
This is John Persinos, editorial director of Investing Daily, with a video update for Tuesday, June 23.
The rest of 2020 promises to be uncertain, with choppy trading and sell-offs ahead. The market has rallied from its March 23 low but don’t get complacent. We’re in the midst of a wild presidential race, the economic fundamentals are appalling, and coronavirus cases are rising.
The World Health Organization last Friday said that the world had entered a “new and dangerous phase” of the coronavirus pandemic. Beijing and other cities around the world are experiencing a spike in cases. In the U.S., infections and deaths are accelerating in Southern and Western states.
As of June 23, more than 120,400 people have now died from coronavirus in the U.S., according to a running tally maintained by Johns Hopkins, which shows that over 2.3 million people have been infected across the country.
The coronavirus doesn’t care if you find social quarantines boring. Premature re-openings and public gatherings are rapidly spreading the disease. Newly opened businesses are going back into lockdown.
When the proverbial “stuff” hits the fan and stocks crash again, will you be ready? Below are eight steps that proactive investors should take now to build wealth and also preserve capital. If you’ve already adopted these measures, you should be in good shape to ride out future volatility and downturns. If you haven’t, it’s not too late.
1. Rotate into defensive stocks.
Your wealth preservation strategy should include the right asset allocation, tailored to your financial goals.
Keep plenty of cash on hand, for the bargains that are sure to arise after another market crash. As the economy contracts, rotate into defensive sectors such as health care, utilities and consumer staples (see chart).
For the best utility stocks now, click here for our report. Utilities tend to perform well during economic downturns, in large part because they provide essential services that people can’t live without.
2. Go to bonds for ballast.
In turbulent waters, bonds can help steady the ship. You may be a growth investor and still several years from retirement, but during the current stage of contraction, don’t give short shrift to fixed-income.
You should be rotating toward safe havens. I recommend bond funds, for greater diversification. Notably, short-term bonds are less vulnerable to interest rates than longer-term bonds.
3. Decrease your portfolio’s weighting in cyclicals.
This is no time to be heavily weighted in cyclical sectors, such as consumer discretionary goods. During this recession, rotate into non-cyclical, more stable companies that provide services that are consistently used regardless of market or economic conditions.
4. Diversify among asset categories.
Spread your portfolio among value, large-cap, mid-cap, small-cap, growth and income stocks. One often ignored move is to invest in mid-caps, which provide greater growth potential than large caps but less risk than small caps. A mid-cap is generally defined as a company with a market capitalization between $2 billion and $10 billion.
5. Seek global diversification.
Don’t withdraw from the world stage and become a parochial investor. To be sure, emerging markets are grappling with multiple crises, but the global diversification imperative applies to all geographic regions and countries. An underappreciated investment destinations right now is Latin America.
Read This Story: The Recovery Will Dance to a Fast Latin Beat
Analysts expect Mexico and other major Latin economies to gain traction in 2021. Although under pressure now, Latin America is home to rising middle classes and the region is positioned for a sharp rebound in the post-COVID era.
6. Add quality dividend stocks.
Dividend-paying stocks are proven tools for long-term wealth building, but they’re also safe harbors because companies with robust and rising dividends by definition sport the strongest fundamentals.
If a company has strong enough cash flow (and sufficiently low debt) to generate high and growing dividends, it also means that the balance sheet is inherently solid enough to sustain the company through the sort of uncertainty that bedevils investors today.
7. Make sure your portfolio contains gold.
Geopolitical turmoil and trade war uncertainties have propelled the price of gold in recent months. Gold probably has further to run.
The rule of thumb is for an allocation of 5%-10% in either gold mining stocks, exchange-traded funds (ETFs), or the physical bullion itself.
Looking for the best gold mining stock? My colleague Dr. Stephen Leeb has pinpointed an under-the-radar gold miner that shines above the rest. This small-cap “rocket stock” is poised to blast off, but most of Wall Street hasn’t even noticed the company.
Dr. Leeb is chief investment strategist of the premium trading service, The Complete Investor. The time to invest in his gold mining play is now, before the rest of the investment herd catches on. Click here for details.
8. Use Stop Losses When Buying Stocks
One of the most widely used devices for limiting the level of loss from a dropping stock is to place a stop-loss order with your broker. Using this order, the trader will pre-set the value based on the maximum loss the investor is willing to tolerate.
If the last price drops below this fixed value, the stop loss automatically becomes a market order and gets triggered. As soon as the price falls below the stop level, the position is closed at the current market price, which prevents any additional losses.
A trailing stop and a regular stop loss appear similar as they equally provide protection of your capital should a stock’s price begin to move against you, but that is where their similarities end.
The “trailing stop” provides an advantage over a conventional stop loss because it’s more flexible. It allows the trader to continue protecting his capital if the price drops, but when the price increases, the trailing feature becomes active, enabling an eventual protection of profit while still reducing the risk to capital.
Over time, the trailing stop will self-adjust, shifting from minimizing losses to protecting profits as the price reaches new highs.
As an adjunct to the above rules, always practice “position sizing.” Position sizing refers to the size of a position within a particular portfolio, or the dollar amount that an investor intends to trade. Position sizing helps you determine how many units of a security you should purchase, which in turn controls risk. As a rule of thumb, risk no more than 2% of your investment capital on any one trade.
Watch This Video: 8 Steps to Preserve Wealth
Questions or comments about portfolio protection? Drop me a line: [email protected]
