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Financial Crisis"Round Two" Survival Guide
Thisbearmarketisnowherenearover.SinceitsMarch10lowof666in2009,theS&P500rallyhasbeenalmostunstoppable.Punditsandmediacommentatorsalikehavetakenthistomeanthatthebearmarketisoverandthatstocksshouldonceagainbetheprimaryassetclassforinvestors.Noneofthemknowswhattheyretalkingabout.
Overthelast30years,theUShasbuiltuprecorddebtsonapersonal,state,andnationallevel.Consumersthoughttheywerefinanciallystablesolongastheycouldcovertheinterestpaymentsontheircreditcards,statescreatedprogramafterprogramfewifanyofwhichtheycouldafford,andtheFederalGovernmentissued$3050trillionindebtandliabilities(countingSocialSecurityandMedicare).Thisallcametoascreechinghaltwhenthehousingbubble(arguablythebiggestdebtbubbleinhistory)implodedin2007.Sincethattime,stockshavestagedoneoftheirworstyearsonrecord(2008),oneinfiveusmortgageshasfallenunderwater(meaningthemortgageloanisworthmorethanthehomeitself),andsometrillionsinUShouseholdwealthhasevaporated.
Theseissuesseemtobedistinct,butinrealitytheyallstemfromadebtproblem.Andasyouknow,thereisonlyonelegitimatewaytodealwithadebtproblem:Payitoff.However,insteadofdoingthis,theFeds(theFederalReserve,TreasuryDept,etc.)havebeenproducingEVENMOREDEBT.Heresabriefrecapoftheirmovesthusfar:
TheFederalReservecutsinterestratesfrom5.250.25%(Sept07today) TheBearStearnsdeal/Fedbuys$30billioninjunkmortgages(March08) TheFedopensvariouslendingwindowstoinvestmentbanks(March08) TheSECproposesbanningshortsellingonfinancialstocks(July08) TheTreasurybuysFannie/Freddiefor$400billion(Sept08) TheFedtakesoverAIGfor$85billion(Sept08) TheFeddolesout$25billionfortheautomakers(Sept08) TheFeds$700billionTroubledAssetsReliefProgram(TARP)(Oct08)
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TheFedbuyscommercialpaper(nonbankdebt)fromnonfinancials(Oct08)
TheFedoffers$540billiontobackstopmoneymarketfunds(Oct08) TheFedsbackstopsupto$280billionofCitigroupsliabilities(Oct08). Another$40billiontoAIG(Nov08) TheFedbackstopsup$140billionofBankofAmericasliabilities(Jan09) Obamas$787BillionStimulus(Jan09) TheFeds$300billionQuantitativeEasingProgram(Mar09) TheFedbuying$1.25trillioninagencymortgagebackedsecurities(Mar09
10) TheFedbuying$200billioninagencydebt(Mar0910) CashforClunkersI&II(JulyAugust09)
AndthatsaBRIEFrecap(ImsureIleftsomethingout).Inanutshell,TheFedshavetriedtocombatadebtproblembyISSUINGMORE
DEBT.Theyrepumpingtrillionsofdollarsintothefinancialsystem,tryingtopropWallStreetandthestockmarket.TheyvemanagedtokickoffarallyinstocksButtheyHAVENOTADDRESSEDTHEFUNDAMENTALISSUESPLAGUINGTHEFINANCIALMARKET.StocksareheadedforanotherCrash,possiblyasbadastheonewesawinOctoberNovember2008.Asyouknow,thatCrashwipedout$11trillioninhouseholdwealthinamatterofweeks.TheresnotellingthedamagethisSecondRoundwillcause.TheFedshavethrowneverythingtheyvegot(includingthekitchensink)atthefinancialcrisisandthingsarefundamentallynobetterthantheywerebefore:
mostmajorbanksareinsolvent,oneinfiveUSmortgagesisunderwater,andthestockmarketisbeinglargelyproppedupbyinhousetradingfromafewkeyplayers(GoldmanSachs,UBS,etc).Makenomistake,wearerapidlyheadedforuglytimesinthefinancialmarkets.ThetimetoprepareyourselfisNOW!AndIvelocatedseveralinvestmentsthatwillnotonlyprotectyourportfoliotheyllalsohelpyouturnaprofitwhenthishouseofcardswecallamarketrallycomescrashingdown.
Ivedetailedalloftheminthisreport,TheFinancialCrisisRoundTwoSurvivalGuide.
TwoWaysStocksPay:InflationandDividendsBeforewegetintothespecificinvestmentsuggestions,itsimportanttotakeabigpictureofstocksasanassetclass.Thecommonconsensusisthatstocksreturnanaverageof6%ayear(atleastgoingbackto1900).
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However,astudybytheLondonBusinessSchoolrecentlyrevealedthatwhenyouremovedividends,stocksgainsdroptoamere1.7%ayear(evenlowerthanthereturnfromlong termTreasurybondsoverthesameperiod). Putanotherway,dividendsaccountfor70%oftheaverageUSstockreturnssince
1900.Whenyouremovedividends,stocksactuallyofferLESSrewardandMOREriskthanbonds.Ifyoudinvested$1instocksin1900,youdhavemade$582withreinvesteddividendsadjustedforinflationvs.amere$6frompriceappreciation.SoasmuchastheCNBCcrowd(andoutserialbubbleblowingFedChairmanBenBernanke)wouldliketobelievethatthewaytomakemoneyinstocksisbuyinglowandsellinghigh,therealityisthatthevastmajorityofgainsfromstocksstemfromdividends.Theremaininggainshavecomelargelyfrominflation.
BillKing,ChiefMarketStrategistM.RamseyKingSecuritiesrecentlypublishedthefollowingchartcomparingREALGDP(lightblue),GDPwhenyouaccountforinflation(darkblue),andtheDowJonesperformance(black)overthelast30years.Whatfollowsisaclearpicturethatsincethemid70sMOSToftheperceivedstockgainshavecomefrominflation.
Whichbringsustotoday.Accordingtoofficialdata,theS&P500iscurrentlytradingataPricetoEarnings(P/E)ratioof20andyields1.7%.Inplainterms,stocksareexpensive(historicaverageforP/Eis15)andpayinglittle.Inotherwords,thereislittleincentive,otherthanfutureinflationexpectations,forowningstocksrightnow.
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Withthisinmind,nowisthetimetobepruningyourlongholdings.WevehadaspectacularruninstockssincetheMarch2009lowandthelikelihoodofthiscontinuingmuchlongerisrelativelyslim.
RunningOutofBuyersBymosthistoricmetrics,themarketisshowingsignsofasignificanttop.Herearejustafewkeymetrics:
1) Investorsentimentisbacktosuperbullishautumn2007levels.2) Insidersellingtobuyingratiosarebacktoautumn2007levels(insidersare
sellingthefarm).3) Moneymarketfundassetsareat2007levels(indicatingthatinvestorshave
goneallinwithstocks).4) Mutualfundcashlevelsareatahistoriclow.
Thisfinalpointiskey.Mutualfundsarethebigboysoftheinvestmentworld.Iftheyhavebecomefullyinvestedinthemarket,thismeanstherearefewbuyerslefttopushstockshigher.Thisisevidentinthefactthateverytimemutualfundcashlevelsdropped,stockscollapsedsoonafter(seechartbelow).
http://home.comcast.net/~RoyAshworth/Mutual_Fund_Cash_Levels/Mutual_Fund_Cash_Levels.htm
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Inplainterms,theoddsarehighthataTopisforminginstocks.Withthatinmind,ifyourportfolioisheavilyinvestedinstocks,nowisatimetobetakingsomeprofits.Ifyoucan,considermovingasizablechunkintocash.
ThemarketisextremelytiredandthesystemicrisksunderlyingtheFinancialCrisisareinnowayresolved.Withinvestorcomplacency(asmeasuredbytheVIX)backtopreCrashlevels,theFedwithdrawingseveralofitsmoresignificantmarketprops,andlowparticipationcomingfromthelargerinstitutions,thismarketisripeforaseriouscorrection.Imnotsayingthiswillimmediatelyhappen.ButatsomepointtherewillbeanewroundtotheFinancialCrisis.Whenthathappens,weWILLhaveanotherCrash.Indeed,itisquitepossiblethatstocksaremakingaVERYsignificanttop,sobeingheavilyinvestedinstocksgoingforwarddoesntmakemuchsense.Takesomemoneyoffthetable.Ifyouneedaplacetoputit,IsuggestphysicalcashorGold/
Silverbullion.
IfYouMUSTStayLong,ShifttoQualityIfyouDOhavetostayinvestedinstocks,nowisthetimetobeshiftingoutofjunkintoquality.ThemarketrallyfromMarch2009haslargelybeenleadbyjunkcompanies(financials,retailers,etc).Meanwhile,qualityhaslaggeddramatically.Asanexample,letscomparetheperformanceofCoke(KO)toBankofAmerica(BAC).KOisoneofthebest,mostprofitablebrandsintheworld.Thecompetitivemoataroundthisbusinessisextraordinaryanditremainsoneofthemosteasilyrecognizedfranchisesontheplanet.YoucandrinksixglassesofCokeadayandstillenjoyitthenextday.Thatqualityisalmostnowheretobefoundinanyotherfood/beverageontheplanet:evenchocolatewouldgetoldaftersixbarsaday.BAContheotherhandhasswallowedCountrywideFinancialANDMerrillLynchsgarbageassets.Itiseffectivelyinsolventbasedonitsderivativeexposurealone(thecompanyhasderivativesequalto3,000%ofassets).BACsbalancesheetislikeanopensewerandwithoutseriousgovernmentinterventionthecompanywouldnotevenexistrightnow.Andyet,BACsstockhasrisennearly200%sincetheMarch09lowswhileKOisuplessthan50%.
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Thisrelationshipworkstothedownsideaswell.WhatImeanisthatwhenstockscomeunhinged,Quality(Coke)thenoutperformsGarbage(BankofAmerica)handsdown.
So,ifyouHAVEtoremaininvestedinstockstothelongsideforwhateverreason,nowisthetimetobemovingintohighqualitycompanies.Thismeansfindingcompanieswithlowdebt,lotsofcash,strongresults(KOactuallyGREWrevenuesin2008),andsignificantcompetitiveadvantages.Also,andthisiscritical,lookforcompanieswithstrongbalancesheets:companiesthatwillstillEXISTiftheresanotherCrisis.Depressionorno,peoplewillstilldrinksoda,alcohol,smokecigarettes,andneedmedicine.Ivecompiledalistofcompaniesyoushouldconsiderifyouneedtoremaininvolvedinstocksgoingforward:Company Symbol Sector Price/Cash
FlowDividendYield
Coke KO SoftDrinks 15 3.2%
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Budweiser BUD Alcohol 14 N/A
J&J JNJ Medicine 10 3.02%WalMart WMT GeneralRetail 8 2.16%
ExxonMobil XOM Oil 11 2.51%
Youllnotethatmostofthesecompaniespaydecentdividends(comparedtotheS&P500s1.7%).Thisiscriticalgoingforward.Withstocksovervalued,youwanttomakesureyoureatleastgettingpaidforremaininginvolvedinthemarket.However,thereisanaddedbonustoowningQualitystocksrightnow.BecausethismarketrallyhaslargelybeendominatedbyGarbagestocks,QualitycompanieslikeCokehavenotyetrisentoextremevaluations.Thus,youcanstillbuythematrelativelycheaplevels(lessthan15timescashflow).So,inasense,theyareagoodinvestmentbasedonpricingaswell.IwanttostressthattheseinvestmentsareonlyifyouHAVEtostayinstocksfor
somereason.Ifthereisanothercollapsethesecompanieswillfalllikeeverythingelse.However,theywilllikelyfalllessthantherestofthemarket(seethechartcomparingCokeandtheS&P500below).
source:YahooFinance
SowhileIdonotexpectthesepositionstomakealotofmoneynow(thesearenotshorttermtrades),theyshouldshelteryoufromlosingtoomuchmoneyshouldanotherCrashhit.Indeed,ifthemarketDOEScollapseandthesecompaniesfall1015%acrosstheboard(whilethemarketfalls30%+)IwouldconsidertheseinvestmentsevenMOREattractivethantheyaretoday.Letmeexplain.Volatilitycaneitherhurtyouorbeyourfriend.Mostpeoplewouldsellapositionifitfell2030%.Thisiswiseifyoureinvestingbasedonmomentum.However,if
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youreinvestingbasedonvalue,thendoingthisiscompletelyantitheticaltoattaininghighreturns.ConsiderCoke.LetssaytomorrowCokecollapsedfrom$55to$25pershare.Mostinvestorswouldpanicandsell.I,ontheotherhand,wouldbebuyinggreedily.Why?
BecauseCokesbusinesshasafundamentalvalue.EvenduringaFinancialCrisisandDepression,peoplewillcontinuetodrinksoda.SotheopportunitytobuyCokeat$25ashare(whichwouldbe78timescashflow)wouldbetrulyanextraordinaryopportunity.Indeed,fromanincomeperspectivealone,theopportunityherewouldbefantastic.Considerthatin2009,Cokepaidout$1.76individends.Withsharesat$55,thismeansadividendyieldof3.2%(roughlythreetimeswhatyoudgetbyleavingyourmoneyinasavingsaccount).
However,ifCokesharesfellto$25,that$1.76suddenlybecomesa7%yield($1.75/$25.00).Thatsaheckofareturnfromanincomeperspective.EvenifgloballytheworldenteredasharpDepressionandCokesincomefellby30%,pullingitspayoutsdownto$1.23,yourestilllookingata5%yield.Indeed,companieslikeCokeofferthepotentialofREALvalueshouldtheirsharepricesdrop.TheirfundamentalsalmostALWAYSoutperforminvestorsentiment.WhatImeanbythisisthatshouldtherebeanotherCollapse,CokessharepricewillalmostcertainlyfallMOREfromitscurrentlevelsthanCokescashpayoutsorincomewillfromtheirs.
During2008,Cokesharesfell30%orso.However,CokeactuallyINCREASEDitsdividendthatyear.AnyonewhoboughtCokeinOctober2008,nowcollectsa4%yieldontheirshares(fourtimeswhatheorshewouldgetfromabankaccount).ThisiswhycompanieslikeCokeremainsostrongduringtimesofCrisis.WiththeFDICbrokeandmostUSbanksinsolvent,investorsdesperatelyneedaplacetoparkcashthatwillstillEXISTinafewyears.CompanieslikeCokeareareasonablealternativetoasavingsaccountinthesensethatyourepaidahigheryieldforyourdeposit(now3%,but5%orhigherifCokesharesplunge).Ofcourse,becauseCokeisastock,youcanlose10 15%ormoreifsharesdrop
andyousell.InaCrisis,plainoldcashwilloutperformjustaboutanything.ThisiswhyIvesuggestedmovingmoneytocash,ifyoucan.ItsalsowhyIsuggestedbuyingCokeandtheothercompanieslistedaboveonlyIFyouHAVEtobeinstocksrightnow.
CatastropheInsurance:TradesForWhentheCollapseHits
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NowisalsothetimetobetakingoutsomeCatastropheInsurancebycompilingalistoftradestomakeoncestocksbegintocollapse.Letmebeclear,thesearenottradesthatyoullmakerightnowthesearetradesyoullmakeWHENstockscollapse.
Personally,IfavorUltraShortETFs.IfyoureunfamiliarwithUltraShortETFs,theseareinvetsmentsthatreturn2XtheinverseofaparticularETF.Letstakeanexample,theUltraShortFinancialsETF(SKF).SKFreturns2XtheinverseoftheFinancialsETF(IYF).SoifIYFfalls5%,SKFrises10%.IfIYFfalls10%,SKFrises20%.Inthissense,SKFisagreathedgeormeansofplayingFinancialstockstothedownside.However,theresanaddedbonustoUltraShortETFslikeSKF:theseinvestments
ALSOtradebasedondemandfromthemarketplace.Soifstockscollapsesay30%,youmightactuallyseegainsGREATERthan60%(2Xtheinverse)duetoinvestorspilinginastheyseektoprofitfromthecollapse.ConsiderSKFsperformancein2008,forexample.In2008,financialstocks(asmeasuredbytheFinancialsETF:IYF),fellroughly50%.
However,ifyoudboughtSKFoncetheCrisisreallytookhold(lateSeptember),youcouldhavemadeMOREthan100%intwomonthstime:
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ThisiswhatmakestheUltraShortETFssohandywhenaCrisishits:becausetheytrulyskyrocketasinvestorsstampedelikeelephantsintosafety.However,IMUSTSTRESSthatthesearenotinvestmentstobuyandhold.Instead,theseareshort termtradesyoushouldmakeONLYoncestockshavebeguntotrulycollapse.SimplyaddthemtoyourondecktradestomakeoncethenextCrisishits.
Youreprobablyaskingyourself,howcanIdistinguishbetweenanordinarycorrectionandaREALCrisis?Letsseewhathistoryshowsus.Ifyourecallfrom2008,stocksdidntgostraightdown.Insteadtheydropped,bounced,andthenbegantheseriouscollapse.Lookingbackatthattime,the50DMAservedasausefulmetricforgaugingthataseriousdeclinewasabouttobegin:
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Asyoucanseestocksrolledoverandbrokebelowtheir50DMAinlate2007.Afterthat,the50DMAactedasstrongresistance.Indeed,therewasonlyonebounceabovethislevel,whichlastedroughlyamonthandahalf.Therealtroublebeganinthesummerof2008,andinvestorsweregivenadecentwarningwhentheS&P500collapsedandthenbouncedtotestthe50DMAandfailedtobreakit.
Similarwarningsappearedbeforethe1987Crash:
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TheTechBubble:
Andthe2008Crash:
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For this reason, I suggest buying the UltraShort Russell 2000 ETF (TWM) when themarket begins its next real collapse.
The UltraShort Russell 2000 ETF (TWM) returns 2X the inverse of the Russell 2000.
So if the Russell 2000 falls 5%, TWM returns 10%. If the Russell 2000 falls 10%, TWMreturns 20%. Its a terrific means of playing the collapse in small cap stocks.
Again, wait for stocks to enter a free fall before opening this trade.
Trade #2: Short Financials
By now you know that the current Crisis has centered on the financial sector, specifically
the banks. TheProtect Your Savings report details the issues extensively. However, asfurther proof, the below chart shows that US banks are about to get slammed with another
round of mortgage defaults from the residential housing sector (Im not even going tobother including the commercial real estate market which is a multi-billion time bomb in
of itself).
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Suffice to say, Financials have a lot of issues coming their way in the future. For that
reason, when the next Round of the Crisis hits, I suggest buying the UltraShort
Financials ETF (SKF).
SKF returns 2X the inverse of the Financials ETF (IYF). So if the IYF falls 5%, SKF
returns 10%. If the IYF falls 10%, SKF returns 20%. Its a terrific means of playing thecollapse in financials stocks.
Again, wait for stocks to enter a free fall before opening this trade.
Trade #3: Short the Retail ETF
TheUSconsumeraccountsfor70%ofUSGDP.Realunemploymentiscurrentlycloseto17%.FoodStampusageisaroundarecord38million.Taxreceiptsfor2010sofarareLOWERthan2009slevels(didnteveryonethinktheentireworldwasendingbackthen?).Andyet,retailstocksarebacktotheir2007highs:
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Asyoucansee,retailstocksingeneralareupnearly200%duringtheworstrecessionindecades.Itssimplystaggering.Forthatreason,IsuggestShortingtheRetailETF(XRT)whenstocksstarttocollapse.XRTgivesbroadexposuretotheretailsector.Itstopholdingsare:
Company %ofAssets
CaseyGeneralStores 1.9%Gamestop 1.9%
JosABankClothiers 1.8%Netflix 1.8%
TractorSupply 1.7%
AnnetaylorStores 1.7%
LimitedBrands 1.7%ChildrensPIRetailStores 1.7%
BestBuy 1.6%
AbercrombieandFitch 1.6%
ShortingthisETFgivesyoutheopportunitytoshortretailacrosstheboard.However,ifyouremoreinclinedtoshortspecificcompanies,IdfocusonapparelandclothingretailerslikeGap(GPS),LimitedBrands(LTD),Nordstrom(JWN),andthelike.Aswiththeothertrades,onlyentertheseshortswhenthemarketbeginstoenterafreefall.
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Trade #4: Short the Emerging MarketsEmergingmarketshaveleadedtheUSonthislatestrally:theybottomedbackinNovember2008,whileUSstockscontinuedtoplungeuntilMarch2009.Thatsnottheonlyleadingemergingmarketshavedone.WhiletheS&P500isupsome60%
fromitsMarchlows,China,BrazilandtheirkindhaveallmorethanDOUBLEDfromtheNovember2008lows.This relationship will reverse in the next Crisis.
During times of Crisis, the flight to safety involves institutional investors dumping
their foreign shares to load up on Treasuries or other perceived safe havens.Consequently, emerging markets are hit hardest when the markets collapse.
For that reason, when the next collapse begins I suggest shorting emerging markets viaany number of inverse Ultrashort ETFs. The most popular ones are:
1) The UltraShort Emerging markets ETF (EEV)2) The UltraShort China ETF (FXP)3) The UltraShort Brazil ETF (BZQ)
All three of these return 2X the inverse of an underlying index: the MSCI EmergingMarkets ETF, the FTSE/ Xinhua 25 ETF, and the Brazil ETF, respectively. As such, they
represent a great way to pocket major gains when the emerging markets collapse alongwith the rest of the financial world during the next Crisis.
Aswiththeothertrades,onlyentertheseshortswhenthemarketbeginstoentera
freefall.
ConclusionThisconcludestheourreport.IfyoufoundthisinterestingyoumightwanttoconsiderdelvingintoourotherFREEreports.Allofthemareavailablefordownloading.Simplyclickhere.Good Investing!
Graham SummersChief Market Strategist
Phoenix Capital Research
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