Hi Antagonist readers.
Welcome to our deep-dive issue for September.
In the most recent edition of Over the Weekend, I shared how you can protect yourself from a credit event and an ensuing stock market crash by investing in assets that aren’t correlated to equities.
In other words, you want to invest in things that don’t move in-step with stocks. In this issue, I’ll suggest some specific ways to do that.
I’ll also explain how and why you should be using trailing stops in your portfolio. A trailing stop is a simple strategy that lets you continue to profit when stocks rise but also minimizes your losses when they fall.
It’s easy to hold onto your stocks as they climb. Many investors, however, make the mistake of hanging on too long during a market correction. A trailing stop eliminates emotions from your decision and helps you keep your profits instead of watching them bleed off as markets crash.
Here’s what’s we’ll cover today:
Assets to consider outside of stocks.
Trailing stops: remove emotion and keep your profits.
Read and tell.
1. Assets to consider outside of stocks.
Let me start with a disclaimer. I love stocks. Ever since my aunt bought me one share of Toys R Us when I was 8 years old in 1986, I’ve been hooked on stocks.
I also love finding stocks that soar double and triple digits. Who doesn’t?!
But while hot stocks grab all the headlines, superior returns don’t come from bull markets alone. After all, anyone can make money in a bull market.
To rise above the crowd and become a truly great investor who beats the market and builds financial wealth, your performance during bear markets is the key.
Every investor will lose money from time to time, but you must minimize those losses when stocks fall for extended periods of time (i.e. during bear markets). Otherwise, you’ll find yourself in such a big hole that it could take you years just to build your portfolio back up to where it was before the market crashed.
If you simply avoid steep drawdowns in your account, you’ll be far ahead of most investors.
But what if you could make money even as stocks crash? That’s the most effective way to supercharge your portfolio’s growth.
This isn’t something reserved for Wall Street professionals either. There are several ways you can do this on your own. Here are some strategies to consider:
Use an ETF-based, momentum strategy like the Papa Bear.
I’ve written several times about the Papa Bear strategy by Muscular Portfolios. It consists of two main components:
Underperform the S&P 500 with less volatility during bull markets.
Keep losses small during bear markets.
Since this strategy is designed for the long-term, any gains you miss out on during a bull market will be more than compensated during a bear market. For example, when the market crashed in the Spring of 2020, the S&P nosedived over 33%. The Papa Bear portfolio, meanwhile, only lost 8%.
Rotate out of stocks when they fall.
The Papa Bear tracks the performance of 13, low-cost ETFs that you can trade commission free with most online brokers.
Notice that the ETFs span multiple asset classes. That’s the key to success when stocks enter a bear market. You have to reallocate your money to assets that don’t move in tandem with equities. Doing so will reduce your losses or even let you make money as stocks fall.
One day per month, you simply check this site to see which 3 ETFs have achieved the best gains over the average of the last 3, 6, and 12 months. You don’t have to calculate anything. All the work is done for you. You then buy the top 3 ETFs, splitting your money evenly across them.
To read more details about the Papa Bear strategy and how to implement it, check out this article.
Buy oil and energy stocks and/or ETFs.
Beginning with this 2-part report last February, I’ve been writing extensively about how we’re heading toward a global energy crisis.
Lack of oil supply and production is such a problem that it’ll overwhelm demand, even if that demand slows because of a recession or inflationary pressures in the short term.
To make matters worse, the U.S. strategic petroleum reserve (SPR) recently reached its lowest level since 1983. This means that the government can no longer drain it to suppress gas prices (that’s not what it was designed for anyway).
Also, slow demand can’t last. There are simply too many people who need energy around the world, and green alternatives are nowhere near capable of fulfilling that need.
From an investing standpoint, these conditions make energy and oil stocks an excellent way to profit even if we enter a recession and other stock sectors fall.
We’re already seeing this play out.
Since the end of May, the energy sector (XLE) and the oil and gas exploration and production industry (XOP) have vastly outperformed the S&P 500 (SPY).
As you can see in the chart below, XLE (red line) and XOP (blue line) are up 19% and 25%, respectively. Meanwhile, SPY (green line) has only gained 3%.
The divergence of energy/oil from the S&P 500 is even more interesting. While the broad market plateaued and then declined, energy/oil increased or at least held onto its gains.
This divergence supports Louis-Vincent Gave’s thesis that energy is the ultimate diversification for your portfolio. To read more about this, check out the most recent edition of Over the Weekend.
The simplest way to invest in energy and oil stocks is via the two ETFs that I mentioned above: XLE and XOP. Doing so will give you exposure to multiple companies.
If you want the opportunity to achieve even greater gains, however, consider honing in on a handful of stocks that have huge upside. That’s what we’ve done in our Blend Portfolio.
The results have been outstanding with 4 out of 5 of our energy picks beating the S&P 500.
In fact, our top performer has gained nearly 8x as much as the index. It’s up a staggering 34% since I recommended it. The S&P 500 is only up 4.5% over the same time period.
To read about these stocks and get access to the entire Blend Portfolio, sign up for a free trial.
Invest in commodities and/or commodity stocks.
AI hysteria might grab all the headlines, but check out how much uranium (red line) has clobbered the S&P 500 (blue line) over the last month.
As stocks continue to struggle, investors will begin to reallocate their money elsewhere. Macroeconomic conditions, geopolitics, high demand, and limited supply are creating favorable conditions for multiple commodities and even a potential commodity “super cycle.”
In addition to oil and uranium, there are other opportunities in agriculture and precious metals (see below) as well. We hold a variety of commodities and commodity companies in our Blend Portfolio. Upgrade to a premium membership to view them all.
Own gold.
In last month’s deep dive, I explained why gold belongs in your portfolio.
Rather than repeating everything here, I’ll simply leave you with this recap of the benefits of owning gold:
When things get crazy, investors tend to buy gold for the safe haven that it offers. That will cause the price of the metal to shoot up, which will reduce your portfolio’s losses from your other positions.
As the U.S. and other countries continue to face uncertainty around inflation and the banking system, gold is a must-own. Precious metals have been used as currency and a store of value for thousands of years. And, unlike paper money, precious metals hold their value.
2. Trailing stops: remove emotion and keep your profits.
Up to this point, I’ve emphasized diversifying your portfolio outside of equities. But does that mean you should ditch all your stocks?
NO!
It’s impossible to time the market much less know what stocks will do in the future. I’m simply urging you to evaluate how diversified you are and determine if you’re protected from a crash.
That does NOT mean, however, that stocks don’t belong in your portfolio.
Stocks could very well rally again. If you sell everything now, you’ll miss out on those gains.
So, what should you do?
It boils down to 2 things:
Hold your stocks as they increase so that you continue to profit.
When they fall into a bear market, sell them before you lose all your profits.
I realize that this sounds like timing the market, which I already said is impossible. No one can consistently sell at the precise top or buy at the precise bottom.
You can, however, get close.
As I mentioned in the introduction to this article, a trailing stop is a simple strategy that lets you continue to profit when stocks rise but also helps you minimize your losses when they fall.
How trailing stops work.
A trailing stop is when you close a position if it drops a certain percentage. There are two ways to employ this strategy.
The first is based on the price at which you buy the stock. To make math easy, let’s pretend that you buy XYZ for $100 and decide to use a 25% trailing stop.
Now let’s say that the stock immediately goes south after you buy it. If the stock drops to $75, you’ll hit your trailing stop of 25%. I use closing prices to determine my stops. If the stock closes for that amount, I sell it the next day no matter what. This helps keep my emotions at bay.
But what if the stock climbs?
That’s where the “trailing” part of the strategy comes in.
Let’s use the same example of XYZ with a purchase price of $100. But this time, the stock leaps to $150. You’re up 50%! Using a trailing stop will help you protect those gains.
You simply apply your trailing stop amount—in our case 25%—to the highest closing price. So, if XYZ is $150, it means that if the stock drops 25% from there, you sell it the next day.
In this example, XYZ would need to fall to $112.50 before you closed it. If that happens, you’ll be disappointed that you didn’t sell at $150, but remember, timing the exact top is nearly impossible.
Also, employing a trailing stop gives your stock a chance to recover. For example, if XYZ hit $150 but then dropped to $135, you wouldn’t sell (as long as you still believed it was a good investment). If you’re correct in your assessment, the stock is probably just going through a temporary downturn like all stocks do.
The trailing stop, however, lets you know when to cut bait. In this case, that’s $112.50. Sure, you wouldn’t gain 50%, but you’d still realize a profit of 12.5%.
This is a very different strategy than setting a stop loss.
A stop loss is a predetermined price that you decide to sell a stock if its price falls to that level.
Let’s use our XYZ stock example again. You buy it for $100, and you decide that if it drops 25%, you’ll sell. Therefore, you enter a stop loss of $75. If the stock falls to that price your stock will automatically be sold.
Stop losses are great for limiting your losses, but they don’t help you keep your profits. XYZ could soar to $150 but then crash to $75. If you just kept your stop loss at $75, your trade would have turned from a winner to a loser.
To protect your profits, you would need to keep raising your stop losses as the stock price climbed. When you do that, however, you’re now employing a trailing stop. The two strategies are similar. The main difference is the “trailing” part.
The “gapping” problem.
A traditional stop loss order turns into a market order once the stock reaches the predetermined stop price. This means that the stock will sell at the best available price once the stop is triggered.
The problem, however, is that most stop loss orders are only active during regular trading hours. This is where gaps come into play.
A “gap” is when a stock opens at a significantly different price than it closed at the previous trading session. This can be due to various reasons, including earnings announcements, significant news events, or changes in the broad market.
For example, let’s say you own a stock that closed at $100 during regular trading hours. You have a stop loss set at $90. After the market closes, the company announces disappointing earnings, and the stock begins trading at $80 after-hours.
The next morning, the stock opens at $80 during regular trading hours. In this scenario, your stop loss would be triggered at the open, but instead of selling at $90 as you intended, it would close around $80. That’s because the stop loss turns into a market order and will execute at the best available price.
This is a problem not only because you’ll end up selling lower than you wanted but also because you can no longer benefit from a rebound.
After a large gap down, stocks will often rise and fill the gap shortly afterward. That’s because gaps are usually (but definitely not always) an overreaction. If your stop loss automatically triggers, however, you won’t have the opportunity to benefit from a price rebound.
That might be okay if you don’t want to own the stock any more. But I prefer to evaluate the reasons for the gap and then make a decision.
Manually close your stocks when they hit your trailing stops.
I don’t enter my trailing stops in my broker’s platform ahead of time. Instead, I keep a spreadsheet that tells me the trailing stop price of each of my stocks. If one of them closes at that price or lower, I manually sell it the next trading day.
I use closing prices because stocks can be volatile during the day. They might hit my stop and then bounce right off it. In that case, I don’t want a pre-set order to automatically trigger.
If you’re a premium member, you have access to our Blend Portfolio dashboard. In addition to showing the performance of all our holdings, it also provides trailing stop prices. I even set it up so that those prices automatically update as the stocks rise to new highs.
Action to take.
To recap, there’s no need to liquidate all your equity positions. Instead, use trailing stops to continue to profit if stocks rise, but also protect your gains if they fall.
This strategy, coupled with investing in assets that don’t have a strong correlation to stocks, will help you succeed in what is likely to be a challenging market for the next year or longer.
3. Read and tell.
That’s it for this month’s deep dive.
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As always, thank you for reading!
Sincerely,
Jason Milton
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