In The Playbook from Gravitational Edge on July 18, we discussed that investors seem to have a conse...
How to profit today when you think the financial zombies will walk tomorrow
10/26/2010 8:30 am EST
But it’s exactly the kind of question investors have to ask. We may think the zombies are coming—in the form of the U.S. debt, a global demographic wave of aging that will soak up savings, a crashing dollar, global water wars, a plunging dollar, or something—but they aren’t here yet, we don’t know when they’ll arrive, and we can’t be absolutely certain that they will show up at all. Cowering in a bowling alley, counting our bullets, and waiting for the first hand dangling decaying flesh to poke through the window isn’t an option for us.
But what is? What do you do to prepare for the attack of the zombies when we don’t know when all our fears will come true or even if they will?
Let me see if I can give you ten ideas for a way to balance the need to make money in the market in the near term and provide zombie protection in the long term.
- Don’t be a fear denier. In all zombie movies—in fact in all horror movies—there are always signs that bad things are about to happen. The family dog disappears. Birds mass on the telephone wires outside the school. The local archeological dig discovers an artifact with indecipherable writing (that later turns out to be as warning not to open that tomb.) The character that ridicules everyone who believes these warning signs always meets a horrible death.
- Don’t get paralyzed by the fear. The character that stands horrified in front of the vampire, the giant spider, or the zombie dies. The character that runs away gets a chance to be frightened another day.
- Study the fear. It’s the scientist who can dissect the alien creature, go face to face with the slime-dripping jaws, and wipe away the disgusting goo that stands the best chance of beating the menace, So do your own dissection by compiling a list of the legitimate long-term fears. (Try not to worry about everything. Yes, the earth could get hit by a comet that sends out an electromagnetic pulse that takes down every computer system in the world, but I don’t think you need to plan for where to safely keep your paper backups. You’ll have bigger problems.) A reasonable but not especially short-list of worries would include: Huge levels of sovereign debt in developed economies from Greece to the United States to Japan. A steady decline in the U.S. dollar. Run away increases in the money supply in both debtor (the United States) and lender (China) nations. An increasing tolerance for inflation. Rising nationalism that makes global solutions whether on currencies, climate change, or water scarcity extremely difficult. A global financial system that still has too much bad debt stashed off balance-sheet whether at private banks, state-owned businesses or national governments. An aging world population that makes solving any of these problems harder and that threatens its own havoc in the form of a steady drain on savings—in those countries that have any.
- Remember that rising fear means rising volatility—and that volatility can equal opportunity. Volatility is scary—I’m not fond of 200-point drops followed by 300-point jumps or 10% month-long rallies followed by 15% corrections. But the heightened volatility of the last ten years is, in my opinion, likely to go on for a while. That’s going to drive the buy-and-holders nuts, especially if the net gain or loss is close to zero. (In some cases we should be so lucky. The NASDAQ Composite Index peaked at 5049 on March 10, 2000. It closed on October 22 at 2479.) But it will mean lots of chances to buy low and sell high. You don’t have to be a day-trader or even a trader to take advantage. Volatility can be a good friend even to long-term portfolios since it gives an investor lots and lots of chances to build positions over time. And to sell partial positions at a profit.
- Towns about to be hit by a plague of zombies, an outbreak of giant underground worms, or an uprising of ghouls from the cemetery under the subdivision descend into panic. People run hither when yon would have been safer. They flee in crowds when ducking down a side street would make escape easier. In investing we say that markets swing to excess and nothing gets more excessive than a market that knows it really has something to fear. Call this volatility written big.
- Buy your hedges early. You don’t want to be in the mob of last minute pump and salt buyers at the hardware store when the news gets out that pumping salt water at them kills the flesh-eating Triffids. Same with any financial hedge. The earlier you buy the protection, the cheaper it is. Of course, the earlier you buy the option, the longer you’ll have to wait for the end of the world and the greater the possibility that information you learn after your purchase will make the protection unnecessary. But there’s obviously a point when the low price of the hedge makes the longer time till you need the hedge, attractive. Right now I’d be asking whether this is that point in real estate (if you want an inflation hedge), natural gas (if you want an energy, climate change or inflation hedge) or stocks in economies that are in a group that haven’t yet achieved anything like BRIC star status (as a hedge against a falling dollar. BRIC stands for Brazil, Russia, India, and China.) This hedge might include Vietnam, Indonesia, Egypt, and Turkey.
- “That town seems normal” may be just the last cruel disappointment in “Invasion of the Body Snatchers before Dana Wynter is turned into a pod person, but diversification does offer real protection from the financial zombies. Worried about the long-term decline of the U.S. dollar? How about the Canadian and Australian dollars? Worried about the soundness of U.S. or Chinese banks? What about their counterparts in Brazil or Singapore?
- Don’t follow the mad scientist. He is mad, you know. Gurus promising 80% returns or guaranteeing total protection from a falling dollar and rising inflation or touting themselves as the next Warren Buffett remind me of the crazed Victor Frankenstein as he shouts, “Mad? Mad! The world thinks me mad!” Well, yes, by golly.
- Don’t fall asleep. (See Dana Wynter above.) Never go to sleep with your windows open when the nights have been troubled by bats. Never let your kid watch TV late at night after she’s told you that she hears voices calling to her from the set. And never take your eye off your portfolio if you’re worried about financial zombies. Take profits. Shift allocations. Never fall in love with your picks.
- And stay constantly alert for anything that promises a solid return without outsize risk. Remember that the idea is to make money while waiting for your fears to take solid shape. If you’re worried about the long-term decline of the U.S. dollar, you should still be able to find profitable investments in the medium term. Keep one-half of your brain on high alert for the financial zombies and one-half on alert for profitable investments. If this sounds hard, it is. (See The Man with Two Brains for instructions.) But I think it’s possible. For example, today I’m adding Citigroup (C) to Jubak’s Picks (see my post later today for details such as a target price.) That’s not because I love the long-term story for Citigroup or think the U.S. economy is going to grow like gangbusters, but because I see the stock as a 12-18 month recovery play as the bank goes from worse to bad. (For more on U.S. banks and thinking about recovery versus long-term prospects for the group, see my post http://jubakpicks.com/2010/10/22/u-s-banks-big-problem-even-after-the-recovery-wheres-the-growth/ )
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. For a full list of the stocks in the fund as of the end of the most recent quarter see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/ )
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