THIS Is Why We Hedge

The Dow dropped more than 500 points on Monday… only to finish the day in positive territory.

Now, even a few months ago, a massive swing like that would have been news. It would have had investors swapping stories and likely high-fiving each other.

These days, it’s just par for the course.

In fact, Monday’s swing was comparatively minor. Last Thursday saw a 710-point intraday rally that left investors believing that maybe – just maybe – the worst was behind us. Of course, this was followed by a nasty 559-point drop on Friday.

Wild swings are the order of the day.

Whenever we see moves like these, investors are hardwired to look for an explanation. They want to know why the market cratered or why it blasted higher.

Was the arrest of a Chinese executive that signaled a worsening of the trade war that pulled the floor out from under the market? Or was it softer language from a Fed speech that lit the fuse for a rally?

Whenever I hear explanations like these on CNBC, I want to reach into the TV and condescendingly pat the anchor on the head like a child.

That’s simply not how markets work.

Stock prices work just like any other competitive auction. When there are more buyers than sellers, prices rise. When there are more sellers than buyers, prices fall.

For the past two months, there have been more sellers than buyers, which is why the general direction has been down. But beyond that, corrections and bear markets also tend to be a lot more volatile than healthy bull markets. Everything gets more extreme. Stocks fall harder on down days and shoot higher on up days, and intraday swings gets larger as well.

Some investors choose to simply buy and hold and ride out rough patches like these. Most corrections tend to be short and relative painless, after all, so why bother selling to try to avoid downside if you’re just as likely to instead miss the upside when the bull market resumes?

That sounds great, of course. But some of those relatively painless corrections end up sliding into full-blown bear markets like 2008 or 2000 to 2002.

Rather than ride it out and hope for the best, some investors prefer to dump everything and sit in cash until the coast is clear.

That sounds great too. The problem is knowing when to get back in. Excess conservatism can cause you to miss major rallies when corrections turn out to be a lot shallower than feared.

In my trading service Peak Profits, I split the difference. When my model flashes warning signs, I neither close my eyes and hope for the best nor pull the ripcord and eject.

Instead, I hedge. I reduce my usual position sizes in the value and momentum stocks I recommend by half. I then use the 50% of the portfolio that is free to take a short position in the S&P 500.

So, instead of running an aggressive long-only stock portfolio, I run a hedged, market-neutral portfolio. At this point, the market can go up down or sideways, and I’m prepared for it.

Let’s say the market tanks on me. No problem. My portfolio’s value and momentum stocks might take a hit, but any damage is offset by the returns I earn from the short position in the S&P 500.

Likewise, it’s perfectly fine if the market rallies. Sure, I’ll lose money on the short position in the S&P 500. But my value and momentum stocks should enjoy a nice bump.

The important thing is that I don’t have to guess the direction of the market.

I simply have to choose a portfolio of attractive value and momentum stocks that are poised to either gain more or lose less than the S&P 500. And once my model signals that the worst of the correction is over, it’s back to business as usual. I close out the short position and increase the position sizes in my value and momentum stocks to their regular levels.

Happy Guy Fawkes Day

Remember, remember the Fifth of November,
The Gunpowder Treason and Plot,
I know of no reason
Why the Gunpowder Treason
Should ever be forgot.
Guy Fawkes, Guy Fawkes, ’twas his intent

To blow up the King and Parli’ment.
Three-score barrels of powder below
To prove old England’s overthrow;

By God’s mercy he was catch’d
With a dark lantern and burning match.
Hulloa boys, Hulloa boys, let the bells ring.
Hulloa boys, hulloa boys, God save the King!
–Traditional English nursery rhyme

It doesn’t get a lot of press on this side of the Atlantic, but today, November 5, is Guy Fawkes Day.

This is the day the English remember one of their most notorious villains or one of their most celebrated heroes, depending on their mood, religion, ideological leaning, or perhaps how early they started drinking that day.

In the early hours of November 5, 1605, Fawkes was found hiding under the House of Lords with a cache of explosives large enough to level the entire building. It was his plan to take out the entire government — king, ministers, parliament and all — during the State Opening of Parliament. Now that’s one way to cut government waste!

Naturally, he was brutally tortured and executed. But he is remembered, in typically dry English humor, as the last man to enter Parliament with honest intentions.

Today, the English celebrate Guy Fawkes Night with fireworks displays and by burning effigies of Fawkes or other contemporary political figures, but it’s always a little ambiguous as to whether they’re celebrating the foiling of the gunpowder plot or the murderous spirit of rebellion behind it.

More than anything, it’s an excuse to get together with friends and light things on fire… something that every red-blooded American should appreciate.

While I was studying at the London School of Economics, I enthusiastically went native and burned a few effigies myself, though to save my life I couldn’t tell you who or what we were symbolically burning.

Coming back to the present, we have a midterm congressional election tomorrow in what is the most polarized political climate of my lifetime.

My normally quiet neighborhood in Dallas is absolutely inundated with campaign signs, which is something I’ve never seen before, even during presidential elections.

Lake Highlands has always been idyllic 1950s America, a place where parents push their kids on front-lawn tree swings and people consider it impolite to talk politics.

Well, that’s changed… and not for the better. Neighbors with opposing campaign signs now flash dirty looks at each other across their perfectly manicured lawns.

I hate that. And I blame both parties for letting it get to this point. We have a Republican president that behaves like an internet troll and Democratic congressional leaders that seem to think it’s acceptable to have angry mobs disrupt the dinners of their Republican counterparts in restaurants.

A pox on both of their houses. There is no civility, and it’s made life materially worse for all of us.

As tempting as it might be, I’m not going to recommend that you follow Guy Fawkes’ lead by blowing up Washington, D.C., and murdering the entire government. Though you’d be doing the world a favor, that’s the sort of thing that gets you locked up in Guantanamo for the rest of your life.

But I do have some suggestions for you.

To start, turn off your TV. If possible, use parental controls to block CNN, Fox News, MSNBC and any other news stations. The way I see it, the caustic political bile is more damaging to impressionable young minds than violent or pornographic movies. Save your children – and yourself!

You don’t actually learn anything from watching the news. It won’t make you smarter, as the format is far too superficial to be truly informative (if you want real information, read a book or watch a long documentary).

The news won’t make you richer either, as it is rarely actionable. The news is really just a respectable-looking form of entertainment. Except unlike actual entertainment, it’s not fun or relaxing. The time you waste watching the news is time you could better spend making money or enjoying proper leisure.

Perhaps even more importantly, step away from social media. Twitter and Facebook are probably more responsible for the breakdown in civility than the politicians and pundits that use them. They bring out the worst in all of us.

At the very least, you should mute anyone who expresses political views in their social media stream… even views you agree with. Reading other people’s political rants will not add a day to your life or a dollar to your wallet. It will just put you in a bad mood and may even damage otherwise decent friendships. You don’t need to that.

In a fit of disgust a few years ago, I deleted most of my social media accounts. You don’t have to be quite as extreme as me, of course, but you can at least delete the apps off of your phone. You can still access the accounts via your computer, but you won’t be impulsively checking your phone every 30 seconds like a heroin addict.

I also advocate what I call the golden rule of the social media age. Don’t tweet or post something that you wouldn’t have the balls to say to a person’s face. It is the height of cowardice to mouth off on social media while sitting on your couch in your underwear. It’s even worse if you do so with an anonymous account.

At the very least, use your real name and post a recent picture of yourself. If you don’t want your name or face associated with it, you probably shouldn’t be saying it.

And finally, drink beer.

I’m not joking. There is nothing more conducive to civilized living than sharing a six-pack with a neighbor. Just make sure you actually listen to them rather than simply waiting for your turn to talk. You may not agree with them on everything (or anything), but you might find you like them anyway.

That’s all for today. A very happy Guy Fawkes Day to all my libertarian, anarchist and other assorted ne’er-do-well friends out there. Have fun tonight. Just try to avoid burning the city down.



Will Value Investing Run Up Next?

I’m going to keep this short because I’m putting the finishing touches on my presentation for later this week at the Irrational Economic Summit in Austin.

Though I have no love for the University of Texas (the Longhorns humiliated my beloved TCU Horned Frogs in a 31-16 rout last month), I’m excited to be headed to Austin for the week. For good music, good food, and good times, you really can’t beat Austin.

If you’re attending the Summit, be prepared for authentic Texas blues, Texas barbecue and, most likely, a little Texas beer too. And be sure to look for me in the crowd.

I love chatting with my readers, and it’s a great opportunity to ask questions and spitball ideas. Just do me a favor and avoid any mention of college football. It’s just too painful to discuss this year.

The theme for the summit is disruption, and my presentation will be on “Securing a Stable Stream of Income Amidst the Chaos.”

I plan to cover three broad themes: My outlook for bonds, the coming rotation from growth stocks to value stocks and, naturally, my favorite sectors for the coming year.

I don’t want to spoil the presentation by telling you too much, but I’ll give you a sneak preview…

Sneak Preview

It’s no secret that value investing works. Countless studies (and real-world practitioners) have proven that a strategy of buying cheap stocks beats the market over time.

Dimensional Fund Advisors recently ran the numbers for the 90-year stretch of 1926 to 2016 and found that a disciplined large-cap value portfolio outperformed the S&P 500 by over 2% per year.

That 2% might not sound like much. But compounded over the length of the study, it made a huge difference. A dollar invested in the S&P 500 in 1926 would have grown to a little over $6,000 by 2016. That same dollar invested in the large-cap value portfolio would have grown to over $13,000.

That’s huge.


The problem with value investing is that it doesn’t outperform every year… or even every decade. There are long stretches where value gets its butt kicked.

Take a look at the chart below.

This divides the value of the Russell 1000 Value Index by the Russell 100 Growth Index.

When the line is rising, value stocks are outperforming growth stocks. When the line is falling, value stocks are underperforming growth stocks.

We’re Poised for a Comeback

Going back to the late 1970s, growth and value have each had three respective stretches of outperformance.

Value outperformed throughout the early to mid-1980s, though growth dominated in the late 1980s. Value enjoyed a nice comeback in the early 1990s… though when the dot-com boom really got underway in the mid-1990s, growth left value in the dust for several years.

Value enjoyed a massive run of outperformance from 2000 to 2007. These were some of the very best years in the careers of long-time value investors like Warren Buffett.

But for the past 10 years, growth has utterly crushed value.

I believe value is poised to make a major comeback. I won’t go into detail today, as I don’t want you skipping my presentation on Friday and hitting happy hour early.

But I believe the next five to 10 years could look a lot like the 2000 to 2008 period.

That’s bad news if you’re betting heavily on social media stocks. But it’s fantastic news if you’re a value or income investor like me.



The Cheapest Way to Own Real Estate Right Now

Most think of it as the “bull market in everything.” But the past decade has been anything but a bull market for my favorite sector.

In fact, prices today are sitting at 2006 levels… and this despite the most accommodative Federal Reserve policies in history over most of this period.

Prices started to sag in early 2007 and then rolled over and died over the next two years. The sector had several strong years of recovery, but prices today are no higher than they were in 2013 and are still a decent bit below their old 2006 peak.

If you’re a value investor like me, that’s the sort of thing that ought to get you excited. At a time when the major indexes are coming off of their best run since the go-go years of the 1990s, this is a sector that investors have mostly left for dead.

The story gets even more compelling when you consider the power of dividends.

When you include dividends paid, the returns look a lot better. My favorite asset class is up about 46% from its pre-crisis top and up 440% from its 2009 bottom.

So, lest there be any doubt, dividends matter. In this case, they make the difference between having losses over the past 12 years and having returns of nearly 50%.

I suppose it’s time to let the cat out of the bag.

My Favorite Sector Is…

My favorite sector is income-producing real estate.

Real estate stocks haven’t exactly been popular of late. The sector got its butt kicked during the 2008 meltdown, and investors have been reluctant to touch that hot stove again. This is particularly true given that the sector was popular with retirees who liked the stocks for their income potential.

It’s been a particularly rough ride since 2013. That year, Fed Chairman Ben Bernanke merely mentioned the possibility that he might scale back the Fed’s quantitative easing program, and that was enough to rattle the bond market and send high-yielding real estate shares sharply lower.

Two years later, Bernanke’s replacement, Janet Yellen, rattled the sector again when she hinted that rate hikes would be coming soon.

Real estate stocks had one last hurrah into mid-2016, but rising bond yield took the wind out of their sails. And the “volpocalypse” this past February slapped the sector around yet again.

Frankly, it’s been a miserable five years to be invested in real estate. But I believe conditions are finally right to see this sector outperform.

To start, real estate stocks are worth more dead than alive at current prices. Recent estimates by real estate consultancy Green Street Advisors shows real estate stocks selling at a 5% discount to the value of the actual property they own.

That should never happen.

Barring a financial panic that sees prices temporarily dip below fair value, real estate stocks should literally always trade at significant premiums to the value of the real estate they own.

Investors pay a premium for professional management and for the ease of buying and selling with a mouse click rather than with a room full of lawyers with contracts.

Yet for most of the past five years, real estate stocks have traded at a discount. That kind of pricing won’t last forever.

But the bigger short-term catalyst will be a moderation in the rise of bond yields we’ve seen recently.

Barring a major recession, I don’t necessarily see bond yields dropping all the way to new lows. But at the very least, I see yields leveling off around today’s levels and probably falling slightly.

Unlike bond coupon payments, which are fixed, rents from real estate tend to rise over time.

Rising rents translate into higher dividends for investors. So, even if we’re stuck with 10-year Treasuries yielding over 3%, owning real estate with yields of 5% to 8% and rising payouts makes all the sense in the world if you want to boost your income.

I think these bargains are so valuable right now, and can help contribute to your retirement so much, that I decided to put together my top five real estate investments in a new report, How to Pocket Thousands in Monthly Income From Real Estate.

I’ll be releasing it this week. Stay tuned to your inbox for details.



Retirement Ain’t Cheap

Your monthly expenses fall once you retire. Or at least they’re supposed to.

But what if they don’t?

Standard financial planning assumes that your expenses in retirement will be 70% to 80% of your expenses during your final working years.

But a recent study by MoneyComb and Duke University suggests that the real number can be a lot higher. As in 130%.

That number might sound ridiculously high at first, but think about it. You might have massive expenses in retirement that you didn’t have in your working years, such as paying for your adult children’s weddings.

Plus, without work taking up eight to ten hours of your day, you have a lot more time to sit around the house and impulsively buy things on Amazon.

But before we get into any of that, consider where the old 70% to 80% rule of thumb came from.

In a simpler time, you might have bought a house at 30 and lived in it long enough to pay off a 30-year mortgage. So, you entered retirement without one of your biggest expenses – the house payment.

Today’s retiring Boomers are far more likely to have moved multiple times for jobs and possibly divorced once or twice. They’ve taken out new mortgages at each stop along the way, resetting the 30-year clock, and enter retirement with those debts left to pay.

That’s a very big difference from previous generations.

Otherwise, where else are big drops in spending going to come from? Your electric bill doesn’t magically drop once your paycheck stops. And you might spend a decent bit more on travel and leisure since you have the free time.

And let’s face it. Unlike their parents’ generation, which learned frugality during the Great Depression, the Boomers were never the most fiscally disciplined. Does that magically change in retirement?

I would take all retirement estimates with a large grain of salt.

As my friend Harry Dent has explained for years, retirement is not the spending breakpoint. Americans hit their peak spending years long before that, between 46 and 54 on average, depending on their income level.

Spending declines after that, but it does so gradually. And it doesn’t suddenly drop 20% to 30% at retirement (or soar by 30%).

As you do your retirement planning, I recommend you take an honest look at your finances.

Unless something is fundamentally changing, such as your mortgage getting paid off, your post-retirement expenses are going to look a lot like your pre-retirement expenses.

And you also might have large expenses you didn’t before, like your daughter’s wedding. Try to set that money aside and out of your regular investment or spending account. Consider that money already spent and not part of your retirement nest egg.

The Social Security Administration estimates that your Social Security benefits will only replace about 40% of your paycheck. That means the remaining 60% has to come from your investments.

That could be $50,000, $100,000, or even a lot higher depending on your lifestyle.

Let’s take a look at the numbers. The following table breaks down how much you’d have to invest in assorted income securities in order to generate $10,000.

I list traditional forms, along with my Peak Income service.



Amount Needed
to Generate $10,000

Savings Account



5-Year CD



10-Year Treasury



Utility Stocks



Peak Income



At today’s current average savings account rate, you’d need a ridiculous $11 million to generate just $10,000.

If you needed an extra $50,000 to top off your Social Security income, you’d need a nest egg of $55 million.

If you have that kind of money, there’s really no point in you reading this. You clearly don’t need my services.

The further you get down the scale, the numbers get a lot more reasonable.

You’d need $751,800 in the average five-year CD in order to generate $10,000 in retirement income, but “only” $325,733 or $304,878 in 10-year Treasury notes or a utilities index fund. That’s still a lot of money. You’d need a million dollars in savings to generate just $30,000.

This is why I write Peak Income. My current model portfolio sports a dividend yield of 6.77%, more than double what you’d get in utilities stocks.

You’d need $147,710 invested for every $10,000 in income. That’s a lot more doable than $304,878… or $11 million.

Bond yields are rising, but they’re still far too low to meet the retirement needs of most investors. And this is where Peak Income comes in handy.

I look for income stocks that are a little off the beaten path. Some sport monster yields over 10%, while others sport more modest yields of around 4%.

But all pay substantially more than what you’re going to get in traditional income investments.