8/28/15

How Not to Lose Your Lunch Over the Markets

It's a beautiful Friday... despite the looming specter of the Stock-Pocalypse we saw this week.

Let me recap that for you. Things were downright FUGLY from last Thursday or so through Monday. Markets across the globe, especially emerging markets, like China, Brazil, Russia, etc, have literally crashed, with unaware and uneducated investors across the globe losing money, sleep, and sanity. The US experienced its first stock market correction (a fall of at least 10%) in over five years.

The US markets are down about 5.7% overall over the past ten days, and have, by and large, recovered their losses. Honestly, a correct like this is nothing to get too concerned about, in my opinion.

But still, people are even jumping off buildings again. It's a sad sight to see, and I pity those who have played with fire, using their life savings as tinder.

I can't help but sit and feel bad about it... but the sad truth is, if you have a well-diversified and hedged ("protected") portfolio, you make money hand over fist, while those around you are getting margin calls and telling the hard truth to their loved ones about all the money they've lost.

I used to be that guy, but not anymore.

What happened, exactly? The market woke up!

I'd like to answer the question that pundits across the globe are milking like a cow to get their ratings quotas for the week: "Why Did the Stock Market Correct?"

The answer is simple. As I've said before, the markets, in an ideal world, should function similar to how things in our natural world do, subject to things like gravity, inertia, and other laws of physics. In a healthy, natural market, there is no central bank intervention, no propping up the economy, no bailouts.

In an ideal world, if a business makes bad decisions, it should go bankrupt. If a country gets itself into debt up to its eyeballs, it should suffer the consequences. Clearing the market of bad businesses, via the process of insolvency, makes way for healthy and profitable businesses to thrive. Propping things up with government intervention only kicks the consequences down the road for someone else to deal with later.

The markets have been defying gravity for years now, without falling, because of unhealthy central bank intervention. Japan has been printing money. The US has been printing money. China has been printing money. Europe IS printing money... but they're all failing to produce anything that even resembles true economic growth.

The markets finally realized this, and they had enough. I speak of "the markets" as if it is a sentient being. And it almost is... it's made up of billions of tiny players, like you and me, who eventually come to a consensus on things. And when everyone is moving in one direction at one time, people get trampled.

That consensus this week was that, it's time for the long-awaited correction.... but not yet time to clear out all the crap in the markets and the economy... I believe that is still down the road a few months, at least.

I've heard the markets referred to as a "rubber band." When it stretches too far in one direction, it will eventually snap back, and things will really hurt when that happens. Alternatively, the rubber band breaks... and the system breaks down, like in 2007-2008. That's when all the crap in the economy truly gets purged, and things can start anew.

It's sad when that happens. Livelihoods are lost. Businesses go bust. Economies suffer--the poor are especially affected, because they haven't been trained on how to weather things out, or prepare for the worst.

Did I Lose My Lunch? Heck No.

Let me tell you how it worked out for me. It's time to reconcile the trades I told you about last month, and a few I've closed since then, which have turned my portfolio around in ways I didn't envision.

Last month for my latest trading caper, I saw an opportunity in Intel Corp. I bought 100 shares at $29.28, and sold a call option on the shares, where I agreed to sell my 100 shares for $29.50 if they were trading above that level on 22 August.

I got paid $57, or 1.9% of the cost of my shares, in cash, to agree to sell my shares. Also, I collected $26.70 in dividends, for a total return of 2.85% in just thirty days.

I keep repeating trades like this every month for the rest of the year, I'll make an annualized return of well over 34% for the year. That's not to mention the other things I did over the past month.

I own some high-dividend stocks in safe, income-producing, business development and real estate companies, which pay me over 10% per year each in straight dividends, not to mention anything I make in capital gains. The BDC I own is up 15% in the last month, and I sold it for a solid 10% gain, in addition to the monthly dividend of .8%.

On Monday, when the rubber band was stretched pretty hard, I knew that things were getting irrational. I took advantage of everyone else's pandemonium to buy an out-of-the-money call option on my shares of Intel which, at the time, were down about 8% from what they are today (I'm down 3% on Intel, and not worried in the slightest, because of the dividends and option premiums I've made). Further, I've sold another option against my shares today.

An out-of-the-money call option, purchased at moments of irrationality, can soar hundreds of a percent when prices normalize, as they have now. The price I bought at was a bit too high to take full advantage of moves like that, so I made only 44% on mine in the three days I held it, selling this morning. 44% in three days. I won't complain.

I have some other holdings which mostly went unaffected during this "mini-crisis." That's because I own a variety of companies with rock-solid balance sheets, gushing cash flows, competitive advantage, and huge market share. When the economy tanks, they lose some value... but nothing like smaller companies do.

During crises like these, I mostly just sit back, watch the show, and snatch up good opportunities when I see them. But they key to making money in down markets, is to already have your ducks in a row before the crap hits the fan. That's what I did.

There's lots of talk out there about the Federal Reserve raising prime interest rates next month. The reason we've seen such a quick snap-back recovery after this week's pandemonium is because investors and speculators realize that it's unlikely the Fed will raise rates, due to this market action. You see, the Fed thinks that the US is experiencing real growth. The Fed also thinks that the stock market is the economy. It's wrong on both accounts.

Keep Doing What You're Doing, as Long as You're Doing the Right Thing

I can tell you what I'm going to continue doing. It's the same thing I always do. I'm going to continue holding my industry-dominating businesses, selling options to generate regular income, and buying minuscule amounts of crisis insurance (less than 0.5-1% of my overall holdings), in the form of put options, until we see the next crisis.

I hope you'll do the same. You won't regret it, I promise. In the near future, I'll be delivering more to you in this regard, so you'll better understand what makes a company "super."

Live long and invest,

Jeremiah