“In the world of finance, the only black swans are the history that investors have not read.” – William Bernstein

Following the 2007-09 financial crisis, many investors decided they needed insurance on their portfolio to protect against the possibility of another “black swan” event.

It’s hard to believe that this was ever the case considering where the markets stand at the moment, but investors tend to have a very short memory.

In the aftermath of the crash, the fund industry took full advantage of the change in sentiment and rolled out a host of new funds that were supposed to help investors if there was another downturn — long/short funds, tail risk strategies, absolute return funds, option hedging strategies, tactical asset allocation funds and the like. Investors poured money into these funds with a heavy dose of hindsight bias by allowing the recent past to shape their investment decisions.

Those who piled into these funds missed the idea completely. They were trying to plan ahead for uncertain events that could surprise everyone. Of course this is impossible, because you can’t hedge out the risks of unknown events…they’re unknown after all.

What investors are really afraid of is losing large chunks of money like they did during the crash. Losing money is a risk that you can define. Black swans are risks that you cannot define. We can work with the former, but not the latter.

Since 1928, the S&P 500 has suffered 24 down years on a calendar basis, a hit rate of roughly 30%. Here is a table with each one of those losses along with the return for the 10 Year Treasuries during the down years:

We always assume that the most complicated solution will prove to be the best one. Wall Street salespeople and brokers will use this to

their advantage and your detriment, to sell you complex and expensive products that play up to your most recent fears.

This was the basis for creating hedged strategies after a market crash.

Yet anyone with a solid grasp of market history could have told you that bonds generally perform well when stocks drop. In 21 out of the 24 years that stocks fell, bonds rose while outperforming stocks by an average of 19%.

Data going back to the 1930s is mostly illustrative to show you how diversification has worked in the past.  I don’t expect most investors to be investing directly in Treasuries for their bond allocation. The Vanguard Total Bond Market Fund is more diversified and allows easier access for investors.

The fund dates back to the late 1980s.  Here’s how it held up against down years in S&P 500 since then:

Bonds have done their job. Of course, stocks still rose 7 out of every 10 years and dominated bonds in overall performance over that time frame, so you can’t completely give up on equities just because they lose money sometimes.

Even though interest rates are low and bond investors can’t expect huge returns going forward, bonds can provide a diversified portfolio the following attributes:

(1) Bonds can act as an insurance policy against poor economic conditions such as a crisis or deflationary period.  Investors flock to high quality bonds during times of unrest.

(2) Bonds will be your dry powder to purchase equities during the periodic selloffs in stocks. The crash marked down stocks a great deal in price, but it didn’t matter if you didn’t have any cash to put to work.

(3) And bonds can help you sleep at night as a way to decrease your risk. This is probably the most important attribute for bonds. They add to your emotional diversification by allowing you to create a balanced asset allocation that you can handle based on your personal risk tolerance.

Following the crash there was also a steady stream of people claiming that diversification was broken. This never made any sense to me. Bonds did their job by providing stability in the face of an economic collapse. Stocks did what they always do when investors freak out — they got slaughtered, but eventually came back to life once everyone wrote them off for good.

This is how the investing cycle works.

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Not surprising… It is now official; the US Federal Reserve has shifted from being US data to global data dependent. Indeed, the Fed left its target rate unchanged, citing adverse global economic and financial developments which could eventually restrain economic activity. In other words, the Fed decided not to rock the bond market, delivering exactly what the consensus of investors was expecting. As for the economic forecasts, the Fed mildly brought down forward inflation targets and Fed fund rates without modifying its economic growth outlook.

But disappointing… As we outlined in our note…

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You remember the old Smith Barney commercials, don’t you? The ones from the late 1970s, which starred John Houseman and his impeccable British accent?

The tagline: “They make money the old fashioned way. They eeeaarrrnnn it.”

Well, Morgan Stanley officially retired Smith Barney’s name a couple years ago. And Wall Street investors all but retired Smith Barney’s reputed approach as well.

Thanks to the Federal Reserve, Bank of Japan, European Central Bank and others around the world, investors gave up on doing much research, worrying about risk, or caring about real economic and corporate earnings news. They came to believe that kind of quaint, old-fashioned stuff was as outdated as the black and white TV Houseman’s ads used to run on in my house growing up!

But now, we’re in a whole new paradigm. We’re in an environment where Wall Street investors are going to have to eeeaarrrnnn their profits again because the tide is no longer rising, and lifting all boats. The great global flood of rising liquidity is draining, even with the Fed deciding to stand pat on interest rates this week. You can see the evidence showing up in everything from the junk bond to currency to commodities markets.

At the same time, volatility and risk indicators in bonds, in stocks and in money markets are on the rise. The major stock averages are starting to stumble, while tons of individual names are doing much worse than the indices. Bad news from the real world is increasingly intruding on the fantasyland environment Wall Street has been living in, causing consternation and worry the likes of which we haven’t seen in years.

Many mainstream pundits haven’t caught on yet … which is typical. They’re comparing the recent market stumbles to the Flash Crash of spring 2010 and the Debt Ceiling debacle of summer 2011. But I disagree. Those were short-term corrections driven by esoteric, one-off events: A breakdown in market function (2010) and a political stalemate in Washington (2011).

What’s happening now looks to be both more severe and potentially longer-lasting. That’s because these moves stem from huge, underlying changes in the world economy and monetary policy rather than one-off trigger events. At the same time, the technical indicators I watch are flashing a much brighter shade of red now than they did back then.

Could I be wrong? Of course. It’s happened before and it’ll happen again.

But doesn’t it make sense to err on the side of caution?

Don’t you think that with so many warning signs out there, capital preservation becomes increasingly important?

Won’t you sleep better at night giving up some potential gains if I’m wrong, in exchange for dodging huge potential downside risks if I’m right?

I know my answers to those questions. I believe they’re the same ones John Houseman would talk about today if he were still alive. So I recommend you take them to heart when you decide what to do with your hard-eeeaarrrnnned money.

Until next time,

Mike Larson

On 23 April 2008, I stated in this article that an “imminent disaster [ ] await[ed] US stock markets”, and that “people seem[ed] to [have forgotten] one central and critical point. Most people seem to believe that they have to lose a great deal of money when crises materialize and forget that it is absolutely possible to prosper during crises as well. Thus, because they feel they must suffer during a crisis, the ‘shoot the messenger of bad news’ syndrome commences.” Many people laughed off my article back then, calling it idiotic, stating that they were happily “all in” and gladly would make tons of money in a rising US stock market while I stayed on the sidelines. Bu now, of course we all know that a US market crash started just a couple of weeks later after I wrote this article, and didn’t stop falling until its valuation had been cut in half. This year, on July 25th, I vlogged here that US crony bankers had shut down the NYSE to prevent a stock market crash that had started to materialize that very day. Again, my vlog elicited some that said they were “not buying” what I believed at the time to be the most plausible explanation, based upon facts, of why bankers shut down the NYSE, which by the way, was an unprecedented move. Just one month later, in case people remained skeptical of my warning on July 25th, I followed up my previous warning with a much more urgent tweet that the bankers would not be able to stop the US stock market crash that they had stopped on July 25th. I released this more urgent warning on August 20th, just one day before the Dow Jones Industrial Index plummeted by more than 1,600 points in the following two days.

Now that the US markets have traded between a range for several days, the mass media is bombarding everyone again with a “it’s a great time to buy more US stocks!” narrative that will prove to be poison to any retail investor foolish enough to swallow these sales pitches. If you don’t understand how Central and Commercial bankers are manipulating these markets to manufacture “up” days to grant the appearance of market recovery amidst great structural fragility, then I recommend that you visit a lot of the referenced links in this article, where you can find a lot of detailed information and analysis about how bankers manufacture these illusions with manipulated rigging. To allocate any of the money you earn on the basis of empty banker promises of higher asset prices without understanding the risk-reward metrics of doing so is NO strategy at all, but instead a risky proposition based entirely on hope. Doing so is extremely likely to separate you from your money. Central Bankers are working overtime right now to sell their “Buy Global Stocks, Sell Gold & Silver” narrative, but even as gold and silver prices continue to remain weak, do not fall for it. You must take the time to dig well beneath the surface to see what is really coming down the pipe.

I want to show you a graph of how the US stock market crash played out in 2008, because with 7 years having passed by now, the details of this crash have been erased from most of our memories by now. In the below graph that illustrates the 2008 US market crash, there are three periods of time that I have circled.

The first circle was the day I predicted an imminent crash was coming. You can see that for two weeks afterwards, the US markets actually trended higher, and during this time, many bombarded me with gloating comments about how wrong I was in predicting an imminent market crash. Then the US stock market decline began. Then for two months, the stock markets leveled out (the period I’ve circled in green), when all the salesmen once again came out of the woodwork to exclaim, “The worst is over. Now is the time to buy US stocks!” (sound familiar to what is happening right now?). Unfortunately, many purchased just prior to a furious selloff (the large red circle). In fact, I wish I had saved some of the headlines from August of 2008, because they were exactly the same as the mainstream media headlines being bandied about today of “the correction being over and the time now being ripe to buy US stocks again at bargain prices!”

However, if you review the US stock market crash in 2008, people called me wrong for months after my prediction just because they didn’t understand the definition of the word “imminent”. Imminent means soon but it doesn’t mean the crash is going to play out in a few days, and indeed, the US stock market crash started less than three weeks after I made that prediction and took a little bit of time to really gain momentum after an initial period when the US stock markets sold down by about 17%. Shortly after this initial strong sell-off, the market actually rose slightly for several weeks, invoking the perpetual salesmen employed by global investment firms to declare that the correction was over and that it was time to start buying US stocks again. This is the period I’ve circled in green above. After many were lured backed into the US stock markets, they finally crashed hard in October. If you look at the US stock market selloff to this point today, I believe that we are currently in that period of that green circle, a period of relative calm before a stronger, more devastating dive occurs. I’ve circled in green in the below graph, this same period when the huge structural fragility that still exists in US stock markets is being sold to the masses as just a “mere correction” in a continuing US bull market. However, if you reference this vlog I released recently, the regular occurrence of 6-sigma and 7-sigma events in global markets every few days to few weeks should make the fragility and risk inherent in many global markets crystal clear. As confident as I was back in 2008 that my prediction would come to fruition, I’m standing by my 19 August 2015 prediction that a US stock market crash was imminent (this prediction has already played out) and I am predicting that this initial sell down phase will progress and become deeper, just as it did in 2008 (this prediction has not yet played out).

With the massive volatility in global asset prices that have been occurring for the past several months, as I’ve spoken about here, many people have told me that they are completely out of the markets because they are afraid of price behavior they cannot make heads or tails of, and are now just sitting 100% in cash. However, in my humble opinion, a “do nothing” strategy is a terrible strategy as well, as one has to plan for difficult times when one has the opportunity to do so, and NOT start one’s planning when the difficult times are full-blown, as any benefits from planning during this phase will be minimal. So while we still have the opportunity to plan,we all should be proactive NOW and not just be sitting 100% in cash. If you haven’t watched this video, just watch this video and you will understand why. In the dozens of nations in which Central Bankers have already destroyed domestic fiat currencies within the past year, those that wrongly believed they would be okay just by sitting out markets in cash unfortunately have had their savings absolutely destroyed and ruined.

If you understand that the global fiat currencies I referenced in this video have been destroyed due to the US Federal Reserve, Bank of England, Bank of Japan, European Central Bank, and Bank for International Settlement banker policies, then you will understand that it is inevitable that these policies will eventually come home to roost for the world’s top-owned fiat currencies as well. Other smaller nation’s fiat currencies have already been destroyed over the last 12 to 36 months because these other nations’ Central Bankers don’t have the power to manipulate and uphold their currencies to make them appear temporarily strong even when they are structurally damaged beyond repair, as do the world’s most powerful Central Bankers. Even though buying physical gold and physical silver is a protective strategy against Central Banker currency wars, as I noted in this referenced video that I posted on 24 August 2015, “This video is not an endorsement of buying gold and silver right at these prices today, as specific guidance of when to buy gold and silver is provided only through our subscription services. However, this video should adequately outline the necessity of owning physical gold and silver to all viewers.” In fact, we shorted and closed out positions in silver to a +16% gain and in gold to a +2% gain after I posted that video on 24 August 2015. So it is necessary to understand banker fraud and manipulation of asset prices well enough to execute your strategies at low-risk, high-reward inflection points in the market.

In conclusion, the critical message here is now is NOT the time to take a do nothing approach. One must be proactive in formulating intelligent strategies now for increasing volatility and financial turmoil that is on the way. Being paralyzed by fear or burying one’s head in the sand because of the extreme volatility in asset prices or clutching to hope that markets will turn higher again are neither strategies or part of an intelligent and well-informed decision-making process. Should you wish to learn how to formulate intelligent strategies to continue achieving positive yields during uncertain, volatile markets, then please come by smartknowledgeu.com and browse through our various services and our detailed annual performance since our inception 8 years ago.

– JS Kim