Well, that was a doozy. I woke up a little later than usual on Friday to see that the futures markets were getting creamed, European banks hit multi-decade lows in some cases, and the British Pound plunged.
Since I was heavily short, I hit the snooze button and went back to bed for nine minutes.
Votes are funny things. You never know what will happen. A WWE wrestler famous for wearing a pink boa constrictor becomes Governor of Minnesota, a reality TV star becomes the presumptive nominee of the Republican Party, and Britain decides to leave the European Union.
So, what’s next? Probably more Brexits. Or, at least the threat of more Brexits.
Britain’s exit from the European Union will take a long time to complete. But this vote will strengthen the resolve of other groups that want to decouple from the European Union. Nationalism is on the rise around the globe. And there are more than a few countries that could use a cheap (or cheaper) currency too. They may take advantage of the opportunity this vote presents.
That will lead to more uncertainty going forward… and uncertainty means more volatile financial markets.
As long as I have been writing in this space, I have stated that volatility is likely to be significantly higher than what investors have seen in recent years.
In my experience, most people are scared of volatility. But, in my mind it’s a good thing. Volatile markets can lead to outsized returns if you play it right. And it doesn’t matter so much whether the markets are experiencing greater-than-normal volatility. It’s how you’re positioned that matters.
In Forensic Investor, we are heavily positioned to the short side. In fact, in 18 months I have only recommended three long positions. Two have been closed, and both with a profit. The rest have been bets on the downside.
And I don’t see our positioning changing.
The stock market remains grossly overvalued, and in recent months investors were way too optimistic regarding expected returns. I think sentiment will start to swing back a bit to the bearish side as the Brexit vote begins to settle in. Investors will realize there could be more surprises around the corner. And that’s why I think it’s prudent to maintain a more bearish positioning.
So, what are some steps you can take to deal with this predicament?
First, cash sleeps softly at night. U.S. dollars are a good asset to hold in times of turmoil. For all of the U.S.’ problems like low economic growth, stagnant wages, and a declining standard of living, the U.S. dollar is still the world’s reserve currency.
In fact, I think the dollar could rise as much as 40% in the next 18 months if equity markets tank and investors from all corners of the globe seek a flight to safety.
Second, you could look to invest outside of the U.S.
It might sound counterintuitive to say you should own dollars in one breath and to look outside the U.S. in another.
But, the last time the pound plunged this much, famed hedge fund investor George Soros made a billion dollars in a day. Sir John Templeton also made billions looking beyond our shores for markets that got stretched too far, too fast. Sometimes, it pays to invest when there’s blood in the streets.
The point is, there will be overreactions, and that will create opportunity beyond just the U.S. markets. Think of the markets as a rubber band. They get stretched too far in one direction. Then something occurs to change the consensus view, and it leads to a snapback reaction in the other direction.
Finally, use alternative investments.
Mind you, alternatives have been a horrible place to be in recent years. For example, I’ve read that as much as $500 billion will come out of hedge funds this year. Performance has been terrible.
But, I think that alternatives could be a boon in the years ahead. For the most part, the stock market has been straight up since 2009. Hedges don’t help much in a low-volatility environment when markets quietly go up, and up, and up.
Instead, they help in times of turmoil.
And what makes them best isn’t higher returns. Rather, they provide a smoother equity curve. If you’re reading this and you’re – I don’t know, human – you probably prefer a smoother ride to investment success than huge swings up and down.
So, while you won’t keep up with the market using alternatives if it’s up 32% in a year, you most likely won’t be down 50% when the market tanks, either.
The $500 billion in redemptions and mass exodus of big institutions from alternative investments tells me that it’s time to start looking at them as a contrarian play. And the good news is that fees are going down, too.
I think these three plays can help your portfolio in the coming years.
But whatever you do, buckle up. It’s going to be a wild ride.
John Del Vecchio
Editor, Forensic Investor
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