From The Viewpoint Of Calamity--Investing With The Next Financial Crisis In Mind

America's Next Financial Crisis

In our last post ("America's Next Financial Crisis"), we wrote about how one economist estimates that America's next financial crisis could lead to a 27% decline in living standards. 

America's Next Financial Crisis Why one economist thinks it may lead to a 27% drop in American living standards. https://t.co/DqAc0wGu2M

— Portfolio Armor (@PortfolioArmor) May 21, 2024

That raises the question of how to invest in response to that, and we didn't really address that there. Instead, we talked about "making hay while the sun shines" and how we were placing an earnings trade on our #1 stock this week. Let's address it here though. 

From The Viewpoint Of Calamity 

Warren Buffett's mentor Benjamin Graham was something of a renaissance man. When he graduated from Columbia University, he was offered faculty positions in three different departments: mathematics, English, and philosophy. "From the viewpoint of calamity" is a phrase Graham borrowed from the rationalist philosopher Benedict Spinoza to describe his approach to investing. Graham lived through the Crash of 1929 and the Great Depression, so calamity was top of mind for him. 

Graham's approach to calamity was basically to find a bunch of stocks that were beaten to hell already: "cigar butts" trading at deep discounts to their book values, ideally. During the secular bear market that started with the Crash of '29 and lasted until about 1950, it was common to find viable stocks trading at deep discounts like this. It's been pretty rare in recent years, outside of some smaller stocks during our last financial crisis in 2008. 

Investing From The Viewpoint Of Calamity Now

We don't have a lot of attractive cigar butts laying around today, but unlike in Ben Graham's day, we have standardized options trading on thousands of stocks, which gives us the ability to hedge them. And if we can hedge them, we don't need to limit ourselves to dirt cheap stocks--we can pick stocks we estimate we'll perform the best instead. 

A Real World Example

This was the hedged portfolio the Portfolio Armor web app constructed six months ago, for an investor unwilling to risk a drawdown of more than 20% over the next six months. No cigar butts here--instead, this portfolio was populated with the names our system was most bullish on at the time: ACM Research, Inc. ACMR, Coinbase Global, Inc. COIN, Fabrinet FN, MicroStrategy, Inc. MSTR, Nvidia Corp. NVDA, Super Micro Computer, Inc. SMCI, and Splunk, Inc., (which was acquired by Cisco Systems, Inc. CSCO). 

How It Performed 

Over the next six months, it was up 41.57%, while the SPDR S&P 500 Trust ETF SPY was up 17.9%. 

You can see an interactive version of the chart above here. 

Do You Care That It More Than Doubled SPY?

Maybe you don't. The world is filled with indifference. But maybe a few of you who read this far will try this approach for yourselves. When the next financial crisis hits, your portfolio will be protected, and you'll have a shot and generating some impressive returns in the meantime. 

If you want to stay in touch.

You can scan for optimal hedges for individual securities, find our current top ten names, and create hedged portfolios on our website. You can also follow Portfolio Armor on X here, or become a free subscriber to our trading Substack using the link below (we're using that for our occasional emails now).

This article is from an unpaid external contributor. It does not represent Benzinga's reporting and has not been edited for content or accuracy.