Alternative Investments That Protect U.S. Investors When the Stock Market Bubble Bursts
- We believe US stock and bond markets are currently grossly overpriced, and their bubbles are about to burst
- Alternatives to stocks and bond investments can protect against the wreckage that will be caused by the bursting bubbles.
- We recommend a 2-asset approach: a diversified portfolio of return-seeking alternatives combined with a safe protection portfolio for risk control.
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You may or may not agree, but we believe US stocks and bonds are extremely overpriced, due in large part to a Federal stimulus of $10 trillion, a harbinger of future hyperinflation. If you don’t agree, there’s no reason for you to keep reading this article because it discusses how investors can protect themselves from the imminent bursting of these dramatically overpriced bubbles.
A good start for defending your net worth is to not own expensive stocks and bonds, but buy “Alternative Investments” instead. Cash would normally be a good way to protect, but it currently provides no return, and may soon have a negative return so we’ll have to pay the government to hold our money.
In this article, we review the following alternatives. Readers should consider owning a basket of these investments because diversification is your best defense against a major decline in the securities markets. Adding the proverbial gasoline to the bonfire, investors should also be concerned about the current COVID-induced recession and the possibility that its effects could linger for many years even after there is a global vaccine that is widely distributed. We see an inflationary recession on the horizon, like the stagflation of the 1970s.
For many of us, our home is our biggest asset and could serve as a major portion of our real estate allocation. The Talmud Strategy advises “Let every man divide his money into three parts, and invest a third in land, a third in business and a third let him keep by him in reserve”. The Talmud is the central text of Rabbinic Judaism and the primary source of Jewish religious law and Jewish theology. In other words, there may be divine guidance to hold a third of your investments in real estate, including your home. The total domestic, residential real estate market is estimated to be $34 trillion, a third of which is held in professionally managed portfolios.
Beyond your home, diversified real estate investments can be made in mutual funds, exchange-traded funds (ETFs), and real estate investment trusts (REITs). Smaller direct investments can also be made in crowdfunding websites and on-line auctions.
Commercial real estate is estimated to be $16 trillion and includes multifamily, industrial, office, retail, and hotel sectors. The pandemic could have long-lasting effects on certain segments. According to this McKinsey report “ healthcare facilities, regional malls, lodging, and student housing have sold off considerably. We add office space to the list because the pandemic has driven people to work from home. By contrast, self-storage facilities, industrial facilities, and data centers have faced less-significant declines.” In researching commercial real estate investments, you’ll need to determine if these troubled sectors will recover or should be avoided.
If you want to keep pace with inflation measured by the CPI it’s good to keep in mind that the “C” in CPI is “Consumer” – Consumer Price Index, so investing in consumer goods should keep pace. The biggest components of the CPI are food, housing, and transportation. Accordingly, agricultural commodities like grains and livestock are good inflation hedges. As for housing and transportation, residential real estate and transportation stocks provide participation.
Other commodities have industrial and wealth preservation applications. Precious metals like gold, silver, and platinum are money substitutes because they are stores of value. They also have industrial uses, but other metals like copper and rare earths are more broadly used in industry. Natural resources like timber and oil round out the commodity group; these commodities are included in the calculation of CPI but are not in the top 3. Natural resources are essential to our everyday living.
Baskets of commodities are available as ETFs and mutual funds. It’s important to know their allocations before investing. For example, some are exclusively precious metals while others are primarily natural resources.
Some collectibles like fine art and expensive cars and jewelry are mostly held by the wealthy to showcase their wealth and to trade with other wealthy people. But other collectibles like stamps and coins are also held by ordinary people because it’s fun and you can usually sell parts of your collection for profit, especially vintage rare items.
Collectibles tend to be a reasonably good store of value if you get expert advice and educate yourself. This education can be fun and socially rewarding. For example, some of my friends collect fine wines for investment and consumption. I personally enjoy a good bourbon.
The paper money we all use is called “fiat currency” because “fiat” means ”arbitrary order.” Pieces of paper with presidents printed on them only have value if we all agree they have value. Otherwise, they’re just pieces of paper. It’s conceivable that paper money will be devalued in the future because per capita world debt now exceeds $200,000. The debt crisis is global.
This possibility has led to the development of alternative money like cryptocurrencies. Gold is also a historical substitute for paper money. And foreign countries have proposed baskets of their currencies as replacements for the US dollar as the world’s trade currency.
Some governments have sought to alleviate concerns about the devaluation of their currencies by offering investments that protect against this. Treasury Inflation Protected Securities (TIPS) pay a dividend plus inflation. Individual investors can also buy iBonds.
Derivative investments like short selling and options can be used to directly control exposures to most risks, including the risks in current stock and bond markets. Hedge fund managers can invest long and short, buying their favorite securities and selling those securities they find unattractive. Hedge fund investing is an investment in manager skill, and most are limited to qualified investors, which basically means only rich people can use hedge funds, although some mutual funds and ETFs are hedged.
Ordinary people can buy put options to bet on the bursting of stock or bond bubbles. They can also purchase inverse ETFs. Or they can hire some Robo advisors and/or individual investment firms who say they can time the markets, although only a few have proven this claim.
The good news is there are plenty of alternatives from which to choose. The bad news is that it’s complicated. We recommend a “2-asset approach” using a separation principle introduced by Dr. William F. Sharpe in his Nobel prize-winning Capital Asset Pricing Model. The best way to control risk is to combine a return-seeking risky portfolio with an uncorrelated safe portfolio. The following example shows these two assets: a safe asset and a risky bundle of alternatives.
Readers are advised to (1) assemble their own 2 bundles and (2) control risk through time by modifying the mix between the two, holding more or less in their stabilization portfolio. You could also move these allocations along a glidepath similar to the way target-date funds manage risk.
Will a portfolio of alternatives outperform traditional stocks and bonds? Most alternatives are priced independently of stocks and bonds so they should not burst when stock and bond market bubbles burst. But there are of course no guarantees. As we say in our introduction, cash is another simpler way to defend but with no return, and if inflation strikes cash will lose value. You decide.