Warren Buffett and Jim Rogers have used this “secret” to make millions. You can use it, too.
The following post details one of the world’s best investment strategies…
It’s a strategy used by elite investors like Warren Buffett and Jim Rogers to buy extremely cheap assets.
This strategy involves taking an unconventional way of looking at world events. And once you adopt this mindset, it will put you ahead of 99% of your fellow investors. In the interview below, S&A Editor in Chief Brian Hunt discusses why you should…
Stansberry & Associates: You say master investors and traders are often marked by their unconventional views of crisis situations.
Can you describe these views… and why they are part of master investors’ mindsets?
Brian Hunt: Sure. I believe a trait great traders and investors almost always possess is the ability to appreciate a good crisis.
A great investor sees crisis situations for what they usually are… which are tremendous opportunities. They are opportunities to buy assets at cheap, depressed prices… and then earn large gains later.
When a great investor reads a headline like “European stock markets crash” or “Offshore drilling stocks plummet in wake of Gulf of Mexico oil spill,” he perks up. He starts wondering if the crisis has created investment bargains.
Most investors don’t realize this, but a crisis situation is one of the few times you’ll ever get to buy assets for bargain prices. A crisis creates panic. When people panic, they dump stocks and bonds and commodities with little regard to their real values. They just sell first and ask questions later.
This air of irrationality creates irrational asset prices. If you can keep your head, you can take advantage of the irrationality and buy assets on the cheap. This leads to huge gains down the road.
Great investors run toward a crisis. Amateur investors run away from a crisis.
S&A: Discuss the amateur mindset.
Hunt: The amateur investor – the guy who always struggles in the market – sees crisis situations much, much differently than the master.
He’ll read those same headlines: “European stock markets crash” and “Offshore drilling stocks plummet in wake of Gulf of Mexico oil spill,” and think to himself, “Wow… that news is bad. I’m glad I don’t own those stocks.”
Of course, if he is an owner of those stocks, he panics and sells them. He reacts to the news… not the values.
The amateur investor is almost always focused on buying whatever the most popular story is at the time. He’s focused on doing what everyone else is doing. He seeks the comfort of the crowd. You can’t blame him. Huddling with the crowd is how humans survived 50,000 years ago. You were either part of the tribe or you would die. But in the investment market, it’s a recipe for disaster.
Seeking the comfort of the crowd… buying what’s popular… buying what is enjoying rosy headlines leads people to buy expensive, overpriced assets.
The master doesn’t like to buy overpriced assets. He prefers to buy bargains.
S&A: What are some examples of a crisis creating trading and investing opportunities?
Hunt: The Gulf of Mexico oil spill during the summer of 2010 is a good example.
That oil spill was one of the worst accidents in the history of the American oil business. It released huge amounts of oil into the ocean. The early efforts to cap the well failed, which made the crisis drag on and on. It was on the news all day, every day for over a week.
In response, offshore drilling stocks of all kinds were crushed. Even good companies that had nothing to do with the oil spill fell more than 33%. Transocean, the company involved in the accident, fell about 50%.
Good drilling businesses were sold down to valuations of around five times earnings. That’s a cheap price for them… and it was created by the crisis.
After the selloff, I went long offshore drilling stocks and made a big return in a short amount of time. Most of the offshore drillers rebounded at least 25% in just a few months.
Another example is the European debt crisis of 2012. Back then, everyone was worried that the European banks would explode. They were worried governments would default on their debts. They were worried about a European depression. It was all over the news constantly.
In response, European stock markets crashed. Spain’s version of the Dow Jones Industrial Average fell from 8,500 to 6,000 in just a few months. That’s a 29% crash. Most other European stock markets crashed as well.
If an investor stepped in amidst all that crisis and pessimism and bought European stocks, he made great returns over the next year. The Spanish stock market gained 66% off its bottom in just 15 months. The Greek stock market doubled off its bottom in less than a year.
A crisis much bigger than the 2012 European crisis was the 1998 Russian debt crisis. Back then, people thought Russia itself was going to implode. The government defaulted on its debt and the currency collapsed. The Russian stock market hit a low in late 1998. Ten years later, it had gained over 6,000%. That’s a six with a thousand after it.
Investing during a crisis can produce truly spectacular returns.
S&A: How about the U.S. credit crisis of 2008? That’s what comes to mind when most people hear crisis.
Hunt: The wake of the 2008 credit crisis was a fantastic time to invest and trade.
This period was marked by the bankruptcy of Lehman Brothers, which was the largest corporate bankruptcy in U.S. history. The housing market crashed. The stock market fell 39% in 2008, which was its worst year since the Great Depression. We were on the verge of a global economic meltdown.
But the world has a funny way of not ending. It turned out that late 2008 and early 2009 was a great time to buy elite businesses like Apple, Altria, and Starbucks. Apple tripled in value off its 2009 bottom in less than two years. Altria doubled off its bottom in about two years. Starbucks more than tripled in value off its bottom in about two years.
Commercial real estate, as measured by the large commercial investment fund iShares Real Estate, also more than doubled off its bottom in just two years. One of the top mining firms in the world, Freeport-McMoRan, more than tripled off its bottom.
All those assets were deeply depressed because of the mass selling… because of the pessimism. The crisis created bargains. Everything was so depressed and cheap that it was like a coiled spring. When a bit of optimism returned to the market, everything soared.
Keep in mind, when things are truly bad, you don’t need them to get “good” in order to make a lot of money quickly. As my friend and colleague Steve Sjuggerud often points out, you make the big money as things go from “bad to less bad.”
The greatest trader ever, George Soros, has a good quote about this… or at least it is attributed to him. He said, “The worse a situation becomes, the less it takes to turn it around, and the bigger the upside.”
That’s a great way to sum up crisis trading. When things are truly bad… and assets are truly cheap… just a tiny bit of optimism can produce giant investment gains.
S&A: Can this apply to individual companies?
Hunt: Absolutely. You can use a crisis to get a good deal on an individual company as well. Warren Buffett is one of the world’s greatest practitioners of buying in times of crisis. He comes off as a grandfatherly “aw, shucks” type of guy, but he’s a stone-cold crisis hunter.
In 1964, he made a hugely successful investment in American Express after it was rocked by a crisis. American Express had extended loans to a company that was busted for falsifying documents. Its share price fell nearly 50%. Afterwards, Buffett bought the stock. He ended up making a fortune and owning more than 10% of one of the all-time greatest American businesses.
Buffett was also a very active buyer and lender during the 2008 credit crisis. He made a handful of spectacular investments during that time.
Buffett is famous for saying that he likes to invest in great companies that have been hit by a one-time huge, but solvable problem. In other words, he looks to buy great companies after a crisis.
S&A: It’s obvious that you can earn big returns buying after a crisis. But it’s very hard for people to take action.
Hunt: Yes. It is hard when you are starting out. As I mentioned, humans are hardwired to seek the safety of crowds. Fifty thousand years ago, it’s how we survived.
But when it comes to investing and trading, you won’t succeed doing what everyone else is doing. And during a crisis, almost everyone panics and sells. You must fight the natural instinct to run away from the crisis… and instead runs toward it.
It’s like any useful skill. You have to practice. After enough practice, it will get easier… and then it will become an automatic response.
When you’re starting out, you can lean on the wisdom of investment masters like Warren Buffett and Nathan Rothschild. One of the best things Buffett ever said about how to succeed as an investor was, “You want to be greedy when others are fearful, and fearful when others are greedy.” You also have legendary financier Nathan Rothschild’s recommendation: “Buy when there is blood in the streets.”
To develop a useful crisis mindset, try this. The next time you read awful headlines about an individual country or a stock market sector, go into the market and buy a very small position in the beaten-up assets. Buy $500 worth of stock.
You’ll feel funny doing it. You might get a bad feeling in your stomach. That’s actually a good sign that you’re doing the right thing. After you do it enough… and make 50% or 100% in a year a few times, you’ll develop an appreciation for a good crisis.
S&A: Okay… let’s say I buy after a crisis. What are the risks?
Hunt: The biggest risk is that the crisis turns into a long-lasting crisis. For example, a quick military flare up between two countries could turn into a full-blown war. A country’s stock crash could turn into a bear market that lasts a long, long time.
That’s why it pays to do a lot of research on what you are considering buying. You need to make sure you’re buying quality businesses at good values. For example, if a sector experiences a crisis, I simply try to buy the best business in that sector.
You also need to employ risk-limiting techniques like position sizing, which is the part of your trading strategy that tells you how much of a position to buy. You don’t want to take a position so large that you get really hurt if you are wrong. You can also set a stop loss on your position, which is a predetermined point at which you will sell if the price moves against you.
S&A: Makes sense. Any parting thoughts?
Hunt: One last thing. I know it may sound heartless to talk about a crisis like this. I don’t root for people to lose their jobs or suffer through bad times. But crisis situations are part of life. It’s how the world works. I didn’t write the rules. I just play by them. And it happens that crisis situations often produce excellent trading and investing opportunities.