Take a look…
Penny stocks are stocks that trade for less than $5.
They don’t meet the strict reporting requirements to trade on a major stock exchange such as the New York Stock Exchange.
Instead, they trade on the over-the-counter (OTC) market.
It’s a bulletin board of stock prices that allows brokers to trade these tiny stocks with one another directly.
There are many reputable stocks that trade over the counter. But in general, penny stocks are small, volatile… and highly speculative.
That makes them popular with day traders and newbie investors who want the chance at moonshot gains.
That’s why this chart caught my eye. Based on the average daily trading volume, the total monthly trading volume in the penny-stock market has gone from averaging about 191 billion shares… to roughly 1.9 trillion shares in February.
That’s a 995% jump… and one of a growing number of red flags that we’re in a bubble.
But as you’ll see today, spotting a bubble is much easier than investing through one.
That’s because of a weird truth about bubbles. You know what will happen – the bubble will burst. But you don’t know when it will happen.
And getting too defensive too early can leave you missing out on massive gains.
I was just starting out in the world of finance at the time in London, England… and I’ve been fascinated by this period ever since.
As you may recall, the tech-heavy Nasdaq shot up 1,002% from the start of the 1990s through March 2000.
Then the party ended… and the Nasdaq crashed.
This is a classic bubble-and-bust pattern. We saw a dizzying rise in asset prices – in this case, tech stocks. Then we got an even more dizzying plunge.
But here’s what jumped out at me when I started researching more into the dot-com era…
Some of the world’s smartest investors started warning stocks were in a bubble in 1995… five years before the bubble finally burst.
That was Ray Dalio in Pensions & Investments magazine in 1995.
Dalio is the founder of the world’s largest hedge fund, Bridgewater Associates. And he was one of the first major investors to warn of the dot-com bubble.
Legendary mutual fund investor Peter Lynch echoed Dalio’s concerns.
Lynch ran the Magellan Fund at Fidelity Investments. And he was a rock star…
Between 1977 and 1990, when Lynch ran the fund, it averaged an annual return of 29%. That was more than double the average annual return of the S&P 500. This made Lynch the world’s top-performing mutual fund manager.
And in an article in Worth magazine, also published in 1995, Lynch warned that “not enough investors are worried” about the risk of a downturn in stocks.
In 1996, Howard Marks of Oaktree Capital – an expert in bubbles and market crashes – wrote a note to his clients.
He warned of the frenzied stock trading taking place…
Every cocktail party guest and cab driver just wants to talk about hot stocks and funds.
Then the guy some would argue is the world’s greatest trader, George Soros, decided the jig was up.
In 1997, he bet that the bubble was about to burst. He “shorted” internet stocks, betting their share prices would fall.
By 1999, Soros’ Quantum Fund had lost $700 million on those bearish bets.
These investing greats all spotted the bubble. But they were several years too early on their bearish calls.
By turning bearish too early, they either missed out on gains… or lost hundreds of millions of dollars shorting the market.
There are huge risks. But the returns on offer in a bubble’s final phases are rare moneymaking opportunities.
The dot-com bubble is a case in point.
Between July 20, 1995, when Dalio warned of a correction… and the peak of the bubble in 2000… the Nasdaq soared.
It rose 42% in 1995… 23% in 1996… 22% in 1997… 39% in 1998… and 85% in 1999.
But you had to have some exposure to stocks to benefit.
Look, these are confusing times. There’s no doubt about it.
Due to the pandemic, the economy isn’t firing on all cylinders. But the stock market is shooting higher… and speculation is rife.
As confusing as that may be… if you follow a sensible asset allocation plan, you’ll protect your wealth just fine.
That means splitting up your portfolio into more speculative assets, such as cryptocurrencies, SPACs, warrants, legal cannabis stocks, and biotech stocks… while also playing defense with cash and gold.
I’ll have more for you on that in tomorrow’s dispatch.
In the meantime, make sure to download your complimentary copy of our Coronavirus Crisis Playbook.
The first chapter is by colleague and former hedge fund manager Teeka Tiwari. In it, you’ll learn more about asset allocation and which assets you should own to protect your wealth from a crash.
There’s even a chapter about how to profit from a falling market. (You’ll find that in Chapter 5.)
As I’ve shown you today, we could still be a long ways off from this bubble bursting. But now is a great time to get better acquainted with these defensive strategies.
Regards,
Chris Lowe
March 10, 2021
Bray, Ireland