Home Deep Analysis Charlie Munger Predicts Crash: Our Favorite Portfolio Insurance Picks

Charlie Munger Predicts Crash: Our Favorite Portfolio Insurance Picks

by WOOWinvest
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Economy Crash


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At the Daily Journal’s most recent annual meeting, billionaire Charlie Munger — one of the greatest investors in history — put Warren Buffett in Berkshire Hathaway (BRK.A) (BRK. B)’s right-hand man – recently predicted that a painful crash is imminent:

What we get is a sad excess and danger of the country. Everyone loves it because it’s like a group of people getting drunk at a party; they’re so drunk that they don’t think about the consequences. Eventually, due to the sad excess, there will be considerable trouble, and that’s how it used to work in the past.

The ominous warning follows his previous warning of a “lost decade” to investors, highlighting to investors that it was an issue of apparent concern to Mr Munger.

Four reasons why a painful collapse is coming

Why is he worried about the outlook for the stock market now?

First, interest rates are more likely to move higher than lower in the short term, which, as his colleague Warren Buffett likes to say, means that the gravitational pull of stock valuations will increase. In fact, if inflation continues to rage near its current 40-year high, interest rates are likely to be forced much higher.

Second, with equity valuations already at nosebleed levels and inflation soaring, the potential to generate substantial real returns becomes increasingly challenging as multiple contractions are more likely than multiple expansions (due to rising interest rates) to deal with the possibility of rising inflation), while high inflation sets a higher bar for corporate growth and dividend payments to generate real returns net of inflation.

Third – and from the second point – the Buffett indicator – one of Buffett’s favorite indicators for determining collective market attractiveness – indicates that the market is overvalued and the more likely it is to produce disappointing returns in the future Come bigger:

Buffett Indicator - Composite Market Capitalization of GDP

Buffett Indicator (currentmarketvaluation.com)

Last but not least, what Mr Munger refers to as a “sad excess” in his comments means – possibly due to interest rate distortions, massive money printing and government intervention in the economy – a serious misallocation of capital In progress now. In fact, at the same Daily Journal annual meeting, Mr. Munger explained:

I think VC is putting too much money in too fast and there is a pretty sad glut of VC and other forms of private equity…we have a stock market and some people use it as a casino…never have anything to do with us Very similar things are being done now. We do know from what’s happening in other countries that if you try to print too much money, you end up in terrible trouble.

Our Top Market Crash Portfolio Insurance Picks

With these caveats in mind and with respect for Mr. Munger’s excellent investment record, we are becoming increasingly cautious about a potential market crash and its impact on our portfolio.

Our preferred market crash portfolio insurance pick is Virtu Financial (VIRT). It is a high-frequency trader that benefits from heightened market volatility. Its profitability increased significantly during the Great Financial Crisis and the COVID-19 crash. While it was privately held during 2008-2009, even with the S&P 500 (SPY) (VOO), Nasdaq (QQQ), Dow Jones (DIA) and real estate investment trusts (VNQ) in the wake of COVID-19 During the crash, its stock price will soar and explode.

Vitu Financial stock price

VIRT and Spies (YCharts)

Even in recent months, with inflation soaring and geopolitical tensions resurgent, VIRT has once again set the market in the dust. We bought aggressively between late September and late October at a weighted average price of $24.48. Since then, the stock has returned about 54% in total, while SPY has gained only 5%, VNQ has produced returns of only about 5%, QQQ has gained only about 1.5%, and DIA has gained only about 2%.

Even today, VIRT is still reasonably valued in a highly valued stock market, with a forward price-to-earnings ratio of 10.8x and a dividend yield of 2.6%. Even more impressive are its numerous high-return investment organic growth plans and a very aggressive share buyback program. In the more than a year since it launched the buyback program, VIRT has reduced its share count (net of stock-based compensation) by 6.4%.

During the most recent earnings call, the CEO expressed optimism that organic growth initiatives in areas such as options, fixed income, and cryptocurrencies will continue to successfully grow and increase the company’s baseline profitability, and management hinted at continued strong performance. , and said: They continue to outperform broader market indicators.

While VIRT has come a long way for us since we purchased it at High Yield Investor for our real money portfolios, it remains an attractive option for portfolio insurance. It’s essentially a way to own the S&P Volatility Index (VIX), but with a solid quarterly dividend and steady growth through organic growth programs, occasional strategic acquisitions, and share buybacks. VIRT remains firmly in buy territory and we plan to continue to hold it as a nice portfolio diversification tool.

If/when the next major market crash comes, we plan to capitalize on the boost to VIRT by trimming our positions and reclaiming the gains into attractive opportunities. For this reason, we currently hold an overweight position in VIRT.

Investor takeaway

While we’ve been very fortunate to see our portfolios have risen significantly over the past six months, we’re not resting on our laurels or taking anything for granted, even though the broader market has fallen.

Given Charlie Munger’s ominous thoughts on the stock market outlook, we’re more cautious than ever. We believe we can optimize our risk-reward by adding to our holdings of dividend-paying stocks like VIRT that have benefited from heightened market volatility and surged profitability (and share price) during past market downturns.

As a result, we can continue to be fully invested in a portfolio of high-quality undervalued stocks that deliver a weighted average yield of 5%-6% and sleep well at night.

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