OIL RIG

Never let a crisis go to waste? Investing in the Ugly

In Investing by C.J. CatoLeave a Comment

THIS POST MAY CONTAIN AFFILIATE LINKS. I MAY RECEIVE COMMISSIONS FOR PURCHASES MADE THROUGH LINKS IN THE POST.

Before we get started

Investing 101 tells us to buy low and sell high. Easy right? OK, we have gone over this before, and I have already laid out why it is probably in your best interest to invest in low fee index funds. So if you haven’t read the article I wrote on that yet… please go read it: THE EASY WAY TO INVEST MONEY AND CONSISTENTLY OUTPERFORM HEDGE FUND MANAGERS.

What else is there?

You may be wondering if I take all my own index buying advice 100% of the time, and the answer is… of course not. Like my mother always said, “Do as I say, not as I do.” And if I’m being totally honest, most of the advice I give is based on mistakes I made in the past. So while I do put most of my money in low cost index funds or ETFs, I still have a less risk averse side of me that likes to push for higher returns. One of the ways I have done this is to try and take advantage of crises. Sounds terrible right?

What is a Crisis?

What I mean when I say I want to take advantage of a Crisis is that I would like to try and time a piece of the market. In other words, I think a part of the market is in turmoil, but I also think that over time it will return to current levels, and that the return will be faster than the entire market will grow as a whole… I want to buy low and sell high(er).

Real World Example

Back in 2016 oil had some serious problems. Basically what happened was that fracking technology in America had gotten so good that the United States could pull millions of barrels of oil out of places it couldn’t get to in the past. Historically when there was a large supply increase like this the oil cartels, headed up by Saudi Arabia, would lower their output so that prices remained high. Well… they decided this time that they didn’t want to give up market share and would rather have the prices collapse, wait it out, and put U.S. drillers out of business.

This is where I come into the story. When I saw oil go from over $100 a barrel to less than $30… instead of seeing a commodity crisis, I just saw one hell of a sale. Oil related companies were taking a pounding and so was their stock. But I thought to myself, are people going to stop using oil? No. Can we even get enough oil out of the ground to meet people’s needs at $30 a barrel? No. Are these companies led by good management with otherwise good fundamentals? Yes. Slowly pulls out checkbook.

Actual Crisis Stocks I purchased

So I purchased all of the oil related companies in the chart below. (BP, COP, CVX, HAL, PSX, RDS, STO, and TOT). In the chart you can see how well they have done compared to the Total Stock Market Index. I would say that overall I have probably received close to a 70% gain. I beat the market by about 50%! Things you don’t see in the chart are that I had to sell a couple of stocks early on when it looked like they weren’t going to survive, but on the plus side most of the remaining stocks pay handsome dividends not shown in the below returns that easily made up the difference. The red arrow shows how the total stock market performed during the oil recovery, so it is easy to see that I have significantly outperformed the market, with good reason to think oil is going to continue to rise for the next couple of years.

A crisis like this happens every few years. We had the banking crisis not that long ago, don’t forget the automotive crisis, and who knows what is just around the corner? So at this point you’re probably thinking you should try this strategy for yourself. Well I’m here to tell you maybe you shouldn’t.

Should you invest in Crises?

  1. Individual Stocks are risky:
    Let me tell you why you might want to be careful doing what I did. Stocks can go to $0… which you will probably agree is bad. So this means that you really have to keep an eye on them and put stops in place to cut your losses, before your losses become everything. This is especially true when you are taking advantage of a crisis. A crisis means extreme volatility, and a company that looked good a month ago may look pretty bad a month later.
  2. Playing with stocks requires research (Time):
    I read every single article that was published about those stocks every day for probably the first 6 months of the recovery. I read every article about oil. I read the one that said oil would go to $20, and the one that said it would go to $200. (Both of those published the same week I believe) I read it all and stayed on top of things.
  3. I had to dump a couple along the way (Losses):
    Some started looking pretty iffy about their survival and I made the decision to cut them from the portfolio while the losses were still small rather than risk watching them move into bankruptcy. If I hadn’t been doing my research I know I would have lost all of my investment on at least one of those investments.
  4. I timed it almost perfectly (Luck):
    I don’t know if it was all the research or just luck, but when I decided to go all in I timed it very nicely. Oil was about $30 a Barrel and it never got much lower. If I had gotten in a few months earlier or later I wouldn’t have beat the market, or not by much if I did.

It’s Complicated

So that was a lot of work to get those returns, and on top of that I still just felt like I got lucky. So will I try this strategy again during the next crisis? I’ve been giving that some thought and the answer is yes and no. Yes, I would probably divert new money going into my portfolio to the part of the market in crisis. But no, I wouldn’t buy individual stocks. I would be much more patient about waiting for what I thought was the bottom, and when I think I am at the bottom I will buy low fee index funds for that entire sector. My returns may not be as great buying the index funds because I am buying a more diversified group of stocks, but my risk will also be much lower in terms of losses.

Banking Crisis Example

So below is an example of how things might work out using the strategy I just talked about above. In this example we’ll be buying financial sector index funds instead of stocks, and it will be during the banking crisis of 09. As you can see, in this scenario the total market gave a 253% return over that time, and the banking index fund produced a 279% return. So that’s about 10% better than the market, significant but not amazing. Timing is important, and it’s easy to see in hindsight when it was a good time to buy. Ideally you would want to have bought any time when that yellow line was touching or lower than the blue one.

Conclusion

I will probably continue to take advantage of Crises in the future. But I will utilize low fee index funds and ETFs more than individual stocks, and it will only be as part of a larger strategy of investing in a broadly diversified portfolio. I hope you found this helpful.