Portfolio Basics for Periods of Crisis

by: Bob Johnson

As events unfold, you wonder how the crisis will affect you. The next crisis, that is. How will your investments hold up? We do not know what the next crisis will be, but we are confident there will be one. Somewhere in the world a government will topple, banks will fail, terrorists will attack, a volcano will erupt or a deadly epidemic will spread. There is no escaping it.

Perhaps the news that we are not recovering as expected from The Great Recession will cause an ongoing crisis on Wall Street. If a rating agency lowers the AAA debt rating of the US that will at least cause some turmoil. Perhaps the European debt problems, especially those of Greece or the continuing unrest in the mid-East will wreak enough havoc to rise to crisis proportions.

The US national debt crisis caused fear that the United States government could run out of money and not be able to meet its financial obligations. Hysteria over the national debt in Washington D.C., spread like wildfire on a windy day. Unlike firefighters who try to stop an out of control blaze, Washington politicians do not try to contain the hysteria, but rather fan it with a lot of hot air.

The hysteria spread to Wall Street by mid-July and a strong downward trend is evident. Brian S. Webster, Chief Economist in First Trust’s “Monday Morning Outlook” on July 25, 2011 said, “This is hysteria and politics. Do you remember the fears about Y2K? Cars will not start…elevators will stop…planes will fall out of the sky... ATMs will freeze. Well, none of it happened then, and a downgrade by ratings agencies, like Moody’s and S&P, or a few days failure to pass a debt ceiling increase, will not make it happen now.“

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Click to enlarge The Dow Jones Industrial Average typically retreats in crisis and the volatility of the market increases. As you can see from the above charts stocks were sold turning the equities into cash. In fact, a number of economists and financial advisors advocate fleeing to the safety of cash. Just how safe is cash, cash in the form of US Dollars? Since August of 2010, the dollar lost about 25% of its value against Swiss franc. In this time of continuing financial crisis, selling stocks to put the money in “safe” cash is probably not a good move.

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My thesis is that in times of crisis and economic stress the majority of investors do not make good decisions. In many cases, they do just the opposite of what is in their best interests. Ideally, one should be prepared for crisis and positioned so that a crisis has a minimal effect on one's wealth. When a crisis strikes one should know what actions to take that are beneficial. Investors benefit when open to new strategies to meet the crisis and the challenges of the times. Presenting an overview of strategies for investing in times of crisis is the objective of this article.

Know when to be a Buyer

Down markets are not the time to sell, rather they are a time to buy. It is much more profitable to buy when the market is falling, during times of crisis “when the blood is in the streets”. Stocks go on sale and obviously this is the time to buy solid but undervalued stocks.

While the stock market falls there are always some sectors, industries and companies that are rising. Often, when companies do well, their earnings increase and their stocks go up. Often they keep going up for quite some time. Will Rogers summed it up: “Only buy stocks that go up. If they aren't going to go up, don't buy them.”

Do Your Due Diligence

Of course some assets rise in value over a period and others fall. Demand for a product may become lower due to changes in technology, a less expensive substitute product or a change in cultural mindset over the desirability of a product. Natural disasters such as bad weather and floods cause shortages. Supply may be constrained for many other reasons, such as a lack of capital to expand production, or by labor actions or political changes. My February 2011 Seeking Alpha article, “The Price of Copper: A Matter of Supply and Demand”, is a good primer on the economics of commodity price changes.

As part of your due diligence in buying any commodity, stock, bond or other asset with a depressed price, it is important to verify that the price drop is not because the company is on the verge of bankruptcy. If it is residential property make sure the neighborhood isn’t in rapid decline. Hire an experienced home inspector to ferret out hidden defects. It is necessary to understand why a commodity rises or falls; it may be the cyclical nature of the product. Or, it could be because of political risk. Does the new South American president want to nationalize the mines?

Be Diversified

The idea of diversification is not a new one. The preacher who wrote of the biblical book of Ecclesiastes (c. 3rd century BCE) advocated diversified international investing. He said:

Ship your grain across the sea;

after many days you may receive a return.

Invest in seven ventures, yes, in eight;

you do not know what disaster may come upon the land.

Ecclesiastes 11:1-2, NIV

While the Dow Jones falls, other asset classes may rise. If you hold these many asset classes you may be said to be diversified. Because of its potential to reduce risk while improving returns at the same time, diversification is the only free lunch in investing

Diversification means reducing risk by investing in a variety of assets. If the asset values do not move up and down in perfect synchrony, a diversified portfolio will have less risk than the weighted average risk of its constituent assets, and often less risk than the least risky of its than the weighted average risk of its constituent assets, and often less risk than the least risky of its constituents. Click to enlarge

In order to benefit from diversification the assets must be of different types that do not have closely correlated prices. Within the stock portfolio, it is important to remember that two stocks that move in concert do not effectively reduce risk. Let us take as an example two US integrated oil companies Exxon Mobil (NYSE:XOM) and Chevron (NYSE:CVX). The companies are indeed very similar. It should come as no surprise that they move together in the market.

On the other hand, look at the performance of 4 stocks from different sectors. They are not in lockstep as are the two oil companies above. Proctor and Gamble (NYSE:PG), a consumer defensive stock, stayed fairly close to the 0% line. Southern Company (NYSE:SO) is a large utility. Nucor (NU) is the largest producer of steel products in the US as well as the largest recycler of steel. It is in the Basic Materials Sector. Caterpillar (NYSE:CAT) is the most volatile company on the chart: it is an industrial manufacturer of heavy equipment.

A stock’s beta is a measure of volatility; it indicates how much a stock moves compared with the entire market. The action of the entire market is given a value of 1.0. PG has a low beta of 0.51. That means it moves up or down only about half as much as the market. CAT has a beta of 1.89. It is nearly twice as volatile as the market. This chart illustrates something else besides volatility. At the time when the financial crisis had the most impact on the market, the space between the two black vertical lines, the stocks performed quite differently, diverging greatly. Do you want to hold stocks that behave like CAT in a time of crisis, or would you prefer to be in stocks like PG.

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One component of your diversified portfolio should be cash. If the market is down and you want to buy a company you have been watching because it is undervalued, you need cash. If you do not have any cash then you will have to sell something to raise cash. This, however, is an inopportune time to sell: the market is down.

Diversity applies to your stock portfolio and to your entire holding of different asset classes, which may include:

US Large Cap High Dividend Stocks – Large Cap high dividend paying international companies with strong balance sheets and healthy cash flows will continue to generate income for investors. They are also defensive in nature for if the market falls, these dividend-paying stocks typically fall less. These highly profitable companies are already selling at reasonable valuations. The PEG (Price Earnings/Growth) of these firms is noticeably low, an indication of the possibility of robust future growth. Another characteristic they share is high returns on equity; this indicates good management effectiveness. My Seeking Alpha article, "Constructing the Core of your Dividend-Growth Portfolio" goes through a methodology for selecting these Blue Chips and offers 18 for your consideration.

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Housing, Investment Real Estate and REITs - US housing is very depressed. If you are upside down on a mortgage you may feel betrayed and trapped. It is very difficult to sell a house now. However, as in any down market there is a buying opportunity. The same is true in some places where you might buy investment property such as a multi-unit house or an apartment building.

Real Estate Investment Trusts (REITs), which are regulated by the SEC, are listed and traded on the stock exchanges. You have the advantage of purchasing a diverse collection of professionally managed properties. Thus, you many diversify into Real Estate without the hassle of being a landlord. These have performed well during the past 15 years. Listed on the stock exchanges, they have little correlation to the performance of common stocks so they serve a very useful purpose in diversification.

The Canadian Dollar and the Australian Dollar

It is not just in relation to the Swiss franc that the US dollar fell. Two other currencies that have risen to record exchange rates are the Canadian Dollar and the Australian Dollar. Taking a position in those currencies could be a very good idea. Another way to benefit from those strong currencies is by buying stocks of companies based there or by buying the country fund ETFs of Canada and Australia.

Canadian and Australian Country Funds


iShares MSCI Australia


iShares MSCI Canada I

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Other World Currencies

Historically the dollar has been strong in in times of crisis; it was the safe haven. That is no longer so. The Swedish Krona is stable; The Swiss franc continues to strengthen; the Yen is strong.

Precious Metals

An ounce of gold is still an ounce of gold. However, when the US dollar is arguably worth $0.75 we can easily see the inverse rise of the precious metals compared with the falling dollar. Silver rose the same way, did the same thing. Two ETFs that hold the precious metal on your behalf and follow the market price are GLD, YTD Return 5.25% and SLV, YTD Return 24.59%.

Besides owning the precious metals, you can take a position in gold by buying stock in mining companies. While the stock market slides the world’s gold miners are booming. Barrick Gold (NYSE:ABX) just reported record Q2 earnings of $1.1B. Vancouver, British Columbia, based GoldCorp (NYSE:GG) reports that Q2 revenues increased 62% over the 2010 second quarter, to $1.3 billion, on gold sales of 606,400 ounces. Freeport also reported increased profits: Q2 Net income for 2011 was $1.4 billion, $1.43 per share, compared with net income of $649 million, $0.70 per share, for second-quarter 2010.

Specialized companies: mREITs, MLPs and BDCs

Mortgage REITs or mREITS, are paying some of the highest dividends of any US companies. This Seeking Alpha article on Mortgage REITs gives a good overview of what they do. Multi Level Partnerships, MLP’s are another type of organization set up around a specific tax code. They are in the oil and gas pipeline and storage business and often pay consistent, high dividends. Because of tax issues, it is best not to hold them in IRAs. Business Development Companies, or BDCs, are designed to meet special SEC and IRS requirements to help small businesses get started. They allow investments by the public and use mezzanine financing opportunities. These excellent and rewarding diversification investments should be fully understood before they are purchased.

International Stocks

If you purchase individual stocks, some of them can be international stocks. Most of the myths that foreign stocks are “too risky” have been dispelled. I believe it is important to own superior large-cap stocks from different venues. The countries might include Germany, Switzerland, the Netherlands, Canada, China, Australia and Brazil.


An American Depositary Receipt (ADR) is a negotiable security that represents the underlying securities of a non-U.S. company that trades in the U.S. financial markets. The stock of many non-U.S. companies trade on U.S. stock exchanges through the use of ADRs. ADRs are denominated, and pay dividends, in U.S. dollars, and may be traded like shares of stock of U.S.-domiciled companies.

International US Firms

Many large and successful US stocks have significant operations worldwide. Abbott Laboratories (NYSE:ABT) is a worldwide developer and manufacturer of healthcare products. It does business in 130 countries. Johnson & Johnson (NYSE:JNJ) is a healthcare giant with a market cap of $172 billion and sales of $62 billion worldwide. International sales surpassed domestic sales in 2009. Kimberly-Clark (NYSE:KMB) has operations in 35 countries and sells in 150. McDonald’s has operations in 35 countries and sells in 150. McDonald’s (NYSE:MCD) is a global company with only 35% of revenue coming from the US. McDonalds serves 60 million customers a day from 32,000 restaurants. Procter & Gamble (PG) is based in Cincinnati, Ohio, but the firm only gets 45% of its sales in North America. It has a sales presence in 180 countries and manufacturing facilities in 40. P&G brands serve about 4.2 billion of the 6.5 billion people on the planet today. It has a plan, a well-articulated purpose.

One can also invest in the country funds of the economic powerhouses. For example, iShares MSCI Germany Index Fund EWG and iShares MSCI Switzerland Index Fund EWL. Another way to get similar diversification is by owning different types of regional international funds.

































Bonds Below this Level are Called Junk Bonds

Adapted from Wikipedia

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Debt instruments, notes, bonds and mortgages to name a few, come in many varieties. The rate at which an economic entity can borrow, that is, the rate of interest it has to pay, is determined by the borrower’s ability to repay the loan or creditworthiness. This is determined by a rating by a credit rating agency such as Standard and Poor’s, Moody’s and Fitch. Top rated bonds are rated AAA, Bonds at the bottom are called Junk Bonds. Unlike individual bonds with low ratings Junk bond funds, such as JNK, are liquid and have lower risk that a small basket of individual bonds.

Quality bonds add a lot of stability to a portfolio as well as a guaranteed steady stream of income. Shorter term bonds are less sensitive to interest rate changes.Click to enlarge

There are corporate bonds, US Government Bonds and the Bonds of other sovereign nations available. TIPS, Treasury Inflation Protected Securities are a special class of US Government bonds, which offer a yield which is higher in times of high inflation.

Many bond holdings by individual investors are in the form of ETFs and Mutual Funds. This option offers more liquidity than owning a few individual bonds. It is also easier.


A commodity is something that is fungible. That is, commodities that can be traded or substituted for an equal amount of a like commodity. Fungible assets simplify the exchange/trade process, as interchangeability assumes that everyone values all goods of that class as the same. For example, specific grades of commodities, such as No.2 yellow corn, are fungible because it does not matter where the corn was grown - all corn designated as No.2 yellow corn is worth the same amount.

Click to enlargeCommodities provide yet another profitable diversification opportunity. One reason commodity prices are rising is that while population is increasing, both in the US and worldwide. Many global resources are decreasing, or in the case of agriculture, the limitation is the amount of suitable land. As demand exceeds supply, prices rise. While the value of the dollar eases against other world currencies, the value of commodities rises.

Corn is a very important grain and its rise in price is significant.

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It should come as no surprise that as the price of corn rises, the value of the land it is grown on increases.


An investment in farmland over the long term will provide a steady stream of income and capital gains due to the increasing global demand for agricultural commodities, driven by the rising world population, rapid growth in emerging markets, and continued demand for ethanol and bio-fuels. Demand for agricultural commodities is outpacing supply, which positions farmland for long-term appreciation.

Enjoying the Benefits of your investment Choices

When first presented with an idea to invest in entirely new asset class, one is going to feel some apprehension. I believe that initially being uneasy is both normal and healthy. It is normal to fear the unknown; it is healthy to be cautious. However, as your knowledge grows about a new idea and you begin to understand it more fully and objectively this uneasiness will subside. You may decide to embrace a new asset class. On the other hand when you objectively view all the information you may decide it’s not for you. On the other hand, you simply may not understand how some investments work. I have that problem, Warren Buffett has that problem. His advice? If you don’t understand it don’t buy it.

No one understands everything; not all investments are suitable for everyone. If you don’t agree with some of the suggestions I make, by all means do what you think is best for you.

My desire is to prosper while sleeping well, enjoying good and increasing yields from both domestic and international assets and businesses of many different kinds. I hope that is the result you have from applying some of these ideas.

Disclosure: I am long PG, ABT, JNJ, KMB, MCD.