Montana-based money manager James Stack is best known for riding out two market bubbles and crashes, and shielding investors from damaging losses.
Stack is the president of Stack Financial Management and owner of InvesTech Research, which got its start back in 1982. The InvesTech’s safety-first philosophy dictates bear-market losses be limited to less than half of the broader market’s decline, while aiming for at least 80% of the upside during a bull market.
He’s credited with predicting the 2008 housing market crash and the InvesTech Model portfolio finished that year down 14.4%, versus a 37% drop for the S&P 500 index (both including dividends), according to the firm’s calculations.
And after the 2000 technology bubble burst, the portfolio was down just 2.8%, versus a 9.1% drop for the S&P 500. The average newsletter portfolio lost 3.45% in 2000 and in 2008 that loss was 30.15%, according the Hulbert Financial Digest.
With U.S. stock markets at record highs, MarketWatch caught up with Stack recently to see what he signals he’s seeing in the current market.
MarketWatch: What’s your outlook for U.S. stocks and how does the Federal Reserve play into that ahead of a widely expected rate cut next week?
James Stack: “I think one of the key elements today that increases the uncertainty in the outlook has been the reversal in Fed policy…but it doesn’t necessarily paint a bull market outlook with certainty. We have to keep in mind that the Federal Reserve started easing in 2007 before the recession started, and then subsequently made 12 rate cuts and was virtually powerless in preventing the unwinding, the downward path into recession.”
He said similar situation played out in the buildup to the tech bubble of 2000. “The bottom-line message from history is if we are on a recessionary course, either by the level of debt and level of overconfidence in the economy, the Federal Reserve may not be able to prevent it, even with multiple rate cuts.”
MarketWatch: You say we aren’t in a bear market yet, but there are problems on the horizon?
James Stack: “The dangers that exist today lie in the high [and] lofty levels of valuation, extremes in confidence in investor complacency, and in some of the divergences that are developing in the broader market and in leadership. For example, the Dow DJIA, -0.47% and S&P 500 SPX, -0.45% are hitting new all-time highs, but transports DJT, -0.62% and the Russell 2000 RUT, -0.70% are significantly off their highs of last October.”
“If the divergence or weakness in the small-cap stocks and in the transportation stocks worsens in the coming months, then it will increase the probability that we’re going into a bear market.”
MarketWatch: What’s the most pressing risk facing investors right now?
James Stack: “The biggest risk is the level of leverage and debt that has been built over this 10-year recovery...One of the most notable is the increase in student debt from less than $200 million at the start of this recovery to over $1 trillion today.”
“We’ve also seen a very large, dramatic increase in low-quality corporate debt...that matters because if the economy continues slowing, which it has been for the past six to nine months, then these companies holding this low quality debt will be forced to cut back or retrench. Along with that comes negative economic surprises, reduction in corporate spending, reduction in hiring, increased layoffs and such.”
MarketWatch: You’ve spoken in the past about looking out for “great buying opportunities”. Are we nearing one?
James Stack: “Within the next two to three years we are going to reach one of those great buying opportunities that only comes around once a decade. Part of the reason for that is that I believe we will have a bear market and probably a recession within the next several years.”
“If the next bear market took back just half of this current bull market’s gains, it would mean a loss of close to 40%...the question is when will it start? There was significant evidence developing that it had started last year and it started to get into full swing, until the Fed reversed policy.”
MarketWatch: Amid this uncertainty, where are you investing in now?
James Stack: “We were 85% invested at the start of last year, and we cut back to under 70% invested before the December swoon. We’ve made some minor adjustments… but today we are over 30% in Treasurys earnings interest rates and the cash is not burning a hole in our pockets.
“Our holdings today are focused heavier on the historically defensive sectors – the consumer staples and health care.”
MarketWatch: Index funds are wildly popular for investors these days but you are not a fan. Why not?
“Index funds are a stellar opportunity for a young investor in their 20s or 30s to obtain diversification and use dollar-cost averaging to build a portfolio...for someone in their 50s or 60s who are nearing retirement the risk is notably different. You can’t ride through a major bear market and lose almost half your portfolio without having negative impact on retirement plans. And I think the danger within index funds is not in the funds themselves, but as much as the belief by older investors that indexing equates to safety. It doesn’t. It simply means you’re going to lose every bit as much as the index you’re following in a bear market.”
MarketWatch: What does the perfect retirement portfolio look like?
James Stack: Treat the next two years differently from the next 20 years. We are in a very mature economic recovery and an aging bull market that is likely to end. When it ends, it will create a lot of pain for someone overly invested. It will also create that great buying opportunity for those who have defensive cash reserves.