|Terror-Proofing a Portfolio: n the event of another attack, author Peter S. Cohan wants a portfolio that can survive the fallout|
It may be natural for people to want the world to be the way it was before September 11, "but it's also natural for ostriches to put their heads in the sand," warns Peter S. Cohan, author and president of Peter S. Cohan & Associates, who has come up with scenarios for trying to terror-proof your portfolio.
Among other things, Cohan points to small-cap stocks in the security field that spiked in price after Attorney General John Ashcroft's terror warning on May 26. He suggests that investors could buy such stocks "after the hubbub has gone down" and then ride them back up -- or, on a riskier level, sell them short.
Cohan also thinks stocks in the defense, gold, and property/casualty insurance industries could be choices for investors concerned about terror. He mentions specifically Raytheon (RTN ), Placer Dome (PDG ), and Marsh & McLennan (MMC ). Or, more broadly, he says buying a put option on the Standard & Poor's 500-stock index could be an insurance strategy. At the extreme level, Cohan advises putting money in a solid bank in a stable country that has no involvement in Iraq.
These were some of the highlights of Cohan's remarks an investing chat presented June 3 by BusinessWeek Online on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff and Karyn McCormack. Edited excerpts follow. A full transcript is available on AOL at keyword: BW Talk.
Q: Peter, let's get the big picture first -- do you see any sign of a rally in the stock market?
A: One thing that I think might help the stock market is if oil prices come down a lot. I think that perhaps there was some expectation built into the market that oil prices were going to hit $50 a barrel, and in the last day or so I'm starting to see some evidence that the market believes Saudi Arabia is going to produce enough oil to drive down the price.
The one question mark built into that is the $10-per-barrel fear premium baked into that current $39 price. If that fear premium starts to drop, I think the stock market could really benefit from that.
Q: So do you take the terrorist alarms seriously, and what can investors do about them?
A: Well, the biggest problem that I see that we're facing right now is that we don't know what the truth is -- the truth is very elusive. And I have a feeling that it may be because the government doesn't know the truth, but the government wants to be erring on the side of being overly cautious, and whenever they get any information that makes them nervous, they immediately want to share it and warn everybody so they won't be accused of pulling the wool over people's eyes.
I think investors have a choice: They can put their head in the sand and hope that another terrorist attack doesn't happen, or they can take defensive action to protect themselves in case something does happen.
Q: What can investors do to protect their portfolios?
A: There are three ways to look at it. One way is, how does the market react to a terror warning? You can profit from the predictable reaction the market will have. The second way to look at it is, what happened on September 11? What stocks did badly, what stocks did well? The third way to look at it is, what are some possible terrorist attacks that could happen, and how would that affect different classes of securities?
Q: So how has the market been reacting to the terror warnings?
A: To look at a recent reaction, on May 26, when [Attorney General John] Ashcroft said the terrorists were 90% ready to hit us hard, there were six stocks that spiked -- that went up more than 10% just on that day. These stocks are small-cap stocks, they're in the security field.
One is called Digital Recorders (TBUS ). That was up 16% on the day of that warning. There's another one called Mace Security International (MACE ), and it was up 31% on that day. Then there's another one called Magnetek (MAG ), and it was up 23%. There are a couple of others, but I can stop there.
Those stocks tend to do really well when there's a terror warning. Somebody with a short-term trading mentality could make money by buying those stocks after the hubbub has gone down after the warning, then waiting to ride them back up. People could also short them after the warning, but it's risky.
Q: What sectors or stocks would you recommend that aren't as risky or momentum-driven?
A: I would say that I've looked at a lot of different terror-attack scenarios, and in general I've come to the conclusion that stocks in the gold, defense, and property/casualty insurance businesses will benefit from a terror attack.... In defense, one of the ones that looks good to me is Raytheon (RTN ), which by the way was up 36% within a month of September 11. There's another called Placer Dome (PDG ). That one was up 10% within a month of 9/11.
The third one, in the insurance business, is Marsh & McLennan (MMC ). That one was up 25% within a month of that date. It's an interesting thing why that was, because MMC makes money as an insurance broker. It doesn't take on the obligation to pay for claims. If a terrorist attack happens, MMC won't have to pay claims. But after the terror attack happens, it's going to be hard to buy insurance, and companies will raise premiums. MMC will get a commission on those higher premiums.
Q: September 11 actually shut the market down completely -- do you have a scenario were that to happen again?
A: Yes, I have one scenario, which I have to admit is among the more ghoulish of the scenarios that I was coming up with. Terrorists could explode dirty bombs near the computers that control our financial system. This would hurt industries like banking, and what I call backup services -- companies that provide the backup for all these bank computers.
For example, somebody like Bank of America (BAC ) would be hurt if something like this happened -- if you had a dirty bomb and people could not go into these computers, enter data, do whatever they needed. SunGard Data Systems (SDS ) and DST Systems (DST ) are computer backup services -- backup recovery sites. They have mirror images of banks' data on their computers. What I'm talking about is a scenario where terrorists attack these companies' sites as well.
If something like this happens, this is where I think investors who are very risk-averse might consider the possibility of opening up a bank account in another country that is not involved in Iraq and is a fairly stable country. These people would deposit enough money over there that if this kind of attack happens, they would at least have some money. If this kind of attack happened, people wouldn't have access to their money in bank accounts or money markets, and it would be a while before they could. So one way to protect yourself is to have some money in a country that is less likely to be a target for attack.
Q: I wonder if people are reluctant to face the terrorism possibilities you discuss. What's your thinking on this?
A: My thinking is that people are definitely trying to get themselves into a mindset where things go back to normal. I think people want the world to be the way it was before September 11, and I guess that's sort of a natural human reaction, but it's also natural for ostriches to put their heads in the sand.
I think if something like September 11 happens again, or God forbid something worse, people will have to start to change their mindset about terrorism and what they should do to protect themselves and protect their portfolios. One of the things that I found very interesting is that if it's unpleasant to contemplate these various scenarios, you can look at individual securities that would be helped or hurt by an attack. Another would be to simply buy a put on the Standard & Poor's index.
One thing that people don't know, or haven't focused on in a long time, is that there was a lot of put activity in United (UAL ) before September 11. The value of those options increased 967%. Somebody made a lot of money on that. The S&P 500 put option was up 650% after the attack, and if I'm not mistaken there was very high put activity in that arena as well. There was an investigation into who was doing that trading, but we still haven't gotten the results.
This got me to thinking that if you had a moderate level of risk aversion, and you thought that what Ashcroft said last week was true, and you looked at the events over the last couple of months -- and upcoming like the G-8 meeting in Europe, the Democratic and Republican National Conventions, July 4 -- if you bought puts on the S&P 500 and something happened, you would be providing some insurance against a massive decline in your stock portfolio.
If you see certain stocks having an unusually high volume of [put] activity -- stocks that are related to these scenarios -- it could be a repeat of that insider trading that led up to September 11. I certainly hope the regulators of our financial markets are looking at that.
Q: Peter, may I ask if you're practicing any of the terror-proofing strategies you suggest here?
A: The answer is I am not. I'm just starting to learn about it. I just started getting specifics on how to buy S&P 500 puts. For my risk tolerance, that's the idea that seems the most interesting to me. If there's going to be an attack, it's very hard to predict individual stocks, and very time-consuming. The insurance protection you get from buying a put on the S&P 500 is very substantial, however.
Another thing I've been thinking about is finding a safe-haven country, and finding a safe bank in that country to put funds into. But again, this is something that has really only been under more serious consideration since last Wednesday, when Ashcroft made his announcement.
Q: So as an extreme case, should we all have gold or another hard asset in a personal Fort Knox somewhere?
A: I would stay away from gold, but I do think the safest of the safe ideas that I had was to pick a country that's less likely to be a target of a terror attack, and that's also a fairly healthy country with a mature banking system, and put your money there. That's the safest safe haven.
A medium risky thing to do is this S&P 500 put I was talking about. And if you really enjoy risk, you could bet against individual stocks or buy stocks in defense, insurance, and gold. Gold stocks would probably go up in value -- I just wonder why people always return to gold in these times.
Q: Peter, finally, would you terror-proof a whole portfolio or keep conventional investments in some of it?
A: I guess it depends on [a few] factors. First of all, how scared you are that a terrorist attack is really going to happen. I guess the other part is how much of your total portfolio you have in equities. Funds in money-market funds or a bank would probably be fairly safe.
My third thing would be the usual caveat about your financial goals and where you are in terms of achieving those. To put it fairly simply, if you have most of your portfolio in stocks and you are very early on in achieving your financial goals, I would insure a good portion against attack. However, if you've achieved your goals and have more in money markets, I'd be less inclined to insure a large portion, because then presumably you could afford to lose a chunk of the equity portion.