Since the October lows, stocks have been on fire, up 34%, with the Nasdaq up 40% and the Magnificent Seven up 57%.
Nvidia (NVDA) has more than tripled.
But, as I like to say, it’s always and forever a market of stocks, not a stock market.
There’s always something extraordinary to buy, even with the S&P posting 31 record closes this year and the Nasdaq 7 consecutive record closes.
Market at an all-time high? It doesn’t matter, there’s always something extraordinary to buy!
I’ve spent an entire day researching for a two-part series on diversification vs. de-worsification and how to tell the difference.
Today, I wanted to share the results, highlighting 11 blue chips that create a high-yield dividend portfolio that’s perfect for today’s overvalued market.
S&P 500 Valuation: 7% Overvalued
% Of Year Done | 2024 Weighting | 2025 Weighting |
48.08% | 51.92% | 48.08% |
Forward S&P EV/EBITDA (Cash-Adjusted Earnings) | 10-Year Average | Market Overvaluation |
14.52 | 13.50 | 7.13% |
S&P Fair Value | Decline To Fair Value | Cash-Adjusted Fair Value PE |
5,109.58 | 6.66% | 19.5 |
The Best Time To Buy Stocks Is Today
Investors understandably fear market downturns, and when stocks are overvalued, they think, “I can’t possibly buy right now, at record highs. I know the moment I buy stocks will fall.”
However, stocks usually go up at record highs since they go up over time.
In the medium term, buying stocks at all-time highs boosts returns. A good economy tends to result in record highs, which is good for returns.
The key to buying with confidence is buying smart assets that you can trust, classic “wonderful companies at fair prices.”
Understanding Risk: Volatility Doesn’t Matter Until It Does
Buffett teaches that fundamental risk has nothing to do with volatility, and technically, he’s correct.
The probability of permanently losing money doesn’t necessarily correlate with prices. Amazon (AMZN) fell 93% in the tech crash, and investors who held on made a fortune.
However, volatility matters if you panic sell, becoming a forced seller at the worst possible time for emotional or financial reasons.
If you don’t have the right portfolio design, you’re at high risk of painful and unnecessary mistakes in bear markets.
Adjusted for inflation, the average investor achieved 29% returns from 2022 to 2021, while the S&P tripled. That’s due to panic selling in corrections and disastrous market timing.
Optimal Portfolio Design Can Protect You In The Inevitable Downturns
I recently added a new metric that allows screening for consensus future Sharpe ratio.
- Future consensus total return potential divided by historical volatility.
Let me show you what I mean.
Return Since 1985
The S&P’s long-term Sharpe ratio is 0.57, meaning that 11.26% annual returns required suffering through 15.33% yearly volatility.
In any given year since 1985, the S&P’s average intra-year peak decline was 15%.
That’s the “risk premium” for owning stocks. Stocks can fall 15% in months or even weeks, and that’s “normal.”
Because individual stocks are more volatile than a 500-stock index like the S&P, the volatility-adjusted returns of most stocks are no better than the S&P.
It’s usually lower.
- The average standalone stock has 29% annual volatility.
- 0.47 Sharpe ratio
That means that for every 1% unit of volatility (in either direction), analysts’ FactSet consensus expects investors to get 0.47% in returns.
This is where hedge funds attempt to shine by combining active management and diversification in up to 20 asset classes to generate volatility-adjusted return ratios of more than 1.
According to a survey by BarclayHedge, the average hedge fund had a 5-year Sharpe ratio of 0.86 through 2021. The top 50 hedge funds had an impressive 5-year Sharpe of 1.75.
Imagine being optimally compensated for each unit of volatility you endure. Let me show you how we can easily build a fully diversified 11-sector portfolio with 100% Ultra SWAN quality blue chips.
Example 1: My Fantastic 5
Here are my Fantastic Five blue chips: Nvidia (NVDA), Brookfield Asset Management (BAM), Amazon, Enbridge (ENB), and British American (BTI).
My Fantastic 5 has an average consensus future Sharpe ratio of 0.77, almost 2X the average companies.
The yield of 4.3% is attractive, the 18% historical discount is a 25% better valuation than the S&P, and the safety and quality of the portfolio are excellent.
- S&P credit rating A- (2.72% 30-year bankruptcy risk)
- 60th percentile optimal risk management
S&P LT Risk Management Score | Rating |
0% to 9% | Very Poor |
10% to 19% | Poor |
20% to 29% | Suboptimal |
30% to 59% | Acceptable |
60% to 69% | Good |
70% to 79% | Very Good |
80+% | Exceptional |
Fantastic 5 | 60% |
95% dividend safety means an approximately 0.5% risk of a dividend cut and 1% in a severe recession, like the Pandemic or Great Recession.
The fundamentally justified return potential over the next 12 months is 34%. That’s not a forecast; it’s how much these five companies can increase in value in the next year if they grow as expected and return to historical market-determined average fair value.
4% yield, 20% consensus income growth, and a 24% long-term consensus return potential with 50% better volatility-adjusted return potential than the average company and much better than the S&P’s 0.56 historical Sharpe ratio.
Let’s Crank Up The Diversification To 11... Literally!
Five Ultra SWANs in five sectors is excellent, but what if you wanted to be exposed to every industry, all 11?
And what if you wanted to sleep well at night being 100% Ultra SWAN blue-chips?
Ultra SWAN quality companies are determined by our safety and quality scoring system that analyzes more than 1,000 metrics, including safety, dependability, and moatiness.
Ultra SWANs (sleep well at night) are blue-chip companies with wide market shares, exceptional safety profiles, and adaptable and trustworthy management teams.
They are as close to “God’s own company” as can exist on Wall Street.
If you owned 11 Ultra SWANs in 11 sectors, that would be an exceptional portfolio, but what if you could then maximize the volatility-adjusted returns?
The Max Sharpe 11 Ultra SWANs
I screened for the highest consensus future Sharpe ratio for Ultra SWANs in every sector.
Here are the results.
Let’s break down these incredible fundamentals.
3.3% yield equals Vanguard High-Yield ETF’s (VYM).
The safety score is 97%, so there’s a 1% risk of a cut even in another severe recession.
The S&P global risk management score? 75th percentile, top 25% of all companies on earth.
S&P estimated bankruptcy risk? 2.51%, which means an A-credit rating.
A 17% growth consensus is exceptional, meaning dividend growth of 17% per year and 24% if you reinvest the dividends.
Annual volatility is 23.6% compared to 29% for an average stock.
0.7 Sharpe ratio vs 0.43 average company and 0.56 S&P.
16% discount to fair value vs. 7% S&P and 26% fundamentally justified 12-month return potential.
The FactSet consensus 5-year total return potential is 17% per year, or 119% over the next five years.
OK, this sounds pretty amazing. But what’s the evidence that these 11 Ultra SWANs can actually do any of these things?
Historical Returns Since 2006
Past performance is not a guarantee of future results. Still, it does help us determine whether or not analyst consensus forecasts are reasonable and whether maximum Sharpe ratio blue-chips like the Max Sharpe 11 can deliver superior volatility-adjusted returns, the entire point of this exercise.
This Sharpe ratio optimized portfolio (consensus future Sharpe ratio) delivered exceptional volatility-adjusted returns and lower volatility during bear markets.
Impressively, during the Great Recession, the second worst market crash in history, this 100% stock portfolio matched the 60-40’s defensiveness.
The smoothness of these returns is impressive. Note how the worst three-year rolling return was 6.4%, compared to the S&P, which delivered -10% returns for three years.
In every down year for stocks since 2006, these 11 Ultra SWANs beat the market by falling less.
8% annual alpha from these lower volatility companies. Whose correlation to the S&P is lower than the 60-40. Why?
Because their average correlation to each other is 0.32.
How low a correlation is that?
That’s the same correlation as stocks and bonds and a lower correlation than commodities and stocks.
Even during the Pandemic mania, when the S&P exploded higher, powered by a speculative casino mentality and $9 trillion in money printing, this portfolio kept up!
No FOMO here! One of the most complex parts of long-term investing is sticking to a strategy when it doesn’t work. If you’ve been underperforming in the market for years, staying the course is tough. FOMO risk is a psychological risk that must be considered.
And here’s even better news. You don’t necessarily have to wait decades to achieve solid results from these 11 Max Sharpe Ratio Ultra SWANs.
Consensus 2026 Total Return Potential
- Not a forecast.
- Consensus return potential.
- These are the expected returns if and only if these companies grow as expected and return to historical fair value by the end of 2026.
- Fundamentals would justify that.
Average: 120% =23% annually vs 35% or 12% annually S&P.
1-Year Fundamentally Justified Upside Potential: 26% vs 7% S&P.
Mastercard (MA)
Amazon (AMZN)
British American Tobacco (BTI)
Ecolab (ECL)
Alphabet (GOOGL)
Novartis (NVS)
Brookfield Asset Management (BAM)
WEC Energy (WEC)
Carlisle Companies (CSL)
Enbridge (ENB)
Public Storage (PSA)
Now contrast that to the S&P.
S&P 500
Risks To Keep In Mind
The limitation of backtesting is that it shows you what happened out of an infinite set of potential outcomes.
Historical data can give us an idea of what will likely happen over the long term, or at least whether analysts’ expectations are reasonable.
However, as Mark Twain said, “History doesn’t repeat, but it does rhyme.”
The goal of any savvy investor is not to forecast but to prepare for anything.
In addition, lower volatility stocks don’t mean any volatility.
Let’s consider the bear markets of these companies.
Historical Bear Markets
An impressive volatility profile, just one bear market in 18 years, and it took the Great Recession to generate one.
In 2018? The S&P fell 20%, and this portfolio’s peak decline was 11.5%, a 60-40 level of defensiveness from a 100% stock portfolio.
Note the power of diversification in all sectors. Sometimes, some of these go up, and that’s the way they outperform in nearly every bear market.
Metric | US Stocks (VOO) | 60-40 (BAGPX) |
Max Sharpe 11 (MA, AMZN, BTI, ECL, GOOGL, NVS, BAM, WEC, CSL, ENB, PSA) |
Yield | 1.25% | 2.55% | 3.13% |
2022 Bear Market (1/4/22-10/12/22 | -27.5% | -21.1% | -16.5% |
Pandemic (2/19/20-3/23/20) | -35.3% | -21.7% | -34.1% |
2018 Bear Market (9/21/2018-12/25/2018) | -20.2% | –11.6% | -15.7% |
2011 Debt Ceiling Crisis (4/29/2011-10/3/2011) | -21.6% | -10.8% | -5.3% |
Great Recession (10/8/2007-3/2/2009) | -55.2% | -29.9% | -34.4% |
Tech Crash (3/27/2000 – 10/7/2002) | -49.2% | -18.6% | 7.7% |
1990 Bear Market (7/17/1990-10/11/1990) | -20.4% | -8.7% | -7.5% |
1987 Black Monday Period 10/13/87-12/4/87 | -28.8% | -13.4% | -17.1% |
Average Bear Market | -32.8% | -17.5% | -15.1% |
Median Bear Market | -27.5% | -18.6% | -15.70% |
S&P Correlation During Crisis | 1.00 | 0.84 | 0.22 |
Tech Boom (10/12/1990-3/27/2000) | 534.9% | 388.9% | 757.2% |
Lost Decade Total Returns (3/27/2000-12/19/2011) | -1.7% | 42.3% | 502.4% |
ZIRP Era Total Returns (12/16/2008-3/16/2022) | 524.5% | 266.3% | 1305.4% |
Post-Pandemic Total Returns (3/23/2020-6/5/24) | 155.2% | 67.4% | 134.2% |
Annual Returns Since Inception/1985 | 11.3% | 8.1% | 17.3% |
Consensus Growth Rate | 11.7% | 7.0% | 12.8% |
Consensus Future Returns | 13.0% | 9.6% | 15.9% |
Historical Tax Expense | 7.2% | 20.8% | 14.4% |
Post-Tax Consensus Return Potential | 12.3% | 7.7% | 13.6% |
Expense Ratio | 0.03% | 0.03% | 0.00% |
Net Consensus Return Potential | 12.2% | 8.4% | 13.6% |
Negative Correlation-Adjusted Net Return Potential | 6.1% | 4.6% | 11.2% |
(Source: Dividend Kings Portfolio Optimizer Tool)
This is a very impressive portfolio, superior to the S&P and 60-40 on the most important measures investors care about, including yield, superior returns, lower volatility, more consistent returns, and better SWAN-adjusted returns.
- Returns adjusted for negative correlation to the S&P in bear markets since 1987.
Never forget about the six-foot man who drowned crossing a river that was five feet deep on average.” – Howard Marks
Great Recession
2022 Inflation Spike Bear Market
Bottom Line:
We can never predict the future, but we can prepare for anything. That’s the key to successful long-term investing.
A bunker portfolio, built when the sun is shining and the market feels like it can only go up, is the best way to compound income and wealth while sleeping well at night.
Not because they don’t go down over time but because you should never expect that from stocks.
Since Jan 2021
If you want something that goes up in a downturn, you need something negatively correlated to stocks in bear markets, such as the Mount Lucas Managed Futures Strategy ETF (KMLM).
Another option is the Simplify Managed Futures ETF (CTA), which has made KMLM more effective.
- CTA: 5 Reasons I Added This 7.6% Yielding ETF To My Portfolio
Since April 2022
Combine 11 Ultra SWAN high Sharpe ratio blue chips with the diversifying power of managed futures, especially non-stock trend funds like KMLM and CTA (zero stock futures exposure). You can achieve even better SWANiness in your portfolio.
Read the full article here