Many investors are pretty pleased with themselves after a big rally in 2013, with 22% gains year-to-date in the S&P 500.
But despite the gains this year, a host of recent headlines should give investors pause and make them consider taking some profits off the table.
Consider that the “dumb money” is returning to Wall Street, with U.S. stock mutual funds attracting more cash this year than they have in any year since 2004. And the Dow Jones just set its 35th high of the year — topping the number of new highs the index set in 2007 before stocks peaked.
Now, for some time, bears have been making noise about how the market seems to be overvalued … and that hasn’t stopped a heck of a run in 2013. But it’s undeniable that there are parts of the market that seem to be running on fumes and set to take a spill at the first sign of broader weakness.
If you’re worried things might be overbought or you’re simply looking to avoid risky areas as you rebalance your portfolio and seek new opportunities, steer clear of these five bubble investments.
Recent Tech IPOs
The fact that Twitter (TWTR) gapped up more than 70% in its recent IPO is great for those early-stage investors who made a fortune on this social media stock. But for those who were left to buy it on the open market, there has been nothing but froth — and a serious risk of collapse.
Consider that by some estimates, Twitter is trading for more than 200 times forward earnings. Also consider RBC’s $33 long-term target and “buy” rating was immediately dwarfed by the first moments of TWTR stock trading, and that Pivotal Research has already put a “sell” rating on Twitter with a $30 price target on fears it has been grossly overvalued out of the gate.
It’s not just Twitter stock, either. Tech IPOs are seeing their biggest one-month returns since the dot-com days as frenzied investors bid them up rapidly. Recent high-fliers include 3D printer Voxeljet (VJET), which has soared 300% from its October offer price of $13, and China Internet stock 58.com (WUBA) that almost doubled from its $17 offer price just a few weeks ago.
If you’re thinking of chasing tech IPOs, think again. These kind of valuations are great for early investors who were in on the ground floor … but those retail investors buying on the secondary market could be entering these stocks right before the bubble bursts.
‘Turnaround’ Retail Stocks
While some investors take sadistic pleasure in the failure of a company, most Americans try to share in a company’s success — particularly if they have a personal connection to the brand.
So it’s not a surprise to see some cheerfulness and relief involving once-battered retail players that have snapped back after some dark days in the last few years. Among these are:
- Department store Sears (SHLD), up over 50% YTD
- Grocer Safeway (SWY), up almost 90% YTD
- Video game retailer GameStop (GME), up almost 130% YTD
- Big-box electronics store Best Buy (BBY), up almost 260% YTD
Unfortunately, the tailwind of a broad S&P rally coupled with a bunch of short squeezes does not make for a sustainable investment.
Furthermore, the underlying issues that brutalized these stocks — slumping sales, weak margins, increased online competition — have not gone away. At best, these retailers were oversold and gained efficiencies that allow them to “right size” for the current economic environment. At worst, they are now grossly overbought after bouncing off the bottom.
Some traders made a pretty penny buying these picks at their lows… but a strategic swing trade in a bad stock is vastly different than going long in a struggling business.
Even if you were to go long, the time for that was a year ago before these big rallies — not now before the bubble bursts.
There are some reasons to be cautiously optimistic about Europe going forward. In the second quarter, a two-year eurozone recession that marked the longest downturn in four decades finally came to an end. And thanks to improving consumer and manufacturer data, things are looking up.
But it’s undeniable that the “recovery” is being led by Germany and France. Both posted growth above expectations in Q2, and these nations continue to be predicted as the drivers of economic expansion — and slowing economic expansion at that, with forecasts for just 0.1% growth for the euro zone in Q3 overall.
So while there might be some opportunities amid the marginal rebound in Europe in the stronger regions like Germany and France, clearly there are trouble spots that need to be avoided. Those include weak countries like Spain, Italy and Greece.
After all, despite the end of recession for the continent in Q2 there was still economic contraction in Spain and Italy. And unemployment in Greece and Spain remains at staggering levels near 26% to 27%!
Investors eager to be in on the ground floor of a recovery have bid up investments in these regions. That’s why the iShares MSCI Spain ETF (EWP) and the Global X Greece ETF (GREK) have both gapped up more than 30% since July 1 to dwarf the 9% returns for the S&P in the same period.
But that snap-back now seems overdone and has already started to fade since highs set in late October. As these regions continue to struggle, the optimism will dry up and the bubble in euro trash equities will burst.
Long-Term Bond Funds
The fact that bond principal declines as rates rise poses a big problem for long-term bond fund investors in the near future. As we get ever closer to the dreaded “taper” from the Federal Reserve and the prospect of higher interest rates, long-term bond funds could seriously suffer despite the perception of these investments as “safe.”
The problem is that the vast majority of bond funds do not hold their investments to maturity and thus face losses in principal as a result. Consider that from May to early July, when rates on the 10-year T-Note rose about 1%, the iShares 20+ Year Treasury Bond ETF (TLT) lost about 15%. That’s because 95% of the holdings are more than 25 years in duration, and the longer the duration, the more susceptible bonds are to interest-rate increases.
Now that rates have rolled back a bit from their September highs, the risk has returned to investors that a jump in interest rates — either because of central bank action or simply because of Wall Street sentiment — could significantly damage bond funds.
If you’ve followed the digital currency at all, you know that Bitcoin has taken Wall Street by storm — starting the year around $20 and soaring to recent highs above $400.
This simply can’t last.
Bitcoin prices crashed in July to about $70, and many wrote off the alternative currency as dead — but now that the rally has begun in earnest again, some investors are being duped into thinking that there is nothing but upside in this odd digital alternative to money or gold.
There are plenty of people who will contend that Bitcoin isn’t a bubble, that it’s a viable alternative currency in an era of corrupt central banks and a lack of faith in gold as the hard asset of choice that it used to be.
But the reality is that any investment that tacks on double-digit gains every week and starts attractive investors simply because it goes up is by definition a bubble.
Bitcoin might stick around as an alternative currency, but these valuations will not. Speculators, particularly in China, have caused Bitcoin prices to soar, and it’s only a matter of time before those traders take their money and run … leaving those who buy Bitcoin at the top to hold the bag.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP.