Now Carl Icahn is spotting bubbles, too! The billionaire investor-agitator said he is “very cautious” on the stock market, telling a Reuters conference he can envision a “big drop” because many companies are depending, for their profits, more on low borrowing costs than on strong management.
As if that weren’t enough, along comes Ben Inker of Boston’s famed Grantham Mayo money-management firm, calculating a fair value of 1100 for the S&P 500 index, about 40% below where we are today. Inker projects that the S&P will generate a negative return, after inflation, over the next seven years.
What are we to make of all this talk of bubbles and overvaluation? As I pointed out recently the concerns are well founded. But that doesn’t mean the market has to fall out of bed immediately.
In fact, the record of past bubbles suggests that prices will continue to advance, even as the “bubble babble” grows in volume—until the cognitive dissonance becomes unbearable and a sudden, dramatic breakdown occurs.
That’s exactly how the NASDAQ bubble collapsed in 2000. During the first quarter of that year, Nazzdog kept soaring even as commentators pointed out the obvious: that a multitude of dot-com companies were burning cash like crazy. Fewer and fewer members of the index were taking part in the rally, but the herd piled into the big NASDAQ names, pushing the index to its peak on March 10 that year.
Prices drifted down for a few weeks, until the bottom fell out on April 12, 2000. That day, the NASDAQ composite plunged 7%. By late May, the index had tumbled 36% from its high. Game over.
History never repeats exactly, but as Mark Twain said, “it rhymes.” Right now, Wall Street seems convinced that Janet Yellen will be able to keep the stock market levitating indefinitely, as Bernanke has done, on puffs of “quantitative easing.”
I don’t disagree that the Yellen love-fest could continue a while longer, perhaps into the first few weeks of her term as Fed chair (starts January 1). At some point, though, reality will intrude. A string of economic reports will come in weaker than expected, investor confidence will wobble—and a substantial market drop (perhaps 15% or more) will ensue.
We want to build plenty of defensive toughness into our portfolios long before any such incident takes place. That’s why I’ve been urging you to weed out vulnerable stocks and mutual funds as the headline stock indexes plow higher. Move gradually and systematically, like the Carl Icahns of the world, with a sense of purpose—not panic.
On the buy side, you’ll be smart to enlarge your holdings of stocks that throw off generous dividends. They’re not nearly as numerous as they were a year ago, but you can still find a few good ones.
For example, Xcel Energy (XEL), a conservatively managed electric utility serving eight states from the Midwest to the Rockies, is yielding 3.9%, almost double the S&P 500 index.
What’s more, XEL’s low payout ratio (only 57% of this year’s estimated profits will go out the door as dividends) virtually assures that the company will sweeten your quarterly checks in 2014, too.
Besides the occasional utility, I’m turning up a fairly broad assortment of values in the real estate sector. For instant diversification, you can buy Vanguard REIT Index ETF (VNQ). VNQ holds 126 stocks, mitigating your risk from a blow-up at any single company.
In addition, VNQ boasts an extremely low expense ratio of only 10 cents a year per $100 invested. As a result, the fund ships more of its income to you, where it belongs!