Add another big-name hedge fund manager to the list of those calling for a rocky market. Should you follow their warnings or stay invested? Remember these stock market realities
We are in the top 10% of historical price earnings ratio[s] for the S&P on prior earnings and simultaneously are in the worst 10% of economic situations, arguably even the worst 1%!
(The coronavirus) is totally new and there can be no near certainties, merely strong possibilities. This is why Ben … is nervous and this is why you are nervous, or should be.
That’s from Jeremy Grantham, the co-founder and Chief Investment Strategist at GMO.
Investors are pouring money into stocks today, fueling one of the most astounding rallies in history. Meanwhile, GMO recently slashed its stock exposure in its flagship fund to just 25%.
Now, Grantham is a smart guy — he predicted the 2000 and 2008 downturns. So, should you heed his warning and trim your own stock exposures today?
In answering that, let’s look at a few stock-market realities, ask a few questions, then we’ll arrive at the takeaway that’s right for you.
***Valuation or momentum?
In the last few months, there’s been a chorus of warnings from big-name investors beyond Grantham.
Jeffrey Gundlach, Kevin Smith, David Tepper, Paul Tudor Jones, Mark Cuban, Stanley Druckenmiller, and Jim Rogers are among those who have cautioned about the rally.
Meanwhile, stocks have raced higher, seemingly unconcerned with these warnings.
After falling 34% from mid-February through late-March, the S&P posted its best 50-day rally of all time. It’s now up 43% in about two-and-a-half months.
This rally has come while average S&P earnings have been hit by the coronavirus.
When we combine soaring market prices with declining earnings, that inflates valuation multiples. This is producing calls like Grantham’s that stocks are expensive.
In fact, by one measure, this is this is the most expensive that stocks have been since 2002. That’s according to data company, FactSet, referencing the forward price-to-earnings ratio of the S&P 500 …
The forward 12-month P/E ratio is 21.5. Prior to the past few weeks, the last time the forward P/E ratio was 21 or higher was January 2002.
So, stocks are pricy.
Well … so what? Despite today’s breather, the market is still blazing higher and is decidedly bullish.
This leads us to the first stock-market reality …
Momentum trumps valuation.
Just because stocks are expensive doesn’t mean they can’t grow more expensive … then nosebleed expensive … then “furious-at-yourself-for-not-investing-12-months-ago” expensive …
As a prudent investor concerned about valuations, you might get out of an expensive market, only to watch it climb hundreds of percent higher as bullish investors ride the wave of momentum to new heights.
The truth? A market won’t fall until sentiment — or momentum — changes. And despite the profit-taking as I write Tuesday, the prevailing market sentiment is offense, not defense.
So, you think that stocks are too pricy today so you’re not investing?
You might be right … to the detriment of your portfolio.
***The devil is in the details
As we noted here in the Digest two weeks, ago it’s easy to reference “the S&P” as we discuss stocks. Unfortunately, far too many details get lost when we do this.
To illustrate, let’s look at the telehealth company Teladoc Inc. (TDOC) one of Matt McCall’s picks from about two years ago (his subscribers are sitting on 305% gains).
The company has been around for a long time, but many of us are now using it for the first time to speak with doctors and receive treatment over the phone rather than visiting in person.
Below, look at TDOC’s stock performance over February and March, while the S&P collapsed into a bear market …
Would selling in February based on fears about “the market” have been a wise move if you’d owned TDOC?
This leads us to the second stock-market reality. In the words of our CEO, Brian Hunt:
It’s not so much a stock market as it is a market of stocks.
Let’s continue quoting Brian, as he recently helped explain this important point:
… the stock market is made up of many different industries and many different companies. Various economic climates affect industries differently. Something good for one industry isn’t necessarily good for another industry …
Instead of thinking of “the market” as a monolithic entity into which you put money, we prefer to focus our attention on individual industries and companies. There’s quite a lot happening behind the curtain we call the Dow Jones Industrials Average.
So, “the market” might be about to dive?
Fine.
But that doesn’t mean that, simultaneously, you couldn’t be making double- or triple-digit returns in select stocks. Remember, there’s always a bull market somewhere.
***What’s your timeframe, and where are you invested?
Perhaps we should have begun our discussion with these questions, as your answers to them could mean no further analysis is required.
Today’s uncertainty appears very different to a 25-year-old investor than it does to a 65-year-old investor.
After all, having decades to bounce back from (and surge beyond) a potential market-crash removes a great deal of stress for younger investors.
Unfortunately, a market crash that happens during retirement could result in a profound quality-of-life change for an older investor.
Similarly, the threat of another crash appears very different to an investor with a tech-heavy “next-gen” portfolio that might be bruised but not broken by a bear market, versus an investor holding old-school bricks-and-mortar companies that may never fully recover.
This points toward our final stock-market reality …
Time and quality investments are the two greatest assets you have.
Where do you stand on these issues? Does your portfolio have lots of growth years in front of it? Do your stocks reflect tomorrow’s market or yesterday’s?
***Putting it all together
Today, a slew of big-name investors sees storm clouds on the horizon; meanwhile the market is surging higher. In light of these inconsistencies, what’s the right move for your portfolio?
First, ignore the calls about “the market.” Unless you’re invested in an index ETF like SPY, which tracks the S&P 500, you do not own “the market.” You likely own a collection of individual stocks with wildly different strengths and weaknesses that could zig while the market zags.
It takes more time, and it’s more challenging, but treat your stocks individually. Knowing what you own is your best defense against selling a great stock unnecessarily or holding a terrible stock naively.
If you’re not interested in doing this yourself, outsource the process to an expert analyst such the ones we’re proud to feature here at InvestorPlace.
Take Louis Navellier — Louis’ quantitative approach to the markets informs him when to buy and sell based on cold, impartial numbers. No hunches or gut-feel. It’s a plan, powered by computers and mathematics, that cuts through the market noise, which he follows without question.
Second, evaluate your investment timeframe. With the stock market, time is the greatest healer of all. The longer you have to allow your capital to grow without interruption, the more market exposure you can handle today, despite the uncertainties.
But remember that time won’t treat all sectors equally — some will bounce back quicker and climb higher than others.
For example, take many of the tech-related sectors Matt McCall focuses on — 5G, artificial intelligence, driverless cars … These sectors should show far more resilience to market weakness than, say, oil. And over the decade, these sectors should compound your wealth at far higher rates.
Finally, to whatever degree you decide to remain invested, ride today’s bullish momentum as high as possible without fear by having a clearly defined exit strategy in place. For most of us, this means some form of a stop-loss, specific to each of your stocks.
This could be a trailing percentage stop-loss (I’ll sell if my stock falls 20% below its most recent high) … a hard stop (I’ll sell if it falls to, arbitrarily, $60 per share) … a conditional stop (I’ll sell if tariffs are renewed with China) … or a “change in thesis” stop (I’ll sell if the merger I expect to happen falls apart).
There are many ways to do it, and the right stop-loss is relative to each investor. What’s important is specificity and follow-through.
For example, Eric Fry recently recommended selling out of what had been a promising opportunity … until the coronavirus hit. But his central investment thesis was impacted by COVID-19, so before suffering any massive losses, Eric stuck to his guns and instructed subscribers to sell and redeploy that capital into investments better suited for today’s market.
Bottom line is you know exactly why you’ll sell, and if/when that condition is triggered, you do it — no second-guessing or waffling.
***If you actually take the time to answer these three questions for yourself and come up with a plan, it will put you ahead of 90% of investors
That’s because most investors have no plan. They simply react. Unfortunately, that’s what leads to underwhelming returns.
But with just a little forethought and effort, you can remove much anxiety, knowing what you’re holding, why, and when you’ll sell.
After that, you can thank Mr. Grantham for his warnings, but then politely ignore them since you already have your plan in place.
Have a good evening,
Jeff Remsburg
