Why The Market Has Me Worried
I had a front-row seat when I got into the investing business in the mid-1990s. I clearly remember recommending dividend stocks as investor appetite increased for growth stocks, primarily in the exploding technology sector. That tech-fueled bull market was born in the mid-1980s as the U.S. economy struggled with inflation, high interest rates and the desire to break free of a stagnant business cycle. That was the pessimism phase.
The skepticism phase was inspired by Reagan-era tax cuts and the worry over the federal deficits they would create. As the business cycle improved, stocks led the march toward optimism after a brief but violent tumble in 1987. That led to the euphoria stage a decade later as all things tech became the everything and the ONLY thing.
The bull market was 18 years old at the turn of the century with the S&P 500 climbing from 117.30 in 1982 to 1,425.59, turning in a staggering annual return of 62% exclusive of dividends. Nine years later -- after the bursting of the tech bubble, 9/11, and the financial crisis of 2008 -- the bull was dead, having shed 40% of its value. The S&P began 2009 under the 1,000 mark at 865.58 and reached a bottom of, gulp, 666 by March.
Pessimism had indeed returned. Stocks were NEVER going to go back up. Nearly a decade later, the S&P has more than quadrupled. Currently hovering above 2700, the index has returned, on average, 36% annually exclusive of dividends.
The chart below goes back to the heady, tech-fueled '90s.
The arrows drawn represent a market pullback immediately after a significant, extended run up. As I've shared before, I am by no means a wiggle reader. However, I do embrace the notion that what separates us from other animals is the ability to recognize patterns.
Going back to the tech bubble, it would appear that most booms were followed by a decline that lasted about two years on average.
Our current bull market is around nine years old. Is recent market volatility the prelude to a more dramatic and prolonged pullback? I can answer that question in three words: I don't know.
What I do know is that trees don't grow to the sky. Markets can and do go down. Recently, I discussed what investors should consider doing during a correction . Here are a few more pointers just in case Mr. Market is setting us up for something a little uglier and protracted.
1. Sell In To Strength
Selloff days are typically followed by bounces. Take advantage of those. If you need to trim a stock position, it's better to sell on an up day than a down day. Don't let a 120% gain evaporate to a 36% gain. Your children do not want to hear "woulda…coulda…shoulda" when it's time to pay tuition.
2. Pay Attention To Valuations
Price-earnings ratios get extended when markets get too far in front of their skis. If you bought a stock with a forward P/E of 11 and that multiple has grown to 23, review the fundamentals of the stock, especially earnings growth, cash flow and debt. A forward P/E of 11 with earnings growth of 5% is not overpriced. A 23 forward P/E with 5% earnings growth is recipe for heartbreak.
3. Review Sectors
Market declines and economic declines are a "chicken and egg " proposition. In 2008, the U.S. economy had already slid into recession. The housing bubble deflated in 2007 and everything tied to it had fallen out of bed. Financial markets and banks were the subsequent dominoes. The Stock Market Crash of 1929, historians argue, was the keystone event for the onset of the Great Depression. Either way, the market will punish sectors that thrive on economic growth: autos, capital equipment, banks, consumer discretionary.
If a falling market is the canary in the coal mine, keep an eye on your holdings in those sectors. If you've got gains, take them. If you need to be invested, look for bargains in utility stocks, consumer staples, and steady income producers. The cash flow will get you through. If you don't need to be invested, there's absolutely nothing wrong with having some dry powder to put to work.
Action To Take : Whether the recent market volatility is just a stair-step to higher highs or the beginning of an eventual (yes…it WILL happen) downturn, having a plan to manage risk is a necessary component of investing. When things get ugly, to quote Sean Connery from The Untouchables , you don't want to "bring a knife to a gun fight."
Editor's Note : Tesla CEO Elon Musk is building a large battery farm in Hawaii to store energy from island sunshine. It's just his latest move to grow his energy storage business. Here are three little-known energy companies riding Tesla's huge 10-bagger technology wave. This report reveals the full story .
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