Investing Daily - Stocks: Bubble in Search of a Pin?

February 13, 2020

Article by John Persinos in Investing Daily

Pop quiz. Who said the following:

“The three- to five-year earnings projections of more than a thousand analysts, though exhibiting some signs of flattening in recent months, have generally held firm. Such expectations, should they persist, bode well for continued capital deepening and sustained growth.”

Perhaps you think those soothing words came from Federal Reserve Chairman Jerome Powell at a recent press conference. Or maybe it was White Economic Advisor Lawrence Kudlow opining last week on CNBC.

Well, think again. It was Fed Chair Alan Greenspan, testifying in front of Congress in December 2000. And instead of going up and up and up, as Greenspan predicted, the market that year fell and fell and fell. And then fell some more.

We’re witnessing similar complacency today. Earnings growth has stalled but the bulls argue that it doesn’t matter. I’m usually an optimist, but I think we probably face a correction sometime this year. Below, I’ll show you how to protect your portfolio and still make money. But first, let’s review the past week.

We’re probably witnessing a “melt-up,” a bout of excessive speculation that marks the end stage of an asset bubble. A melt-up is typically followed by a significant downturn.

The bulls are conveniently disregarding the disconnect between weak corporate earnings and high valuations.

What’s more, growth is slowing. The U.S. economy grew 2.3% in 2019, the slowest performance in three years, after posting 2.9% growth in 2018. Growth this year is expected to hover at 2% or below.

The father of value investing, Benjamin Graham, famously said: “Buy not on optimism, but on arithmetic.”

The long bull run has continued this year, but the laws of economic and market cycles have not been repealed. Consider the dot-com boom and bust, which served as the context for Greenspan’s remarks as noted above.

Whether it’s 1929, 1987, 2000, or 2008, a crash can ruin retirement plans. It can take many years to break even.

Pick your spots…

So how should you trade now? Stay invested, but avoid aggressive risk-taking. Here’s a prudent portfolio allocation under current conditions: 50% stocks, 25% hedges, 15% cash, and 10% bonds. About 5%-10% of your hedges portion should be precious metals such as gold and silver. 

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