The stock market fell in price three days in a row this week. This hasn’t happened in a long time, and we are not used to it. Curious how little it takes to bring out the fear.
So is this the start of the big one? The answer is, it could be. Whether a stock market correction (defined as prices down 10%), a bear market (defined as prices down 20%), something worse than a typical bear market, like the collapse of 2008-9, or something altogether better, like a resumption of the rally we have enjoyed in recent years – – you just don’t know. These events come unannounced. One thing is for sure, though, you cannot jump in and out of markets and expect to accomplish any benefit of a long-term nature. You may be able to get it right once, but never double-lucky enough to get back in in time to do better than if you had just stayed put.
Having said this, there are ways to “de-risk” a portfolio to mitigate the pain of a correction, a bear market, or the something worse, if indeed that’s what lies ahead.
Figure out where the excesses are and stay away. Readers of this space have heard it before: excess, not the passage of time, is what kills a bull market. So the fact that the stock market has been ratcheting higher for 9 years is not in itself the problem. We would look instead to the price action of a handful of “can’t lose” stocks, and avoid these, because they are excesses.
In the last year, Amazon, Apple, Facebook, Google and Netflix have contributed almost as much to the total value of the S&P 500 as the other 495 stocks combined. While all five stocks are expensive, Amazon and Netflix fall into the irrational exuberance category. With valuations at 200 times earnings, they are about where high-tech stocks were in the late 1990s, just before the Internet bubble burst. This is an easy one.
What about lesser stars like Apple, Google and Facebook? They are not cheap at 17, 30 and 38 times earnings, respectively, but that’s a long way from 200 times earnings. And they are great businesses suitable for the long term. With these we would sell the amount of the recent gain. For instance, with Apple up 40% in the last year, we’d sell 40% of the position. Same for other big winners, like Boeing. Sell the amount of the last year’s gain.
What to do with the sale proceeds? This is tricky. You want to be careful you don’t inadvertently increase risk. Utility stocks and government bonds, for instance, used to be the automatic place to hide. Not anymore. NextTera, a Florida utility, is more expensive at 24 times earnings than Apple! As for Treasury bonds, their prices are the highest in history, their yields the lowest. No help there.
Earlier I spoke about excess. Typically one thinks of stock prices through the roof. But excess can cut the other way too. I am thinking of excessive fear. This is the case today in regard to just about any stock in the retail sector. Investors are behaving as though Amazon will shortly be the only retailer left in America. Way over done. One idea is to buy shares in Tanger Factory Outlet Centers. The stock is down 37% in the last year, despite earnings that are doing just fine, and a 4% dividend. This looks like a risk-adjusted value a lot safer than old standards like utility stocks and government bonds.