For the past few days, my old mate Vern Gowdie has been regaling you with stories of fear and loathing about the stock market’s ridiculous valuation.
I get it. I have a great deal of respect for Vern’s views.
I too think the market is due for a correction. It may start tomorrow, next week, or in three months’ time. I have no idea. And to be honest, I’m not overly concerned.
The thing is, you should expect a correction and volatility when you invest in the stock market. It’s just how things work. It might not feel like that now, because seemingly everything has been rising in a straight line for the past 6–8 months. But more volatility is as certain as the sun rising in the east tomorrow.
And Vern’s spot on in saying that when everyone thinks the same, expect something different.
But I respectfully differ from Vern on some points.
For example, unless you’re a trend-following index investor, you’re not investing in a stock market. You’re investing in a market of stocks. While the ‘market’ might appear overvalued, that doesn’t mean every stock is too.
And you don’t have to be all in either.
You can buy assets that act as a hedge against stock market volatility, like the US dollar, bonds and gold. If the market corrects/crashes at some point this year, these assets should do relatively well.
And then there are individual stock picks that give you the ability to take less risk than buying ‘the market’.
For example, the major US indices have become incredibly concentrated. There are a handful of companies that dominate the value of the S&P 500.
According to a recent article in Seeking Alpha:
‘The S&P 500 is now approaching record concentration. The top five index components account for just over 22% of the total index capitalization. In contrast, the bottom 250 components together account for just over 10% of market capitalization.’
Source: Advisor Perspectives/Seeking Alpha
As the article states:
‘For many investors, the S&P 500 defines the stock market. Based on data from S&P Global, approximately $4.5 trillion is indexed to the S&P 500. An additional $6.6 trillion is benchmarked to this index. Passive investing now controls over 60% of equity assets, and the majority of that is linked to the S&P 500. A large portion of these assets are in the retirement plans of conservative investors. Many institutional and retail investors believe that the SPDR S&P 500 Trust ETF (SPY) represents a diversified portfolio that is representative of the broader economy.’
You don’t have to expose yourself to this risk
It’s anything but. The S&P 500 is hugely concentrated in the world’s largest tech companies. Which is fine when everyone wants a piece of tech. But when the tide inevitably goes out, what then?
The point I’m trying to make here is that you don’t have to expose yourself to this risk.
You can avoid the S&P 500 and expensive tech stocks and look at other alternatives. Like the Aussie market!
In November last year I showed you this chart. It shows the performance of the ASX 200 relative to the S&P 500. As you can see, the Aussie market, relative to the S&P 500 is nearly as cheap as it’s ever been.
True, when the S&P 500 goes down, Aussie stocks tend to take a hit too. But often, that’s just sentiment. It has no real impact on the fundamental value of the companies.
In August last year, I made this point to subscribers of Crisis & Opportunity. This is what I wrote:
‘It reminds me of the 1999/2000 market. Back then in Australia, the “old economy” stocks were left behind during the rally phase. But they strongly outperformed during the subsequent bust, which meant that the Aussie market faired pretty well compared to the US.
‘You can see this outperformance in the chart below…
‘If we do see a correction or bear market unfold in the months ahead, you could be looking at another scenario of ASX outperformance.
‘It might not be so bad to own boring “old economy” stocks.’
The old economy sector is heating up too
Granted, tech stocks are still hot. But the old economy sector is heating up too. Banks have put in a big rally over the past four months or so and ‘old energy’ is now heating up again.
The point is, there are alternatives to buying an overvalued ‘market’. And those alternatives are better than cash. Cash might provide stability and the illusion of safety…but in this environment, with lunatics running the show, cash is just as dangerous (long term) as buying an index stuffed full of tech stocks.
Having said that, having a tactical allocation to cash is crucial. When the volatility hits and the inexperienced punters panic, you’ll want a bit of cash on hand to take advantage of the carnage.
When I say carnage, I don’t mean a ‘crash’, like what happened in 2008.
In tomorrow’s edition, I’ll explain why such an event is very unlikely this year…
Editor, The Rum Rebellion