Market at all-time high: Danger or opportunity?
Recently, the Dow Jones reached an all-time high of 22,000. This occasion seems to have produced two competing thoughts from investors. "With the markets at all-time highs, is it time to get out of the market, or reduce exposure?" And, "The market seems to be on a roll, should we add more money to our investments and buy more stock?" Obviously, the answer to both questions can't be yes!
The fact that investors seem to be stuck between excitement and fear is probably a good anecdotal gauge of where we are in the current market cycle. We have been in a bull market cycle, where stock prices trend higher and bounce back quickly from corrections, since March 2009. As the ensuing eight years ticked by, investor sentiment has slowly moved along from fear to dread, from dread to relief and from relief to cautious optimism. As the markets hit all-time highs, it seems to me that the mood of investors is now drifting somewhere north of optimistic, and we are starting to see signs of excessive risk-taking by market participants.
Stock valuations are also beginning to look expensive. Stocks are often judged to be "cheap" or "expensive" based on their price-to-earnings ratio. The P/E ratio divides the current price of a stock by the trailing years' earnings to give a sense of how much you're paying to be a stock owner. Currently, for example, the S&P 500 has a P/E of about 24, whereas five years ago, in August 2012, the P/E ratio was 16. By this measure, the S&P, which broadly defines the U.S. stock market, is today trading about 50 percent more expensive than it was five years ago.
It seems clear that investors are becoming less fearful of stock market volatility at the same time that stocks are becoming more expensive, and this is often an omen of rougher waters ahead. To use a baseball analogy, my view is that we are in the latter innings of the current bull market, and investors should probably prepare for the next bear market cycle.
Does this mean investors should sell their investments and get out of the market? Almost certainly not. For one thing, continuing the baseball analogy, we may be in late innings, but we do not know how long these innings will last, or whether the game might extend to extra innings. The current favorable market could go on for years, even at these elevated valuations.
Secondly, getting out of the market and hoping to get in later at lower prices is market timing, and market timing has, in my experience, proven to be a rather terrible investment strategy. A market timer has to be right twice, both in selling, and then on repurchasing. But almost invariably, an investor trying to time the market is operating on a gut feeling. Not a good foundation on which to make investment decisions.
A better approach, in my opinion, is to evaluate your current risk profile to ensure that you and your financial plan are in a position to weather the next bad market storm when it arrives. No one can tell you exactly when the next storm will arrive, only that it will come. Better, then, to prepare now.
Your investment allocation (or mixture of stocks, bonds, cash and alternatives) is the key to understanding your current market risk exposure. Most sophisticated financial planning programs can tell an investor, based on their specific investments, their downside risk exposure. Broadly speaking, the greater the exposure to stocks, high-yield bonds and other higher-risk assets, the higher the downside risk.
I suspect that many investors, after eight years of favorable market conditions and a stock market at all-time highs, might be surprised to uncover just how much risk has built up in their portfolios. If so, now might be a good time to rebalance your investments to lower downside risk to an acceptable level.
Remember, the act of investing necessarily entails taking risk with your capital. You cannot eliminate the risk, but you can understand and control it.
I'll leave you with a famous quote from our country's most successful investor, Warren Buffet. "Be fearful when others are greedy. Be greedy when others are fearful."
Jonathan Lokken, CIMA, is managing principal of Lokken Investment Group LLC in Lewes. He has been professionally managing client investments since 1997. For more information, go to www.lokkeninvest.com or call Lokken Investment Group LLC at 302-645-6650.
Disclaimer: The foregoing content reflects the opinions of Lokken Investment Group LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Past performance is not a guarantee of future results. All investing involves risk. Asset allocation and diversification does not ensure a profit or protect against a loss.
