The stock market is overvalued. You may find a few dissenting opinions out there, but statistics do not lie. The CAPE ratio (a measure of a company’s earnings adjusted for typical market cycles in relation to its share price and trusted measure of S&P 500 valuation) is currently1 35.08. In simpler terms, this means that for every dollar of earnings in for an S&P 500 company, the aggregate share price is more than 35 times that. The historical average for this measure is 19.6 and hit its record high (44.19) in the dot com bubble at the turn of the century2. Despite this high valuation, the market continues to plow ahead.
So, where in the world should you be with your portfolio? You don’t want to miss out on the historically positive market performance, but you’re also concerned about a return to average or below average multiples that will inevitably occur.
First and foremost, your answer should not be to go “all-in” and predict when to get out. For most investors, this strategy results in significant if not catastrophic failure. Not only do you have to accurately guess the peak of the market (your exit), but you also have to accurately identify the bottom (when you’ll need to get back in).
A more sound answer will depend on where you are in your “investing career”. Namely, how far you are from retirement and what assets you have accumulated thus far. This is a question that you’ll want to discuss in detail with your financial advisor, but the key principle I’d like to discuss here is asset allocation – namely your mix between stocks & bonds or equity & fixed income.
Stocks/Equities serve as the primary driver of investment return and asset accumulation in your portfolio. Bonds/Fixed Income serve to limit volatility in your portfolio and preserve capital. Early in your “investing career,” you can be more aggressive (more concentrated in equities) as you have a longer time horizon to recoup losses and generate return. Later in your “investing career” and in retirement, you’ll likely need a heavier tilt to fixed income as you will be far less equipped to sustain losses and still provide for your lifestyle.
So, you think a market downturn is coming and feel that you must take action. Most good advisors will encourage discipline on the macro scale (regarding any large shifts in your portfolio) and I would agree. However, here are a few thoughts that are worth discussing with your advisor.
- Do I have what I need to weather a market downturn? The longest bear market (when major indexes drop by more than 20%) in US history, the Great Depression, lasted 61 months3, while the average bear market is closer to a year in length. With that in mind, retirees (dependent on income from their portfolio) should have enough fixed income to weather a bear market cycle without having to deplete equities. You’ll find different opinions amongst advisors, but I’ve found that three to four years’ worth of annual expenses is both a conservative and comfortable figure to maintain as a minimum threshold in retirement.
- I am early in my “investing career”, but do not wish to stand idly by. What can I do? Opportunistic is the word here. If you have a heavy equity allocation and feel strongly that the market is overpriced, DO NOT dump your equities. Rather, discuss the impact of taking a portion of your equities off the table with your financial advisor. If you both conclude that there is a sensible strategy for capturing some of your present investment gains, these funds can be repurposed towards your fixed income allocation. Such a move will allow you to mitigate the impact of an economic correction and will also allow you to be opportunistic in later redeploying the funds back into equities at lower prices.
The market is overpriced. You’re a bit anxious and understandably so. However, drastic action is probably not your best course. Discuss these issues with your advisor. Perhaps you’re already well situated. Perhaps there may be an opportunity to make incremental changes.
At Buckhead Capital, we always encourage our clients to reach out in times of uncertainty and have the experience and resources to ensure your finances are based on and reflect a solid plan.
1) http://www.currentmarketvaluation.com/models/price-earnings.php
2) https://markets.businessinsider.com/news/stocks/stock-market-sp500-cape-ratio-highest-dot-com-crash-overvalued-2020-12-1029869993
3) https://apnews.com/article/84ee301c404539d8731da34128330752
