Bubble or Not Here’s How To Trade It

Whether you think the market is in a bubble or just forming a short-term top is mainly irrelevant but if you’re nearing retirement, or are a retiree, your investment horizon is shorter than that of much younger people it may be wise to consider the possibility.

By Lance Roberts (in this edited and abridged version by the Managing Editor of munKNEE.com – Your Key To Making Money!)

How To Navigate the Current Situation

…[Below are some ideas:]

1. Avoid the “herd mentality” of paying increasingly higher prices without sound reasoning.
2. Do your research and avoid “confirmation bias.”
3. Develop a sound long-term investment strategy that includes “risk management” protocols.
4. Diversify your portfolio allocation model to include “safer assets.”
5. Control your “greed” and resist the temptation to “get rich quick” in speculative investments.
6. Avoid making the emotional mistakes of  getting caught up in “what could have been” or “anchoring” to a past value.
7. Realize that price inflation does not last forever. The larger the deviation from the mean, the greater the eventual reversion. Invest accordingly.

The increase in speculative risks and excess leverage leaves the market vulnerable to a sizable correction but, unfortunately, the only missing ingredient is the catalyst that brings “fear” into an overly complacent marketplace.  [As such,] currently, investors believe “this time IS different.” but that’s only because the variables are different. The variables always are, but outcomes are always the same.

When the market corrects, the media will tell you, “No one could have seen it coming” but, of course, hindsight isn’t very useful in protecting your capital.

How We Are Trading It

We remain in the camp that a 5-10% correction is coming over the next few months and, as such, we remain cautious about deploying new capital and taking on excess risk in portfolios at current valuations. With the earnings season behind us, the focus will return to the economic data and the Federal Reserve.

We have yet to see a meaningful rotation into value from growth, leaving this market confined to a tight trading range but we suspect that will change at some point so we suggest reverting to basic portfolio management rules to reduce portfolio risks for now, namely:

1. Keep in mind that when the market is overly bullish, it is also when the risk of a reversal is the greatest.
2. Trim Winning Positions back to their original portfolio weightings. (i.e. Take profits)
3. Sell Those Positions That Aren’t Working. If they don’t rally with the market during a bounce, they will decline when it sells off again.
4. Move Trailing Stop Losses Up to new levels.
5. Review Your Portfolio Allocation Relative To Your Risk Tolerance. If you have an aggressive allocation to equities, consider raising cash levels and increasing fixed income accordingly to reduce relative market exposure.