…Bubbles can continue to inflate for months or years after they are first identified and we are now in the most overpriced market in history, bar none. It can, and probably will, go higher as the speculative juices of investors cause them to continue to buy equities with little regard for valuations or market history. [That being said,] investing while in a bubble requires defensive tactics and I deploy a system that ensures that I will be out of the market when the bubble finally bursts. Let me explain.
How overvalued are we?
As the below chart from Jill Mislinski at dshort shows, we are now officially in a stock market bubble. We could be in the early stages or the late stages, but it’s a valuation bubble, nonetheless.
According to Ms. Mislinski:
- “The peak in 2000 marked an unprecedented 129% overshooting of the trend – substantially above the overshoot in 1929.
- At the beginning of December 2020, it was 154% above trend.
- The major troughs of the past saw declines in excess of 50% below the trend.
- If the current S&P 500 were sitting squarely on the regression, it would be at the 1457 level.”
How do you invest in a stock market bubble?
First, it’s reasonable to assume that our current bubble will continue to inflate, but it’s unknowable how far it may go. Therefore, I’m advising clients to stay invested for now…
Investing while in a bubble requires defensive tactics…I, for example, use a moving average crossover system that tracks the short-, intermediate-, and long-term moving averages.
- When short-, intermediate- and long-term MAs turn negative, I raise some cash which ensures that I will be out of the market when the bubble finally bursts.
- The downside is that I will probably give up some of the upside (but not much) if the market continues to rocket higher.
Here’s what my MA strategy looks like:
As of today, January 22, all three MAs are positive, which means my clients who use this system are 100% long equities. When the bubble bursts, this strategy will have moved them to 100% cash or bonds before the big down arrives. (This strategy returned 26% in 2020, vs. 16.6% for the S&P 500)…
In a bubble market the game begins to resemble Musical Chairs. When the music stops, who will have a chair and who will leave the game.
- The True Believers will continue to buy every dip in the market. They have made lots of money thus far but, at some point, there will be a “Come to Jesus” moment when they realize that the game is over – that the bubble has burst and everyone around them is headed for the exits – and they will suffer significant losses, due to their stubborn clinging to the ever-expanding bubble myth.
Having a well-constructed exit plan in place can save you 20%-50% of your invested wealth. Hire a CFP, hire an financial advisor or hire an investing coach but don’t play musical chairs with your nest egg!
Editor’s Note: The original article by Erik Conley, has been edited ([ ]) and abridged (…) above for the sake of clarity and brevity to ensure a fast and easy read. The authors’ views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor. Also note that this complete paragraph must be included in any re-posting to avoid copyright infringement.
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