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Moves to Make… Before The Next Shoe Drops

Trying to process the news lately is downright exhausting. Wall Street is encouraged by President Trump’s pro-business policies, but fear is in the air. The daily barrage of sensational headlines prompts many investors to wonder: What’s the next shoe to drop?

And yet the Trump rally still lives, proving the adage that the market climbs a wall of worry. On Wednesday, the S&P 500 capped its seventh straight gain, marking its longest winning streak in three and a half years. In addition to positive economic data and Trump’s promises to cut taxes and regulation, much of the exuberance is fueled by healthy corporate earnings growth.

According to Thomson Reuters, earnings for the fourth quarter of 2016 are on track to grow 8.4% from last year’s fourth quarter. That’s nearly twice the growth rate posted in the third quarter and a sure sign that the three-year earnings recession is finally over.

Conflicting signs…

But don’t get complacent. Linda McDonough, chief investment strategist of Profit Catalyst Alert, has nearly 30 years of experience with hedge funds. When she speaks, the Investing Daily team sits up and pays attention.

And right now, Linda describes the market as a “good news-bad news” scenario:

“The good news for the market is that earnings are coming in better than expected… The bad news is that valuations are higher than ever.

The S&P 500 is valued with a price-to-earnings ratio (P/E) of 17.5 times expected earnings. One year ago the S&P 500 traded with a price to earnings ratio of about 15. Even after accounting for the higher growth rate of earnings, the overall market valuation is frothy.

Prices have run up so far, so fast, that most stocks are trading with P/E’s that exceed their growth rates.”

Other concerns should give you pause as well. Since 1961, recoveries on average have lasted about eight years — roughly the length of the Obama recovery. According to cyclical precedents, an economic recession is in the cards for 2017.

Is the bull on its last legs?

The bull market is nearing its eighth year, which is perilously long by past standards. It’s now the second-longest bull run in history and it can’t defy gravity forever.

For the last four decades, every bull market has experienced a correction, which is simply a healthy restoration of equilibrium.

Most money managers and financial opinion leaders are calling for a stock market correction this year. By definition, a correction occurs when the market falls 10% from its 52-week high.

With stock valuations now at excessive levels, you should welcome a correction. It’s hard to find value nowadays; a correction would put many appealing but overpriced stocks back on the bargain shelf.

Jim Pearce, chief investment strategist of our flagship publication Personal Finance, offers this perspective:

“A correction usually acts as a cleansing mechanism that separates overhyped momentum stocks from companies that are priced fairly and can generate profits without assistance from artificially low interest rates.”

While you’re bracing for the inevitable correction, there’s one proactive move you can make now to protect your portfolio: Trim your growth stock allocation.

The crashes of 1929, 1981, 1987 and the more recent tumbles of 2007-2009 are all examples of situations when investing in only growth stocks with the highest potential return was not the wisest course of action.

Credible research studies have found that asset allocation explains nearly 100% of the level of investor returns. At the heart of asset allocation is the risk-return trade-off. Many investors make the mistake of setting their asset allocation once and then walking away. It’s not a one-time task; it’s a life-long process of fine-tuning.

Jim Pearce also serves as Director of Portfolio Strategy for Investing Daily. Jim currently recommends these allocations: 35% in stocks and the remaining 65% in cash, bonds, and inflation hedges.

As hedges, consider adding precious metals such as gold and silver to your portfolio.

Got any questions or feedback? I’d love to hear from you: mailbag@investingdaily.com — John Persinos

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