Don’t Be a Greater Fool
Investors continue looking for justifications to bid stocks higher, but sources of optimism are increasingly elusive. The delusional behavior of the perma-bulls can be explained by the greater fool theory.
The greater fool theory refers to those who buy an investment based on the notion they will be able to sell it at a profit to a “greater fool.” In other words, the price of an asset is determined not by its inherent value, but rather by irrational expectations. Today I will show you how to avoid becoming a greater fool.
To be sure, there’s more to this extended rally than unwarranted exuberance. Notably, investors last week were cheered by positive economic news from the global growth engine of China.
China’s Manufacturing Purchasing Managers’ Index (PMI) for February rose to a three-month high of 51.6, exceeding the consensus expectation of 51.1. At the same time, growth in the U.S., while meager, remains on track.
However, projected corporate earnings growth is hardly gangbusters. For the first quarter of 2017, 75 companies in the S&P 500 have issued negative earnings per share guidance.
Meanwhile, the forward 12-month price-to-earnings ratio for the S&P 500 is 17.9, a level that exceeds the four most recent historical averages: five-year (15.2), 10-year (14.4), 15-year (15.2), and 20-year (17.2).
Linda McDonough, chief investment strategist of Profit Catalyst Alert, sees today’s market as a good news-bad news scenario. Despite these risks, she doesn’t think you should bail out of the market altogether. After nearly 30 years of experience in hedge funds, Linda has seen all kinds of market conditions. She currently counsels caution combined with careful stock picking.
Regarding the over-hyped Initial Public Offering (IPO) last week of mobile chat service Snap (NYSE: SNAP), Linda actually sees a silver lining:
“Maybe the most important lesson is that only a healthy market treats a frothy IPO so kindly. The market digested the Snap IPO quite well…
While teens and Millennials worldwide Snapchat their latest adventure to their coterie of friends, I’ll sit back and rest a little easier knowing investors’ hunger for growth and appetite for risk are showing no signs of slowing down.”
Nonetheless, you should remain wary and reduce your portfolio’s allocations to growth stocks. In today’s jittery investment environment, triggers for a long-belated correction lurk everywhere. “Brexit” anxiety has eased, but traders now fear that France, Holland and Italy are next. Bloody terrorism could strike anywhere, anytime. China’s debt bubble could burst.
It’s also fair to say that socio-political turmoil in the U.S. these days is unnerving Americans and leaving the world aghast, which in turn undermines investor confidence around the globe.
Optimism is warranted over the long haul, but investors probably face a short-term headache.
Brace yourself for a hangover…
Jim Pearce, chief investment strategist of our flagship publication Personal Finance, examines the dangers now facing investors:
“It is sometimes said that the Federal Reserve’s job is to take away the punch bowl when the party gets out of hand, meaning the Fed should raise interest rates to keep inflation in check. In fact, the Fed has every intention of being a party pooper and may raise rates again in March if the economy remains strong.
If there’s one thing wild parties often leave you with, it’s a hangover.”
Regardless, our in-house energy experts are confident we’ll see at least one positive trend for the markets: rising oil prices.
Robert Rapier, chief investment strategist of The Energy Strategist, asserts:
“Acknowledging that presidents seldom get the oil price they want, Trump does have a way to get there that fulfills another campaign pledge and other policy objectives.
Tearing up the Iran nuclear accord would give him a foreign conflict around which to rally the domestic base, and squeeze the oil exports of Iran, while potentially giving Saudi Arabia an incentive to curb its output.”
How should you trade in this volatile market? Pocket some profits from your winners that are now overvalued; increase your allocations in cash and inflation hedges; and make sure your portfolio contains at least 5%-10% in gold.
Are we seeing the return of tech stock mania? Let’s quickly consider this case study:
In 1999, near the apogee of the Dot.com bubble, an IPO prospectus was issued by a U.S. company called NetJ.com. The prospectus stated: “The company is not currently engaged in any substantial activity and has no plans to engage in such activities in the foreseeable future.”
You’d think those vague words would have scared away investors, but far from it. The $110 million capital raising was oversubscribed as greedy investors piled in. Within a few months, NetJ’s share price climbed 18 fold. But after the Dot.com bubble burst in 2000, investors who still held their NetJ shares lost their shirts. NetJ soon went bankrupt.
Now consider last week’s wildly successful IPO of Snap. By the time Snap closed the books on its IPO last Thursday, the company was worth about $30 billion, even though it has never made any money.
We’re not saying Snap is another NetJ. And to be sure, there are still outsized gains to be reaped by investing in IPOs. The key is being highly selective, which is where our investment experts can help you.
Is “buy and hold” a thing of the past?
It’s been an investment mantra for decades: buy reasonably valued stocks with intrinsic merits and hold them forever. But transformative technologies, from the Internet to aviation to pharmaceuticals, are showing investors that we live in a brave new world.
Jim Pearce and his investment team have been crunching the numbers and discovered that a system called Rapid Profits Matrix has outperformed buy and hold by up to 4.9 times in direct competition.
And yet, this trading system racks up stellar returns without relying on day trading or complex options. This presentation explains it all.