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Mid-Year Review: Time to Take Stock of Equities

Compared to the first quarter of this year, which included a meteoric 7% rise in January followed by a nerve-racking 10% plunge over the next two months, the second quarter of 2018 was a veritable cakewalk.

The S&P 500 Index ended the month of June nearly 2% higher than it started the year, despite mounting trade tensions that threaten to destabilize a fragmented global economy (see chart).

The stock market’s recovery coincided with a sharp rise in oil prices, which is unusual in that higher energy prices represent a drag on earnings for most businesses. At the end June, oil was selling for $75 per barrel, more than 50% above its price a year earlier.

Oddly, the share prices of major oil producers such Chevron (NYSE: CVX) and Exxon Mobil (NYSE: XOM) barely budged, while huge consumers of oil such as airlines predictably hit the skids.

At the same time, high-multiple momentum stocks continued their assault on the record books. Amazon (NSDQ: AMZN) is up more than five-fold over the past four years, gaining 50% this year alone, while Netflix (NSDQ: NFLX) has nearly doubled over the past six months. Coincidentally, both companies are valued at roughly 85 times forward earnings, despite rising interest rates that cheapen the value of future profits.

So what are we to make of this upside-down world where good is bad and bad is good? If revenue growth is all that matters anymore, shareholders have effectively become unsecured lenders. That’s because there isn’t much in the way of dividends or profits to share with them from many of the companies that are driving the market higher.

It appears some investors are adhering the sports truism that the best defense is a good offense. They burrow into overpriced momentum stocks without regard to valuation. So long as enough people think that way then they’ll be okay. This is known on Wall Street as the “greater fool” theory, which depends on a perpetual supply of optimistic investors to keep share prices high.

Eventually, the market gets it right. The next round of quarterly results will start hitting the street next week. The combination of rising fuel prices, higher borrowing costs, escalating trade wars and a tight labor market may start creeping into those numbers. If not now, forward guidance may reflect narrowing profit margins over the remainder of the year.

As the second half of this year gets underway, now is a good time to take a close look at your portfolio to determine if you own any “greater fool” stocks that are at risk of taking a big hit. If you do, be prepared to act quickly if quarterly results come up short of expectations. By the time Labor Day rolls around, it may be too late.

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Here’s What’s Really Going to Crush the Market

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And there are two reasons for that…

First, the U.S. government’s calculations barely take into account two of the things you and I are paying more and more for every day: energy and food.

Second, since inflation really hasn’t been an issue for the past 30 years here in the U.S., most analysts won’t dare to say it’s on the rise because they’ll suffer professionally. 

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Stock Talk

Frank Johnson

Frank Johnson

I hope Apple is not included in the “greater fool” caegory, as that is my largest single investrment. Microsoft is next.

Jim Pearce

Jim Pearce

Apple most definitely is not a “greater fool” stock. If anything, it is slightly undervalued at 14 times forward earnings. Microsoft, priced at 25 times forward earnings, is fully valued but not grossly overvalued like AMZN and NFLX.



Your explanation of AMZN supporters makes some sense – but not completely.
“They burrow into overpriced momentum stocks without regard to valuation. …” .
I believe they have been supporting amzn even without regard to profitability, let alone valuation – so how would potentially narrowing profit margins in coming quarters, make any difference to those supporters?
For some reason, they want to support the ‘big guy’, or even the ‘biggest guy’ in the game, which guy also wants to be the ‘most diversified’ guy; this support is the antithesis of American prudent business practices – supporting a huge wanna-be monopolist who seeks to grow into any market and with no bounds to market size.

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