VIDEO: Moves to Make, Before The Next Shoe Drops
Welcome to my video presentation for Friday, July 16. The article below elaborates on my topic.
Trying to process the news lately is downright exhausting. Rising inflation, the COVID Delta variant, extreme weather events, partisan rancor in American politics, geopolitical turmoil, persistent cyberattacks, ransomware…you name it.
The daily barrage of sensational headlines prompts many investors to wonder: What’s the next shoe to drop?
Let’s step back from the stock market’s daily ups-and-downs to examine the big picture.
A mixed bag of data…
Investors face a “good news-bad news” scenario. A major positive for the stock market is the continuing strength of corporate earnings, as exemplified by stellar Q2 operating results this week from the big banks.
The economic recovery is on track. New applications for unemployment benefits fell last week to a new pandemic-era low. In the week ending July 10, the advance figure for seasonally adjusted initial claims was 360,000, a decline of 26,000 from the previous week’s revised level.
However, consumer prices jumped 5.4% in June from a year earlier, the biggest monthly gain since August 2008.
Also troubling are excessive valuations. The cyclically adjusted price-earnings (CAPE) ratio currently exceeds 38, higher than the levels reached right before the 1929 and 1987 crashes.
Speaking of bubbles, the red-hot housing market is reminiscent of the lead-up to the financial crisis of 2007-2009.
Standard & Poor’s reported in June that its S&P CoreLogic Case-Shiller national home price index posted a nearly 14.6% annual gain in April, up from 13.3% in March. That represented the 11th consecutive month of rising prices (see chart).
S&P CoreLogic Case-Shiller’s 20-City Composite notched a nearly 14.9% annual gain, up from 13.4% in March, surpassing the consensus expectation of a 14.7% annual gain. Housing prices in all 20 cities rose.
Soaring home prices boost the so-called “wealth effect” for Americans. But the torrid rise also invites speculation, reminiscent of the subprime mortgage collapse that triggered the financial crisis and great recession of 2007-2009. Case in point: Private pension funds are snapping up homes across the country, outbidding home buyers, and then jacking up prices.
Here’s another shoe that’s possibly poised to drop: synthetic collateralized debt obligations (CDOs). They were among the chief culprits of the global meltdown about 14 years ago. Well, incredibly, they’re coming back into vogue.
CDOs are securities that hold various forms of debt, such as mortgage-backed securities and corporate bonds, which are then chopped up into different levels of risk and sold to investors. The assets inside a synthetic CDO aren’t physical debt securities but rather derivatives.
The recent re-emergence of highly risky synthetic CDOs doesn’t seem to bother financial regulators, but it should. If you remember, starting in early 2007, massive losses in the synthetic CDO market were proliferating, crushing high-risk hedge funds and spreading panic throughout the fixed-income realm.
But Wall Street never learns from its mistakes. As Steely Dan sang: Go back, Jack, and do it again.
Will the dog days bite?
The stock market has been on a tear since the November 2020 election, which is remarkable considering the stresses exerted by the still ongoing pandemic. But stocks can’t defy gravity forever.
I think the S&P 500 will finish the year with a healthy gain but along the way, the dog days of summer could bite investors. Fewer and fewer stocks are participating in the rise of the major indices. At the same time, an increasing number of stocks are hitting new lows. These divergences could spell trouble.
For the last four decades, every bull market has experienced a correction. By definition, a correction occurs when the market falls 10% from its 52-week high. I don’t expect a full-blown correction, but stocks are due for a pullback.
With stock valuations now at nosebleed levels, you should welcome a modest retreat, which would be a healthy restoration of equilibrium. It’s hard to find value nowadays; a breather in the rally would put many appealing but overpriced stocks back on the bargain shelf.
While you’re bracing for the inevitable stock market swoons, there’s one proactive move you can make now to protect your portfolio: Trim your growth stock allocation.
The crashes of 1929, 1981, 1987, 2008, and 2020 are all examples of situations when investing in only growth stocks with the highest potential return was not the wisest course of action.
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.
The following allocations, as recommended by our flagship publication Personal Finance, generally make sense now (see pie chart).
We’re in the midst of a market rotation, from growth to value. You should do likewise.
Keep plenty of cash on hand, for the bargains that are sure to arise after another market sell-off.
For the hedges sleeve of your portfolio, consider adding gold. The yellow metal is a proven safe haven, especially if current inflationary spikes turn out to be lasting and not transitory. (For details about our favorite gold investment play, click here.)
Commodities and agriculture-linked investments also help protect investors from the ravages of inflation. Their prices tend to rise faster than consumer prices, making them hedges as well as growth opportunities. Long-term tailwinds for commodities include the global boom in infrastructure spending and the trend to “go green.”
Forget exotic assets like crypto and “meme” stocks. Keep it simple. In fact, our investment team has pinpointed five safe, high-yielding stocks that you need to buy now.
Think of these stocks as “bullet proof” buys. They’ve withstood every dip and crash over the last 20 years. One of these companies hasn’t missed a single dividend since Richard Nixon was in office…and it’s still a buy!
As the headlines attest, there’s seemingly no end to Wall Street’s shenanigans. When the “Fear Of Missing Out” dynamic emerges, you should get nervous. To learn more about our five bullet proof stocks, click here.