“My level’s too high to bring me down. Can’t nothing, bring me down, I said clap along if you feel like a room without a roof.” —Pharrell Williams
Investors are not worried about sky-high stock valuations or contrarian sell signals, such as over-optimistic buyers. Throughout the previous two months, I’ve said a) I am concerned that the U.S. equity market is overextended, but b) instead of getting defensive, I will react to any correction by rebalancing to increase exposure to stocks of U.S.-based, small-capitalization companies and the emerging markets.
The good news is that I have exposure to both of those asset classes. The bad news is that I was too wimpy to buy more of those things. I could have done better if I had accepted more risk. We all have a mental file full of “woulda-coulda-shoulda” investment opportunities; this is just the most recent addition to my file.
To be clear, I have been buying small-caps and EM with new cash that hits my portfolios. I’ve been investing cash deposits across my entire portfolio. I’ve been hesitant to materially increase the allocation of those more volatile positions as we sit on what feels like the cusp of a market pullback.
I am fully invested, so it’s not as if I’m feeling left out. Maybe just a little left behind. I’m kicking myself for not having a higher allocation to those higher-flying stocks that are on my radar.
This emotion scares me. I’m a professional; I’m not supposed to have feelings!
I am humble enough to admit I wish I had been more aggressive the last couple of months. I am also self-aware enough to recognize I am beginning to join the crowd in these FOMO-feelings (fear-of-missing-out). That is a sign that euphoria has reached the market. It might have been more profitable to have introduced more risk into my portfolios, but it wouldn’t have necessarily been prudent.
However, an overextended market can keep going higher. I’ll continue to add to my target positions as cash is deposited. I’ll wait before I make significant changes. I don’t need to squeeze out every penny from the market, but I do want to protect every penny I make. Maybe it’s just me, but the pain of losing a dollar dwarfs the joy of gaining a dollar.
That expected pain shouldn’t last too long. The stock market is overbought, but the breadth is positive. Generally, when many stocks are participating in the rise of an index, that’s good news. Just like exercise, too much effort in the short-term can overwork your muscles, and you will require rest. In the longer run, so long as you don’t hurt yourself, it turns out that exercise is good for you. In gym parlance: no pain, no gain. A little bit of pain in the stock market will reset prices and, I suspect, renew demand from investors to bid prices back up.
As of January 25, 2021, 88.9 percent of stocks in the S&P 500 index traded above their 200-day moving average. That broke a 20-day streak. There was also a 20-day streak that ended as recently as December 22, 2020. These are examples of very positive market breadth. Such 20-day streaks don’t happen often. Aside from those two instances, 20-day streaks have only occurred five other times since 1990.
The average and median returns for the S&P 500 six months after those prior streaks were 0.44 percent and -3.33 percent, respectively. Those are not good returns, but they are not something so shocking that it might end the current secular bull market. That is part of the reason I remain fully invested — major bear markets don’t start when breadth is that good. Bear in mind, that doesn’t mean stock prices are invulnerable to significant short-term setbacks.
Another reason I remain fully invested is because the U.S. consumer is expected to go on a buying spree later this year and in early 2022. Households are starting 2021 with lots of cash available to act on pent-up demand for goods, services, fun, travel, and everything else we’ve been deprived of. The household savings rate as a percentage of disposable income is about 13 percent. Aside from its record highs in 2020 following the CARES Act, this is the highest level in decades. The consumer is loaded up and ready to buy. They just need to be let off the COVID leash.
The U.S. is averaging about 1.25 million COVID-19 inoculations per day. It’s possible to achieve herd immunity as early as late summer or the fall of 2021. Depending on your definition, we could get back to our normal lives by the first quarter of 2022. That seems like a lifetime away. But the stock market appears to be okay with looking that far into the future.
Not that we are out of the woods yet. I won’t let the euphoria that exudes from investors blind me to the risks. Bespoke came up with a list of what they call “Ludicrous” stocks. The number of U.S. stocks with a market capitalization greater than $500 million, with a price-to-sales ratio greater than 10, doubled over the last month (as of January 25, 2021) to 79. That’s a sign of over-optimism. As a contrarian investor, that surge worries me. It feels like a “blow-off top” type of buying, that last whoosh up, which attracts the “FOMO” investors who are snapping up stocks like they’re Veblen goods.
Also, remember when we just needed two weeks to “flatten the curve?” Then some people said COVID-19 would be behind us by Easter 2020. Then it would be a memory by Independence Day. And then, and then, and then … I am optimistic about vaccinations helping the global economy get back on track. However, time and time again, promises were broken, and optimism proved to have been misplaced. Just as too much optimism is terrible for the stock market, it’s been a dangerous emotion when predicting the path and effects of COVID-19.
This article originally appeared in The Berkshire Edge on February 1, 2021.