Are The Lemmings Getting Too Close To The Cliff?

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Includes: KMB, PG, XLP
by: Reuben Gregg Brewer

Summary

The bull market is long in the tooth.

Indexes are near all time highs.

And there's a bit of lemming activity going on that you should probably try to avoid.

I've recently written about a few stocks I believe are overvalued, even though the companies themselves are perfectly fine. I've specifically focused on consumer staples, like Procter & Gamble (NYSE:PG) and Kimberly-Clark (NYSE:KMB). That's because it looks like these names are incredibly popular right now, which with an aging bull market could be a danger to your financial health.

The crowded trade
Investors are often like lemmings, piling into a stock or sector at the same time. That, of course, helps to push prices higher, but when the lemmings move on to another area or get spooked out of the one they're in it also tends to exacerbate the downside. Bloomberg recently highlighted interesting research by Sanford C. Bernstein & Co. on this topic.

Looking at first quarter earnings, Bernstein examined stocks that were "crowded" and stocks weren't. The stocks of the most crowded investments went down nearly 6% when they missed earnings expectations compared to a gain of around 2% for the least crowded stocks when they missed. The news on the other side was just as bad. When a crowded stock beat or met expectations the shares only went up about half a percent. Stocks not in the limelight, however, advanced nearly 5% on a beat or meet.

Bernstein's Ann Larson, who heads up the company's quantitative analyst group, summed things up on the crowded side nicely: "Crowded trades are typically already priced for perfection, and as such incremental positive news has little impact, whereas negative news has a more pronounced effect." One of the most crowded sectors right now, according Bernstein, is consumer staples.

Nice showing
There's a reason to be attracted to consumer staples. For starters, the companies tend to pay consistent and even growing dividends and many in the sector offer yields that are relatively high right now. In the current low interest rate environment that's a huge plus. Procter & Gamble is a great example, with a yield of around 3.25% compared to a yield for the S&P as a whole of closer to 2%. And it has a 60 year history of annual dividend hikes to back that yield up. P&G happens to be the largest holding in the Consumer Staples Select Sector SPDR Fund (NYSEARCA:XLP) at roughly 11.5% of the exchange traded fund, or ETF.

That ETF, for reference, is up around 6% so far this year. The S&P 500, meanwhile, is up just 2% or so. So this really is a popular sector bet right now and it's playing out well for investors, overall. But this isn't a new trend, over the past year Consumer Staples Select Sector SPDR Fund is up around 11% while the S&P is down almost 1%.

So here's a question... What's driving this? Consumer staples are viewed as something of a safe haven in a storm-you aren't going to stop buying deodorant or toilet paper just because stock prices are falling. So, my guess, is that the shift into this sector is about investors becoming increasingly concerned about the overall market. That makes complete sense to me, I'm worried, too. But I'm also thinking that following the crowd into consumer staples is a bad call right now, even if the main attraction is the dividends.

Too long
The current bull market is getting old. It started roughly in 2009, making it around six years old at this point. No bull market lasts forever and when they end the subsequent bear market tends to bring down most, if not all, boats. It's pretty hard to believe that consumer staples will avoid the pain of the next bear market.

To be fair, looking at the one-year period between February 2008 and February 2009, consumer staples fell around 25% while the broader S&P lost nearly 50% of its value. That's a pretty good relative showing. But it doesn't change the fact that consumer staples stocks lost a quarter of their value in a year. And since consumer staples like Procter & Gamble and Kimberly-Clark are kind of expensive right now, the lemmings that have run into consumer staples really don't look like they are worth following.

Here's the thing, there's no rule that says you have to be 100% invested at all times. Sure, mutual funds, insurance companies, and other investments managers may have such mandates, but as an individual investor you don't. Sitting on cash can be painful, especially as a market continues to make small, but incremental highs, but you still don't have to invest.

I often fall back on this great quote from Warren Buffett on this very topic: "You do things when the opportunities come along. I've had periods in my life when I've had a bundle of ideas come along, and I've had long dry spells. If I get an idea next week, I'll do something. If not, I won't do a damn thing." I feel the pain of not investing right now since I've been stockpiling cash, but I simply can't find anything that I think is a good value for a new investment.

In fact, step back a little bit. The S&P 500 has basically gone nowhere since the start of 2015. And between January of last year and today there have been two notable drops and recoveries. Is it possible that the market simply goes higher from here? Sure. But you have to juxtapose that outcome against the length of the bull market and high valuations.

Waiting for some value
For me a notable stock market drop would be a welcome outcome because I'm holding cash. If there is a bear market on the way, I'll have plenty of firepower to buy companies on my wish list at what I hope will be particularly cheap prices. Only time will tell if I'm doing the right thing. But with increasingly crowded trades pushing up valuations of the very stocks I tend to like, such as consumer staples, I'm going to follow Buffett's advice and do nothing. When a good value comes my way, I'll be ready because I'm not following the crowd.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.