In a recent SA article, found here, I explained that I had sold almost all my stocks on Friday afternoon, March 3, 2017, with the S&P 500 at 2380, about where it is today. I had retained TBT and small positions in each of the 10 stocks which constitute a portfolio I created to beat the S&P 500 during 2017, found here. TBT is now also gone.
My reasons for selling can be simply summed up as: I believe the market has gone up too high, too long and lately, too fast; is waiting for a catalyst to tip it into correction or bear territory; and I am in a financially happy place and just want to stay there.
Some readers agreed with my reasons and decision, and some didn't; believing it folly to try to time the market. Some also wanted to know my plan for getting back in. Some of my responses to the getting back in part of the decision matrix were: " It is indeed a round trip - out and back in. What will dictate when to get back in will be developments between now and then. I won't know the specifics for maybe many months. But, getting back in, maybe early or late, will have been partially mitigated by having gotten out at close to a possible high … I don't know what the re-entry point will be. I don't think anyone can pick a re-entry point before the decline. This is what I do know: in the last 4 years, I've read thousands (I'm retired so I have plenty of time) of investing articles. Maybe 500 have discussed when the next correction/bear was going to occur. I didn't act on any of them. But, hopefully built up a mental data base of information about the subject. When the markets recently got to being the, whatever it is, 2nd longest streak and 4th strongest bull, I decided to act. It wasn't compulsive at all. It's been years in the making. I'm just at a good place and want to stay there. If it takes 6 or 24 months for the bear to arrive, I'm ok with that. I'll be patient. As to when to get back in ... as I read thousands of articles before, I'll continue doing that. After the correction/bear, many articles will be about when to get back in. I'll bank that knowledge, also. At some point, I'll believe it's the right time, and act. I'll be either too early or too late getting back in. That, also, is ok. Even if the market gets back to its current level before I get back in, that, too is ok, because the market won't be in a too-long and too-high situation. I'm happy with what I've done and happy where I am."
For me, those sentiments still ring true.
But, let's take a more empirical look at the question of when to get back in, premised on the basis of markets always reverting to their mean, and they usually overshoot in so doing.
What is the mean?
Note on the FASTGraph below: SPX's normal long-term P/E is 17.8 (red arrow), it is overvalued (red box) and the 17.8 P/E is overstated because it includes the massive overvaluation of the dot com bubble in 2000 (red circle).
So, let's take out the impact of the dot com bubble by slicing a few years off the FASTGraph. The graph below shows a more accurate long-term P/E of 16.7 (red arrow) and better illustrates the overvaluation (red box).
With a current P/E of 19.9, one could calculate a current over-valuation of 19% (19.9/16.7)
A reversion to the mean of a 16.7 P/E would imply a 19% drop from the current SPX price of 2372.60; or a drop of 455 points to 1918.
Because markets usually (?) overshoot when making reversion moves, a drop to 1850 would seem reasonable. But, who knows. It could only be 7% correction, to 2200, or a 25% bear drop, to 1780.
I personally think the level of the drop will depend on the catalyst which tips it over. If it's something big, like Europe coming unglued or a hot war over some islands in the South China sea or a trade or currency war, then I expect it could go to below 1500. If it is not that big a deal and potentially quickly reversible, like a perception the FED is tightening too fast, or Trump and the FED getting into a war of words, then a 10% drop to 2100 is feasible.
So, for now, for me, I'll plan on keeping my powder dry until slowly nibbling back in at about 2100. But, depending on the catalyst, and the then-current news, I may wait for a lower re-entry point.
I hope you enjoyed this journey. Comments are encouraged. Successful investing.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation. (Borrowed from Chuck Carnevale.)
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.