Every bull market has an expiration date, which is why last week's magazine cover from Barron's reminded me to remain defensive. This cover encapsulates the kind of unbridled optimism and disregard for risk that I have seen near previous market tops. It doesn't tell us when a top is in place, because market tops are processes rather than events. It doesn't tell us when a bear market begins. We may be in the middle of a bear-market rally right now, with the all-time high achieved last September behind us, and the bear-market lows still ahead. Or we may achieve new all-time highs in the weeks or months ahead, setting the stage for another leg of the current bull market. No one knows for sure.
What investors must do is lean towards what they view as the most probable outcome as opposed to being all in or all out and hedge exposure if incorrect in their assessment. That's what portfolio management is all about. The outlook I have been leaning towards is that we are in the process of a major market top for this economic cycle, and in my experience, the "fear of missing out," or FOMO, has always coincided with that process.
I will admit that over the past couple of weeks, I have had a touch of FOMO. It's perfectly normal when markets make massive uninterrupted moves upward over short periods of time, and we have cash sitting idle on the sidelines. Why am I not all in dammit! What can I buy today? This fear of missing out is the exact opposite of the fear of being wiped out, or FOWO, which most investors experienced last December.
These fears continually lead the majority of investors to make what look like bad decisions in hindsight, which can be seen below in the money flows into and out of stock funds. What did investors see in March, leading to the largest inflows in a year, that they didn't see last December?
Investing is not a competition unless you consider yourself the competitor. Overcoming these fears, staying disciplined and consistently following your investment strategy are the keys to long-term success. I contend that the long-term view of the market still looks dubious at best, as the S&P 500 tests the upper end of the trading range it has held over the past 15 months. Furthermore, the fundamentals that support valuations have been steadily deteriorating, which doesn't bode well for a break-out to new all-time highs.
Still, the fear of not being fully invested should we achieve new all-time highs can overwhelm the most experienced of investors. This is why I shared the Barron's cover, which like a pungent smelling salt brought me back to my senses. Stay focused and stay disciplined. I am currently exceeding my annualized long-term return objective on a year-to-date basis, and I am doing so taking far less risk than I would have otherwise assumed I would need to take. That is what I need to focus on.
While I remain on defense, which dictates elevated cash levels in the portfolios that comprise my asset allocation, I can always find attractive investment opportunities that I believe are actionable today. Yet I must look at those investment opportunities in the context of the overall market backdrop, which does not look attractive. Therefore, I will continue to hedge any increase in exposure to higher-quality and lower-valued investments with strategies that will appreciate from the decline in lower-quality and higher-valued assets.
Stay disciplined and stay focused!
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