Prudent to Reduce Exposure to Equities

By on October 18, 2006

Originally published in July 1999:


DJIA 11,066.42

S&P 500 1,380.96

NASDAQ 2,706.18


Anytime something becomes a fad it becomes overpriced. It doesn’t matter what it is: real estate, precious metals, beanie babies….even stocks, and stocks are one of the biggest fads going right now. Anytime people buy into a fad they are putting their hard earned money at risk. It doesn’t matter what Peter Lynch says in the Fidelity commercials…stocks are currently a very high risk play and priced for perfection. Even Alan Greenspan’s model suggests stocks are 40% overvalued given the current level of interest rates.

How can you justify a $300 billion company trading at 70 times annual earnings? You can’t. How about several trillion dollars (NASDAQ 100) worth of stock trading at 50 times earnings. Again, not possible. The chance of a major market meltdown has increased dramatically. With long term interest rates pushing above 6% from the low of 4.75%, the attractiveness of stocks as an investment vehicle has diminished substantially. This, along with the fact that S&P 500 company earnings have not grown strongly over the past 4 years, while stock prices have soared, make this a very precarious market. Y2K related concerns, whether justified or not, could cause investors to panic sometime in the next 6 months. I have a confession to make. It was with a good degree of trepidation that I sold the majority of stocks in my non-taxable (IRAs and pension) accounts over the past few weeks. I did not sell stocks in my taxable accounts due to the capital gains taxes that would be due. I have also not altered the strategies of the featured “real world” portfolios. I’m committed to sticking with the Tactical Timing System, especially since it has provided very good risk-adjusted returns and is the cornerstone of this newsletter.

After making unusually high returns over the past decade I feel it is simply prudent to reduce exposure to the equity market and wait for a re-entry point sometime in the next 6-8 months. It is possible that the market will make its way higher despite these concerns. This is a price I’m willing to pay. There are just too many negatives on the horizon to ignore right now. U.S. consumers are over-indebted and over-spent with a negative savings rate (the lowest ever recorded), the gulf between rich and poor continues to widen dramatically (the top 1% of households own 40% of the nations wealth), bullish sentiment is overwhelming on Wall Street (some surveys show 60% bullish sentiment), and the S&P 500 trades at the highest P/E ratio ever. If stocks are really worth as much as people are paying for them we must be heading for an economic nirvana/utopia of strong growth, unbelievable productivity gains, low inflation and rising wages for everyone, not just the multi-million dollar salaried CEOs. Who needs stocks in this sort of scenario. You’re starting to get the idea.

I’ve made much more money in the market the past 10 years (and especially the last 4) than anticipated. I hope this doesn’t sound like bragging, because the returns haven’t been spectacular in any one year. Unfortunately, I didn’t catch the internet wave and didn’t invest heavily in technology. I haven’t even matched the S&P 500’s return. But who has? However, the compounding of money at 20% per year over the past decade has provided a wealth effect that I never would have dreamed of a few years ago.

This newsletter was started with the idea of generating some extra income if it became successful. It turns out that the extra income is not needed due to the strong stock market. It seems to be a little hoggish, and perhaps somewhat foolish to remain heavily invested in equities after the abnormally high returns of recent years. And so the decision was made to sell where it doesn’t hurt when the tax bill comes due.

About the Checkers Picture in the Last Issue

Last month I saw a local Checkers Restaurant advertising a $1000 bonus for new hires. This is just one more sign of the tightening labor market and the pressure that will be placed on company costs. Firms are either going to have to eat these higher costs and face reduced profits or they’ll need to raise their prices. Either scenario is not good for stocks.

P.S. This newsletter will be produced intermittently from now on. You may only get an issue every 3-4 months. This is my idea of a sabbatical from the stock market, which I definitely need. However, the Tactical Timing System buy/sell signals and stock selections will be sent whenever generated. Good luck to you all over the next few months.

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