Is it time to sell stocks before the bubble bursts or buy more because they will be underpriced as the dollar loses value? The suggestion that one sell stocks before the bubble bursts is based on the fact that stocks are at a historic high. When stocks hit a historic high they tend to get overpriced and then the market collapses. Investors who put their money in the US stock market in 1853, 1906, 1929, 1969, 1999 and 2008 needed a long time to make a decent return on investment. Investors who entered the market after these stock market collapsed got an immediate boost as the market climbed out of the depths. We wrote last week about asset bubble investment risks. There are a whole host of real reasons why markets could collapse across the globe and take stocks with them. On the other hand the major Free World economies are intentionally devaluing their currencies (USA, Euro Zone, Great Britain, Japan). This being the case you want to collect assets now instead of holding cash.
When Have Stocks Hit Their Peak and When Are They Overvalued?
In retrospect it is always easy to see when one should have sold stocks. But, let us look at the last twenty years. The S&P 500 was 46 in 1994 and rose to 144 by late 1999. It fell to 87 by mid-2002 and rose to 152 by early 2008. It fell to 82 by late 2008 and has risen to 197 as of this month.
Image taken from Google Finance
Anyone who invested in a basket of US stocks in 1994 made money by 1999. If they were able to sell stocks before the bubble burst they were able to reinvest in 2002 and buy three times as much stock with their profits. If they also got out in time in 2008 they doubled their money from 2002 and were able to reinvest in late 2008 and buy roughly twice as much stock again only to see it go up two and a half times until today. This would be a thirty-fold increase on investment capital for those who sell stocks before the bubble bursts and patiently wait for the market to bottom out before re-investing. And this is not picking spectacular stocks but rather a portfolio that simply mirrors the S&P 500. An exchange traded fund that tracked the S&P 500 would have sufficed. Alternatively an investor could have waited until 1999 to invest in the S&P 500 and gotten out in a panic when the market finally bottomed out in 2002, repeated this again in 2008 and waited until today to reinvest. For every dollar invested this way the investor would have eight cents left over.
Fundamentals and Market Sentiment
We talk often about the need for sound fundamental analysis of stocks. Equally important is to know when herd instinct instead of sound analysis is driving the market. Our concern today is that a lot of money is chasing too few investment vehicles. And many are trying to make up for lost opportunities and using highly leveraged investment vehicles that will evaporate in value if the market tanks. AND it is our belief that the USA, EU and Japan will continue to devalue their currencies in order to stimulate their economies and make their products more competitive on the world stage. This currency devaluation will make real estate and stocks more valuable in the long run as valued in these currencies. The trick to making a profit in this world is the dual analysis of fundamentals and market psychology. Get in when prices are low and no one is interested and sell stocks before the bubble bursts when they have become obviously overpriced.