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Is it time to be cautious?

If you follow my blog and read my outlooks for the market, you know that since December 2016 I have been bullish and pretty much criticized long term investors selling their positions in their portfolios based on valuations.
 

Here is a pictue from Hedgeye I posted to support my bullish view:

 
S&P 500 Composite
 

And as you will see below, the economy accelerated even more since then.

Any time the stock market dipped I wrote “buy the dip” although many disagreed with me.
 

It wasn’t a time to be a bear. And if you were a bear and sold your positions, you missed a great rally in the recent market history (not overly unique, but extraordinary for sure). I watch time to time some investors on their blogs and on Stocktwits and followed their actions. I time-stamped their sells to se how would they do later on. On average, they missed about 10% of additional growth if they kept holding the positions they deemed too overvalued (note, many of them were selling in 2016).
 

My response to their criticism was that I would be the first one changing my mind should the data supporting my view change.
 

What data?
 

The US macro economic data propping the stock market up.
 

Look at it this way: recently we had many bearish views and opinions out there – North Korean nuclear tests, two hurricanes, and many pundits comparing today’s market to 1987, 2000, and 2008.
 

Every time a bearish event hit the market, it dipped and continued higher.
 

My theory was that it was the US economy accelerating and low inflation propping the market. Many, who were comparing the market to 2000 or 2008 forgot to include inflation. They said that the S&P 500 had pre-2000 or pre-2008 valuation of P/E 20 or 30 or whatever their number was. But what they didn’t include was that in 2000 or 2008 the inflation was at 14% and today below 2%.
 

A P/E 20 at 14% is not the same as P/E 20 at 1.5%. Fudge the number any way you want but you will not be able to go around this fact unless you decide to blatantly ignore it. And many did.
 

Did anything change?
 

I am beginning to see a change in the growth acceleration. We are still growing, but it seems to be slowing down. Let’s review the numbers:
 

S&P 500 Composite
 

There is no time to panic as we are not yet in deceleration but Q1 2018 may be a tough one for corporate earnings and growth. If this cycle continues, we may see the market to follow and investors taking their profits out of the table on a large scale. That may push this market significantly lower.
 

I am still bullish but not as bullish as I was before. It is time to be cautious now.

What should you do?

This all depends on your strategy and time horizon.

If you are a long term investor building your retirement portfolio with 20 or more years before retirement like me, do nothing. As stocks become cheaper, reinvest dividends and buy cheaper. If you buy stocks which do not pay dividends, maybe slow down in purchasing your stocks and save cash for purchases as the stock market corrects. I still wouldn’t sell a single stock if it meets your original criteria. A sell off cycle in the market is normal. It won’t last forever and on the 20 year long scale such sell off will be an insignificant blip.

Also, this slow down may reverse and we may see another up cycle. Then all I said above will be irrelevant.

As an option trader this will not change my strategy too much. I trade strangles and those are neutral trades which allow me to skew the trade in any direction. Should the market really enter a bear market correction, I just simply add more calls to my trades to offset puts losses while reversing puts at the same time. However, it is definitely a time to start preserving cash unless the data start showing growth again.
 

What is your expectation for the rest of the year and beginning of 2018? What will be your strategy in case the market goes into correction? Please, share your thoughts in the comments.





One response to “Is it time to be cautious?”

  1. Stalflare says:

    Ciao Mart,

    Not a fan of the doom and gloom predictions that you get every other minute, I find your analysis more in touch with the way I like things assessed. Excluding black swan events (wars, epidemics, whatever), the economy will eventually slow down and will switch in a lower gear, it’s part of the business cycle and there’s nothing much that it can be done for that. I agree on your reading and 2018 might be one of those transition years, where general economical factors will be very good (GDP, consumer confidence and so on), but there might be a marked slowdown in earnings and growth from companies. What remains to be seen is what QE in USA and EU will do to accelerate things, especially because the bond market (which I find extremely dangerous right now) is very inflated and might come down in a bad way if things interest rates start rising in a stronger way…

    Ciao caio

    Stal

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