Buying Stocks at the Top

Jonas Elmerraji, CMT

Here’s a thought experiment – if you knew exactly when the next major market top was coming, would you rather allocate your entire portfolio to cash or stay in stocks?

Given that context, I think most people would pick cash…

But it’s not necessarily the best move.

Right now, with tech stocks charging higher, we’re seeing lots of folks drawing comparisons to the dot-com bubble, which peaked in early 2000.

So, let’s run with that example.

The Nasdaq 100 peaked back in March 2000, handing investors an awful 62% negative total return over the next six years. Clearly cash was a better alternative. But there were pockets of the market that fared far better than that.

Utilities were one of them; the Dow Jones Utility Average actually surged more than 72% higher during that same stretch:

dot-com-bubble
Source: Bloomberg

There were plenty more baskets of stocks that fared similarly. The point here isn’t that it was possible to find some individual stocks that did well in the face of a market top with the benefit of hindsight – that's almost always true – it’s that entire sectors still did well.

Utes and other “old economy” names even outperformed treasuries over the six years from the Nasdaq 100 peak (albeit with higher volatility).

There’s a narrative that seems to be going around right now that the stock market is a monolith.

“The stock market is overvalued,” they say.

And while it’s true that the biggest stocks are currently sporting very frothy valuations, it’s also true that the cheapest decile of stocks still looks really cheap right now.

(I’ll be sharing a 2021 update on that valuation data soon – stay tuned.)

Part of the reason the stock market may feel like a single entity right now is that the major indices are extraordinarily concentrated among the biggest dozen or so companies right now, and those big names are also highly correlated currently.

But the cheapest chunk of the market is trading very differently here.

I don’t think it’s unreasonable to imagine a topping scenario where undervalued interest-rate sensitive stocks outperform meaningfully as the Fed pull out any remaining stops to give equity investors a soft landing.

So as stock investors get antsy in the early days of 2021, I think it’s wise to rethink cash as the ideal anti-stock trade right now. Considering the current value bifurcation in the market, the best thing to own when the stock market peaks is probably still stocks – just different stocks than the ones that have been “working” best in the current environment.

(And reminder, gold is another lousy stock market hedge.)

In the meantime, I think it’s still very premature to start piling into defensive old-economy names in this market. A big chunk of the market may be overvalued right now, but valuations are more likely to get even further stretched than burst in the intermediate-term.

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