The last Friday note was two weeks ago, and I noted that some basic wave analysis projected a peak just ahead for the pivotal S&P 500 index, at around 5744, 4% above today’s level.
More recent analysis has added more weight to that possibility of a peak just ahead, one which could be on a scale to truly punctuate the 40 year cycle which is ending. If something of that magnitude occurs (it will one day, it is only a matter of when) it is important to understand what that implies for investors, and here I paraphrase John Hussman…
To reach run-of-the-mill valuations, associated with future returns around the average of 10% annually, the S&P needs to fall by about 70%.
I repeat, fall by about 70%.
Over the last fortnight I have had a growing sense that an awful lot of investors are sleepwalking into Armageddon. I know that is very “Daily Mail” of me. But the Armageddon to which I refer is not in financial markets per se - they will not be destroyed in a literal sense. What will be destroyed are the financial plans and well-being of much of the Baby Boomers across the developed world. They are utterly and fundamentally unprepared for a multi-year bear market.
It gets worse. Many of those most exposed don’t even think of themselves as “investors”. They have passed the investor responsibility to an IFA or wealth manager or some packaged online portfolio. Very few of them have a real sense of investment risk, nor how far markets might fall and for how long. They would be even more shocked if they realised that none of their investment managers have a mechanism to limit those losses in a bear market e.g. a stop-loss – if you know of any, please let me know.
Of course, different portfolios will fall by different amounts, but in a bear market led by the US stock market, directionally they are all heading one way – down. It isn’t just that life plans (e.g. on income levels) will be disrupted…
…When markets fall precipitously in a bear market, fear is all pervasive. That is a certainty, even if the timing of that downturn is not, and fearful investors make bad decisions. The typically worst decision will be selling near the bottom in a panic, perhaps when you have already lost 50% or more.
In the history of the investment industry, stretching back to the 18th century, the investing public, now dominated by Baby Boomers, have never before been exposed on this scale to losses of this magnitude.
As the evidence projecting that peak has grown in the last month, so has that of extreme complacency. Here are 3 examples:
One UK investment platform sent out an email with this worryingly smug headline:
“Summer sell-off encourages savvy investors to buy at cheaper prices”
Notably buying S&P trackers, it was reported. Savvy?
They are bombarded with similar in the US, so it is no wonder that the percentage of US household financial assets allocated to equities has never been greater, at 42.2% - that allocation was 38.4% in March 2000, before the market fell 50%.
The dangerous combination of mania and ignorance was typified by this quotation from a dentist in the Wall Street Journal, as he piled into equities in August:
“The most conservative approach is ‘all in, all the time’”.
I fear he might have to delay his retirement for a few years.
In contrast, what action is being taken by those who might be more accurately regarded as savvy and conservative? Take Warren Buffet. He has a record $277bn in cash, and he is still selling, and as he said in May:
“I don’t mind building the cash position… when I look at the alternatives, we find it quite attractive.”
Not for nothing did Robert Prechter (Elliott Wave International) say in August:
“At no time in history has there been such a series of brightly flashing, long term cautious signal for US stock prices”.
It is fair to say that Robert and his merry men have been saying for a long time that their US market is about to crash, where I merely point out its vulnerability and the need to stay on your guard. But a range of indicators do highlight elevated risks this month and next.
Don’t get me wrong. I am not predicting a terminal top and 70% falls beginning in October. But the risks of such an outcome are elevated, and you must be on your mettle in the weeks ahead.
Two of our Dynamic Portfolios up for review this month, Bonkers 6-Months and Dynamic Asia & EM.
Bonkers was down slightly over the period as the big AI names had a wobble. A gold fund makes its way in for the next 6 months. The long-term performance of this Bonkers Portfolio is staggering – up over 19,000% since inception in September 1995, 17x the World Index.
Dynamic Asia & EM had a strong period driven by India, up nearly 9% over 6 months. Just like Bonkers, the long-term numbers of this portfolio are also exceptional, returning over 7,500% since inception – 19x the index.
In our What’s Hot? funds feature, Japan rebounded from August’s flash crash, with four top-performing funds. U.S. small caps struggled with three funds in the dud list, and also the worst of the dud Sectors in August. There was little excitement in the Hot Sectors list, with modest gains from Property buoyed by optimism around potential rate cuts.
I am sorry not to be more cheerful today! The U.S. market might help us raise a smile with a last hurrah in the week or two ahead, perhaps 4% or so into the projected peak. Better still the mounting evidence of a peak might be a total red herring, and that’s perfectly possible. Just don’t get suckered by over-optimism.