DAVID DRISCOLL’S MARKET OUTLOOK
Are we in for a wild ride in 2018? With the S&P 500 Index currently trading at 23.14x earnings and its historical average at 16.2, one may surmise the market is 43 per cent overvalued. However, according to history, the largest market peaks in 1929 and 1999 suggest we could go another 40 per cent higher – the “melt-up phase.” Unfortunately, the ride down to its historical norm after such a peak would be about 50 per cent.
So, what to do? Here are some ways to deal with today’s markets:
- Re-balance positions when necessary – if you own a 30-stock portfolio and one of the holdings becomes greater than six per cent, sell half and allocate the cash to those positions with a weighting less than three per cent. This avoids any emotional struggle – instead it’s mechanical.
- Pay attention to the stock’s beta – if you own stocks with betas over 1.50, it’s important to either sell outright or re-balance. That’s because if the market drops 50 per cent, these stocks could drop 75 per cent (50% x 1.5). That could destroy your capital quickly and the return to break-even could take decades.
- Keep some money in cash. We hold 20 per cent times the equity weighting of a client’s portfolio. If the portfolio is 100 per cent equity, then we’re 80 per cent invested with 20 per cent in cash. If the portfolio is 50 per cent stocks and 50 per cent fixed income, we’d have a 10 per cent cash weighting (50% x 20%).
- Diversify globally. If the market drops 50 per cent, the Canadian dollar will come under pressure and a global portfolio would help ease the pain. In 2008, the Canadian dollar fell 22 per cent as investors flocked from minor currencies like the Loonie to the more liquid currencies of the U.S. dollar, euro and the Japanese yen.
- Avoid correlation risk – don’t own multiple stocks in the same industry. In 2008, it wasn’t one Canadian bank that fell 40 per cent, they all did. If you’re living off the capital and it falls 40 per cent, you could run out of money before markets recover.