Don’t Get Burned by This Market written by: Trevor Gerszt
Throughout the history of investing, market crashes have always come as a surprise. The interesting thing about those surprise turnarounds is that, in hindsight, they were pretty obvious. Anyone in real estate in 2006 knew there was something very wrong with the way Washington Mutual was handing out home loans. In the run-up to the 2000 dot.com disaster anyone with a calculator could figure out those tech valuations were not sustainable.
So, if market crashes are so easy to see in the rear view, why are they always a surprise? Understanding the answer to that question is the key to being a successful small investor. Knowing how to position yourself for the next, inevitable, crash is the key to building wealth.
Abacab Fund Sees Mispricing In Options As Black-Scholes Has Become “Inadequate”
Abacab Asset Management's flagship investment fund, the Abacab Fund, had a "very strong" 2020, returning 25.9% net, that's according to a copy of the firm's year-end letter to investors, which ValueWalk has been able to review. Commenting on the investment environment last year, the fund manager noted that, due to the accelerated adoption of many Read More
The First Sign of Trouble: No Signs of Trouble
One of the big reasons market crashes are always a surprise is they tend to be preceded by times of stability. Businesses don’t take crazy chances with investments during turbulent periods in the market. It takes the confidence born of stability to lull decision makers into a frame of mind where they’ll be comfortable taking the big risks. That’s how we get bubbles in the economy, generated by more and more money flowing into risky assets.
The Gambling Mentality
If you’ve ever been to a casino, you quickly discovered the place with most emotion is the craps table. Even though the odds are a merciless master, irrational exuberance is what makes craps profitable for the house. Huge sums of money come into play when a hot shooter defies statistical gravity, repeatedly beating those odds. It’s easy to get caught up in the excitement, despite that little voice in the back of your head that keeps urging you to pick up your chips and walk away. The great killer of fortunes on the craps table is the phrase, “Just one more pass.” The odds don’t change but that exuberance makes us perceive our chances with greater confidence than the numbers warrant.
New Record Highs
Success tends to breed more success and that’s exactly what we’re seeing in the stock market today. U.S. equity markets are on fire mainly due to an influx of foreign capital fleeing Europe in the wake of the Brexit vote. That’s combined with a slow year for earnings and problems in China that depressed the market value earlier in the year. So, for the next few days, weeks or possibly months, the U.S. stock market has become the next Tulip Bulb market.
What to Do Now
What you should be doing now will fly in the face of every instinct you have as an investor. This is the time to start converting some of those high flying equity funds into cash. Crazy, right? You’re selling at the time the rest of the world is buying. As the market moves higher, other asset classes, like gold and silver bullion, will likely sink lower as investors discard caution and throw money at the S&P 500 craps table.
No Safety in Bonds
Normally, you’d take some of that cash from selling stocks and put it into something safer, like bonds. Unfortunately, the bond market is a bigger mess than the equity market right now and people are actually trading bonds like stocks! It’s insane. Move to cash and protect the buying power of a fixed percentage of that cash with regular buys of liquid hard assets.
At some point in the near future one of the many asset bubbles we see today will pop. That one event, and no one knows what that might be, will start the next crash. There’s plenty of time to see this one coming, so don’t get caught. As the market reaches new highs, skim off some profits and build up your cash and hard assets. You’ll be glad you did when the bubble bursts