The Most Dangerous Investing Decision You Can Make

What is the most dangerous investing decision you can presently make?

Your choices are these:

A): Buying and holding through thick, through thin, through peak, through valley

B): Loading up on “FAANG” stocks (Facebook, Apple, Amazon, Netflix, Google) — plus Microsoft

C): Chasing biotechnology stocks in pursuit of a COVID vaccine jackpot

D): Going “long” the S&P

E): Heeding The Daily Reckoning’s investment advice

In the spirit of transparency, we eliminate E from contention — rightly or wrongly.

A-D are your choices. Have you made your selection? Answer shortly.

Let us first look in on that pit of quicksand known otherwise as the stock market…

More Long Faces on Wall Street

Markets sank deeper into the muck again today.

The Dow Jones plunged another 525 points today. The S&P dropped 78. Percentage wise, the Nasdaq fell even lower — 330 points.

What do the experts have to say?

Ian Shepherdson, chief economist for Pantheon Macroeconomics:

It’s hard to be optimistic about September and the fourth quarter, with the chance of a further relief bill before the election receding as Washington focuses on the Supreme Court.

JPMorgan’s John Normand has this to say:

Even if just coincidence, September has become the month when most of investors’ widely-held reservations about the global economy and markets have converged. These include an early-stage downshift in global growth; a rise in US/European political risk; and virus second waves. The only missing component has been the use of systemically-important sanctions in the US/China conflict.

Perhaps these are next?

Finally, we turn to Art Hogan, chief market strategist at National Securities:

September is a historically tough month and this one has been a quagmire of headwinds. Today is reflective of that.

As we reminded you yesterday: History says September is the stock market’s cruelest month.

59 Years Until the Next Rate Hike?

Gold, meantime, took another solid whaling today — down $42. Why?

Chicago Federal President Charles Evans claims he and his fellows may increase interest rates before attaining their blessed 2% inflation.

The dollar surged in consequence. The U.S. dollar index put in a seven-week high today, in fact.

Perhaps Mr. Evans took note of a freshly released Bank of America report.

He would have learned that the Federal Reserve will attain its cherished 2% inflation rate in 59 years — at the existing pace.

And the Federal Reserve certainly cannot wait 59 years to raise rates. It must retain some rag of credibility… however thin.

But to return to today’s central question: What is the most dangerous investing decision you can presently make?

Four Choices

Let us briefly review your choices:

A): Buying and holding through thick, through thin, through peak, through valley

B): Loading up on “FAANG” stocks (Facebook, Apple, Amazon, Netflix, Google) — plus Microsoft

C): Chasing biotechnology stocks in pursuit of a COVID vaccine jackpot

D): Going “long” the S&P

If your answer is C… you are incorrect.

Rather, it is not the answer we advance today. You may or may not be wise to chase biotechnology stocks in pursuit of a COVID vaccine jackpot.

Is A the correct answer?

Buying and holding forevermore may prove defective strategy.

Yet it is not today’s answer. We are then left with B or D. Let us dangle you in suspense no longer.

The correct answer is… B.

Don’t Get Bitten by These FAANGs

Loading up on “FAANG” stocks (Facebook, Apple, Amazon, Netflix, Google) — plus Microsoft — is the most dangerous investment decision you can presently make.

This we have on the authority of Mr. Eric Nelson. He is the founder of Servo Wealth Management.

From whom:

These seem like “can’t miss” stocks, and investors are abandoning diversified portfolios en masse (or opting against diversification from the start) in favor of these high fliers.  Collectively, these stocks now account for about 25% of the U.S. stock market!  So even if you are not going the individual stock route and putting all your assets in a U.S. stock index like the S&P 500 or Vanguard Total Stock Index, you’re chasing these stocks higher and higher.  What’s wrong with that?

A leading question, you say. And a leading question it is:

The graphic below looks at all of the top 10 largest stocks in the market, going back to the 1920s.  The list changes regularly as winners fall, and new firms ascend (just a few years ago, Exxon was the biggest stock but is no longer in the top 10), but we can track their returns before and after.  On the way up, the stocks that will eventually reach the top 10 have incredibly high returns: in the prior ten years, they outperform the market by +10% a year; in the preceding five years they beat the market by +19.3%, and outpace the market by +24.3% in the preceding three years.

But the outsized returns don’t last. After reaching the market’s peak, on average, the top stocks underperform the market by -1.1% over the next five years and -1.5% per year over the next ten years. Chasing yesterday’s hot stocks is a recipe for lower returns.

Here is the graphic in question:

IMG 1

Reversion To the Mean

The assembled evidence compels us. As we have noted before…

Scales balance, that which goes up comes down, that which goes down comes up.

Mountains rise, mountains crumble, the meek inherit the earth.

That is why we are certain today’s mighty will be tomorrow’s meek.

We do not know precisely when the rotation occurs. We know only that it will occur.

These FAANGs are presently “correcting.” Yet most expect a temporary, even healthful swoon before refinding their legs.

Perhaps they will refind their legs in the short run. Many will certainly “buy the dip.”

It has been a successful gambit for years and years.

But if the term “mean reversion” has anything in it — we believe it does — FAANG investors are ultimately in for a good hard walloping.

This Time Is Always Different

Do you recall the late 1990s… when that time was well and truly different?

Perhaps then you recall Pets.com… Etoys.com… Webvan.com… Kozmo.com… and go.com.

Traditional metrics like valuations were out. New metrics — “eyeballs” and “clicks” — were in.

They were in, that is, until they were not.

Valuations are out once again. These FAANG stocks each trade over 30 times earnings — nearly twice the S&P’s historical P/E ratio.

Yet we are told that zero interest rates and low inflation justify today’s extreme valuations.

This is the narrative that presently prevails. Yet no narrative lives for eternity.

It is true… until the day it is no longer true.

We are confident that day will dawn. We do not know when, of course.

But on that fateful day, we hazard the FAANGs will join the meek of this world. Recall the aforesaid Mr. Nelson:

After reaching the market’s peak, on average, the top stocks underperform the market by -1.1% over the next five years and -1.5% per year over the next ten years.

If the FAANGs are destined for sub-performance… may we then suggest a trade of outperformance?

Anti-inflation.

Dormant but Not Dead

Deflation is enjoying its moment, it is true — at least as official numbers run. Yet inflation’s seeds are in the ground.

The Federal Reserve has buried them. One day they will sprout from the earth… like choking weeds.

“The most contrarian trade in the 2020s is [going] ‘long inflation,’” says Bank of America’s Michael Hartnett.

His crystal ball yields glimpses of Modern Monetary Theory, universal basic income and boomtime for commodities… among others.

Of course, we tell no one what to do — though we suggest you slant in certain directions — and away from others.

We merely thumbtack our humble note to the community bulletin board and walk away.

You are free to stop for a closer look… or jog on… as you choose.

But if inflation roars this decade, may we suggest gold?

Regards,

Brian Maher

Brian Maher
Managing Editor, The Daily Reckoning

The Daily Reckoning

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