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Now is the time for caution

Recs

16

November 03, 2013 – Comments (16) | RELATED TICKERS: CRM , SCTY , ANGI

"Be fearful when others are greedy, and be greedy when others are fearful."
Warren Buffett

With the stock market hitting all time highs, which side of this spectrum do you think we are closer to? Interest rates will rise. Profit margins and earnings multiples will eventually decline. At some point we will have another recession.

"Price is what you pay; value is what you get."
Ben Graham, as told to Warren Buffett 

The S&P 500 is up 24% this year. My portfolio is up 45%, and I'm sure many of yours are up substantially as well. Do you think that the value of your shares has risen as quickly as their price? NO!

"In all affairs it's a healthy thing now and then to hang a question mark on the things you have long taken for granted."
Bertrand Russell 

Improving the risk-reward profile of your investments should be a continuous process, but reducing risk is increasingly important as the market marches higher.  There has never been a better time than right now to take an honest look at your investment assumptions.

You can reduce risk by lowering your equity exposure, moving towards higher quality stocks, or moving towards cheaper stocks. Find the biggest risks in your portfolio and find ways to reduce them.

"The ideal business is one that earns very high returns on capital and that keeps using lots of capital at those high returns. That becomes a compounding machine." 
Warren Buffett
 

How much cash flow and earnings do your companies generate? If they're not profitable (for example, cigar butts or growth stories), you better have a plan to get profitable or get out.  

"Only when the tide goes out do you discover who's been swimming naked."
Warren Buffett 

But losing substantial amounts of money is worse than being naked. It's more like getting eaten by a shark. If you aren't looking for the shark, you are in danger.

16 Comments – Post Your Own

#1) On November 03, 2013 at 7:44 PM, awallejr (85.56) wrote:

I honestly don't understand how that chart correlates to anything really.  It is just listing 2 completely different metrics.  I think charting interest rates and inflation might be more useful. 

1981 was the peak because Volcker was trying to crush double digit inflation.  As for 2000 PE peak that was when internet companies were not required to generate earnings.

This Bull market still has legs provided no black or red swans get in the way.  And if Washington ever got their act together we would see double GDP growth.  

This is the one chart I take stock in (no pun intended):

http://caps.fool.com/Blogs/chart/882049

That and the fact that I always understood Uncle Ben and took him at his word.  Hopefully I will be able to read Aunt Janet just as well.

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#2) On November 03, 2013 at 7:55 PM, Mega (99.95) wrote:

awallejr 

Low / falling interest rates generally allow higher multiples. High / rising interest rates generally result in lower multiples. Obviously the correlation is very rough.

Pre 1995, we only spent a few months of the previous century above the current multiple (1901, 1929 and 1966).

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#3) On November 03, 2013 at 8:31 PM, HarryCarysGhost (99.70) wrote:

Hey Mega,

I wouldn't put much faith in that chart. As long as we have QEn interest rates will remain artificially low.

Now here's a chart with some merit ;)

http://us.yhs4.search.yahoo.com/yhs/search?p=benner+cycle&hspart=att&hsimp=yhs-att_001&type=att_lego_portal_home

 But losing substantial amounts of money is worse than being naked. It's more like getting eaten by a shark. If you aren't looking for the shark, you are in danger

The way I see it, it's only a loss if you sold otherwise it's a buying opportunity.

 

(disclaimer- I sold all stocks that I deemed bottom feeders quite awhile ago)

Cheers.

 

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#4) On November 03, 2013 at 8:54 PM, Mega (99.95) wrote:

The way I see it, it's only a loss if you sold otherwise it's a buying opportunity.

And if you don't have the cash to buy? It's a lost opportunity even if it's not a loss. 

I wouldn't put much faith in that chart. As long as we have QEn interest rates will remain artificially low. 

I wouldn't put too much faith in any chart. I wouldn't put too much faith in the Federal Reserve either. They do not control the market, they are just an important player.

Don't forget, Greenspan looked like a genius until he started to look like an idiot in the 2000s. But the two crashes weren't all his fault any more than the recovery is all Bernanke's credit.

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#5) On November 03, 2013 at 9:21 PM, awallejr (85.56) wrote:

Mega perhaps but I really think an interest rate/inflation rate chart might be more helpful.  The Fed is concerned with 2 things, inflation and unemployment. And unemployment is to a large extent a function of economic growth.  So low interest rates are good for economic growth and high interest rates are good to bring down inflation.

So low interest rates good for stocks, high interest rates not so good.  And interest rates are going to stay low because we don't have strong economic growth nor serious inflation. And I don't see that changing in the foreseeable future.

That being the case where else are you going to put your money?  The "yield play" is still there.  Once I see interest rates back over 6% then the storyline changes.

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#6) On November 03, 2013 at 9:23 PM, awallejr (85.56) wrote:

And if you don't have the cash to buy? It's a lost opportunity even if it's not a loss.

Then you sell puts.  Limited gain but still a gain.

 

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#7) On November 03, 2013 at 10:04 PM, Mega (99.95) wrote:

awallejr 

Note what I said: You can reduce risk by lowering your equity exposure, moving towards higher quality stocks, or moving towards cheaper stocks. Find the biggest risks in your portfolio and find ways to reduce them.

You make some good points. Maybe your equity exposure is appropriate. Maybe your portfolio has some other risk factor you should think about reducing. 

HarryCarysGhost: I sold all stocks that I deemed bottom feeders quite awhile ago 

Glad to hear it. All I'm saying is think strategically about how to improve your risk/reward because the market is cyclical and unpredictable. I don't think anyone will regret doing that.

Perhaps the kind of people who comment on this blog are not the target audience - the kind of people who are more oblivious to the risks they are taking. If possible I would like to get their attention.

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#8) On November 03, 2013 at 11:06 PM, awallejr (85.56) wrote:

If possible I would like to get their attention.

Sadly that won't happen here.

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#9) On November 03, 2013 at 11:06 PM, awallejr (85.56) wrote:

If possible I would like to get their attention.

Sadly that won't happen here.

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#10) On November 04, 2013 at 10:11 AM, Teacherman1 (57.70) wrote:

MegaShort

I agree it is time for some rational risk reduction.

I am still looking for opportunities, but find them getting harder to locate.

In the meantime, I am selling off some and increasing my cash position.

I don't know if interest rates are going to be the "spark" or some other outside event, but at some point there will be a correction and it will be significant.

Markets can not just keep going up, even if there is not really a good alternative.

We are experiencing "market inflation" as a result and there is a lot of irrational chasing of momentum.

Thanks for the "wake up call".

Each can take it the way they want and make up their own minds what, if anything, they want to do.

JMO and worth exactly what I am charging for it.

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#11) On November 04, 2013 at 11:45 AM, EnigmaDude (93.08) wrote:

It's great to see a blog from you!  I hope that many beginner/less experienced investors will listen and heed your advice.  I agree with you that the market is looking frothy now and lots of bubbly stocks are getting way over-valued.  Good time to take some profits and build up cash or at least adjust asset allocations to reduce exposure to riskier plays. 

If you have any specific examples to share that would be great! In my case I sold some shares of CKSW which is looking weak and added to my SLRC position, which is hopefully less risky in the long run and also yields better dividends.

I'm still learning and trying to understand how the market works so I really appreciate your thoughts. 

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#12) On November 04, 2013 at 5:07 PM, Mega (99.95) wrote:

EnigmaDude

Glad you found it interesting.

For several months I have been slowly attacking all three angles. At the beginning of the year I was approximately 135% long / 35% short (net 100% stock, 0% cash). Now I am approximately 105% long / 35% short (net 70% stock, 30% cash).

I've been selling value stocks like SYA, SKUL and TPCA, which I still think are below their intrinsic value but I don't particularly want to own for the next 5 years. And to a lesser extent I've sold growth stocks like DAR and APO, which I'd like to own for the next 5 years but the valuation seems a little stretched.

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#13) On November 05, 2013 at 12:56 AM, jiltin (28.24) wrote:

Nice to go through this blog. I am a beginner & less experienced investor, especially investing money into stock market. Many years, from 1998 onwards, watching economy going up and down. 

During 2008, I clearly called out with my friends, around 20 of them, at coffee time that stocks are going to fall exactly after interest rate hike was made. I had seen similar situation during 200/2001 period.

If I have the same mindset in future, I will definitely pull out of the stocks, the day after interest rate or QE is pulled whichever comes first.  

There was a false alarm previously and I pulled my stocks wrongly.

http://caps.fool.com/Blogs/15542-dow-and-1687-sampp-/829721

It was nice opportunity to pull out and reinvest (Missed the boat at that time).

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#14) On November 06, 2013 at 4:41 PM, ElCid16 (95.62) wrote:

http://brooklyninvestor.blogspot.com/2013/11/what-to-do-in-this-market.html

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#15) On November 10, 2013 at 7:54 AM, MKArch (99.72) wrote:

"So low interest rates good for stocks, high interest rates not so good.  And interest rates are going to stay low because we don't have strong economic growth nor serious inflation. And I don't see that changing in the foreseeable future"

***************************************************** 

Or maybe interest rates are a placebo. Is there anyone else out there besides me that thinks the FED has waaaaaaaaaaaaaay less influence over the economy than it thinks it has? Here's my favorite joke about politicians taking credit for the economy:

"It's like some guy standing at the end of an airport run way jumping up and down taking credit for planes landing".

 IMO this applies to the FED as well. At least when they try to pump the economy up anyway.

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#16) On November 10, 2013 at 1:21 PM, awallejr (85.56) wrote:

Actually The Fed consists more of bureaucrats.  Personally I think you are in the minority. We've seen for years now the power of interest rate and printing press. But it isn't suppose to be a one horse show.  It would be nice if Congress got their act together and help on the Fiscal side.  But I don't see that happening until after 2014 elections.

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