I stumbled upon a fantastic article about the Tech Bubble and I wanted to share a few key points with you. This is relevant because current market valuations appear to be very stretched by most metrics. After an extremely strong 2019 and nearly an 11-year old bull market, investor optimism is quite high. It is at times like this when the risks are highest, because most people aren’t thinking about risk.
It is very natural to keep getting more aggressive because the most aggressive behavior has been rewarded. Many people think they can spot the top and get out in time so that they don’t get hurt, but in reality that almost never happens. If you want to follow Buffet’s recommendation, “be fearful when others are greedy, and greedy when others are fearful,” you must not be fully invested during periods of euphoria.
When I say you don’t want to be fully invested, that means a 100% allocation to stocks and bonds. We want to be buyers of stocks as they become cheaper, or obtain an attractive return if they stay flat or go up. The best way we can do that right now is selling puts on already undervalued securities. There are certain industries and companies, which are still undervalued. By selling puts on these securities, we are obtaining an enhanced margin of safety. Instead of having to be precise on timing, we still get rewarded if the markets tread higher.
If you are looking to obtain income via traditional fixed income and obtain a measly 3.3% return, you basically are going to have to take about 11 years of duration risk in the investment grade arena. Rising interest rates and inflation would significantly reduce that return. Utilizing some of these alternative options such as cash-secured puts can potentially generate double-digit returns, while positioning us to own stocks at discounted prices in our “worst-case” scenario.”
I’m not a perma-bear by any means. Those that have followed me over the last decade know that I’ve been bullish the whole time, despite some cautiousness in periods of euphoria, but we’ve been consistently long and our performance has been strong, uniquely among most value-oriented firms during this period of growth out-performance. Equities are still far more attractive than bonds, but I’d argue that selling the puts on value stocks is our most attractive risk-adjusted option right now. There are still stocks we are buying, so I’m mostly speaking in general terms, but I want you to know that I think we will benefit greatly long-term by being a bit more conservative here over the short-term!
Below are some quotes from the article and also there is a link to the article. As always, if you have any questions or if I can help in any way, please don’t hesitate to contact me!
“Over the second half of 1999, it wasn’t a question of whether or not a bubble existed, it was a question of how big a bubble it was, and when it would pop.”
“On January 14, 2000, the Dow Jones Industrial Average peaked at 11,722.98, a level it would not return to for more than six years. The tech-heavy Nasdaq peaked on March 10, 2000, at 5,048.62, a level it would not reach again until March, 2015. From the March 2000 peak, all the way down to the trough it reached on October 9, 2002 (the bear market bottom would be 1,114.11), the Nasdaq would lose nearly 80% of its value.”
“By April 2000, just one month after peaking, the Nasdaq had lost 34.2% of its value.”
“So, who ended up holding the bag? Average investors. Over the course of the year 2000, as the stock market began its meltdown, individual investors continued to pour $260 billion into U.S. equity funds. This was up from the $150 billion invested in the market in 1998 and $176 billion invested in 1999. Everyday people were the most aggressive investors in the dot-com bubble at the very moment the bubble was at its height.”
“By 2002, 100 million individual investors had lost $5 trillion in the stock market. A Vanguard study showed that by the end of 2002, 70 percent of 401(k)s had lost at least one-fifth of their value; 45 percent had lost more than one-fifth.”