Warning: Don’t Get Complacent In This Bull Market…
I was picking up some beef recently from a friend of mine who is a cattle buyer.
After I got my 250 pounds-worth of strip loin (New York strip), tri-tip, and brisket, we were standing around his shop and chatting. One of my buddies asked me if I’d been watching Micron Technology (Nasdaq: MU) lately (he happens to work for the company).
I haven’t been, and told him as much. But I had a hunch of where the conversation was going…
You see, this is typical of the sort of market we are in right now. A market that climbs higher and higher nearly every single day, and investors — new and old to the game — are making a killing. And they want to boast about it…
I’m happy that folks are doing well in the market right now. But mark my words, the day will come when the average investor loses it all. The market will take a turn for the worse and all these newly minted traders will panic. They will freeze. They will tell themselves that on the next green day they will sell. But they don’t. They continue to hold on and they watch their gains evaporate.
They will become so beaten down that they will turn into “buy-and-hold” investors. They won’t be bringing stocks up again at the next social event because they’ll be too embarrassed by how much money they lost… after bragging about how well they were doing earlier.
I’ve seen it happen time and time again. This time will be no different.
Why A Lot Of Investors Fail…
Many of these traders have no plan in place, no sell signals, no stop losses, and it will be devastating. To be fair, they haven’t had to think about those things, because to this point they’ve simply typed in a ticker symbol, hit buy, and watched shares soar higher.
Sure, some might survive, figure it out, and even make a comeback. But a large majority of traders will go back to investing in exchange-traded funds (ETFs) or mutual funds. They’ll turn their attention to their next hobby to take their mind off of how much money they once had in their brokerage account.
When asked about their stocks, mental accounting will kick in. They’ll tell stories like one of my favorites that my colleague Brad Briggs has shared about a man’s experience at the casino on his honeymoon…
By the third day of their honeymoon in Las Vegas, the newlyweds had lost their $1,000 gambling allowance. That night in bed, the groom noticed a glowing object on the dresser. Upon closer inspection, he realized it was a $5 chip they had saved as a souvenir. Strangely, the number 17 was flashing on the chip’s face.
Taking this as an omen, he donned his green bathrobe and rushed down to the roulette tables, where he placed the $5 chip on the square marked 17. Sure enough, the ball hit 17 and the 35-1 bet paid $175. He let his winnings ride, and once again the little ball landed on 17, paying $6,125. And so it went, until the lucky groom was about to wager $7.5 million. Unfortunately, the floor manager intervened, claiming that the casino didn’t have the money to pay should 17 hit again. Undaunted, the groom taxied to a better-financed casino downtown. Once again he bet it all on 17 — and once again it hit, paying more than $262 million. Ecstatic, he let his millions ride — only to lose it all when the ball fell on 18. Broke and dejected, the groom walked several miles back to his hotel.
“Where were you?” asked his bride as he entered their room.
“How did you do?”
“Not bad. I lost five dollars.”
Don’t Fall For This…
This amusing little story comes from “Why Smart People Make Big Money Mistakes And How To Correct Them”, by Gary Belsky & Thomas Gilovich. And it perfectly illustrates the “mental accounting” that we become accustomed to after riding a wave of success and then watching it all evaporate. And it all happens because we didn’t take prudent steps (i.e. follow our trade plan).
Don’t get me wrong, I’m enjoying this roaring bull market as much as the next guy, and we’ve done quite well with many of our trades over at Maximum Profit.
For instance, shares of Zillow Group (Nasdaq: ZG) just passed our 50% profit target price this week… and we only added the real estate website company to the portfolio two months ago. Sea Limited (Nasdaq: SE) is up more than 250% since May when we added it to the portfolio.
But given the shortened period, these are not normal returns. Most trades aren’t going to shoot triple-digits in a matter of months like we’ve seen this year.
For many new traders who have been doing well this year, this will become the expectation. And those expectations will be shattered.
I only bring this up because I want you to excel in trading beyond this year. I want to help you build wealth for years to come. Not just one year.
As I’ve said before in these pages… Don’t fall victim to your own success.
From a valuation perspective, the S&P 500 is trading at historical premiums on all fronts. Just take a look at the data in this table that’s been making the rounds in the investment community…
Action To Take
The table above isn’t meant to scare you. Instead, it’s to help you understand the stretched valuations in the market right now. Similar to when a rubber band gets stretched, it violently snaps back to its “normal” position. The market can — and will — do the same.
Be sure you understand that. And when it begins to happen, don’t let your ego or your emotions get in the way of booking your profits, cutting losses, and building your cash account up to take advantage of wonderful trades that will undoubtedly come from the correction.
I don’t know when that day will be. And I try not to make any predictions about the market. But I do know human behavior. When the market turns south, we tend to ignore our sell signals, wait for a “green” day, or simply freeze and do nothing, watching gains eviscerate.
This might all sound alarming, but I think it’s a good reality check. It’s a good time to reassess expectations, and do our best to prepare for whatever the market throws our way.
On a final note, despite the lofty market valuations, I think a number of factors could continue to push markets even higher. First, we have a very accommodative Fed keeping interest rates low. We have the potential for another stimulus package, the rollout of a vaccine, and we could see our GDP expand rapidly compared to this year’s dismal numbers.
So, we will continue to enjoy this ride the market is giving us. We will continue to make hay while the sun is shining. And when the joy ride is over, we will simply hop off and wait for our next great opportunity.
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