Tags: beatles | breakup | teach | investing

What the Beatles Breakup Can Teach You About Investing

What the Beatles Breakup Can Teach You About Investing
Kenneth D Durden | Dreamstime.com

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Friday, 23 March 2018 02:45 PM Current | Bio | Archive

I’m glad the Beatles broke up.

Yes, it seems like a controversial opinion when I say that at social events. But my logic is simple. They became one of the best rock and roll bands in history with years of practice. And they were able to change with the times, starting off covering bubble gum pop songs before evolving along with the tumultuous 1960’s.

Much like the TV show Seinfeld, they had a great run. But even better, they got to go out on top. It’s better to do that than to try and evolve with markets and lose the winning formula or become stale and bland next to new, hungrier competition. If the Beatles continued doing experimental work, eventually the market would have soured. And eventually, even a hit show like Seinfeld would have run out of ideas about nothing.

The markets can work in a similar way. There are often periods of overvaluation and undervaluation, and the market swings between them like a pendulum. If you time it right, you too can go out on top. Today, over nine years since the Great Recession bottom in stocks, the pendulum is near the extreme range on the overvaluation side.

Consider earnings ratios, the simple and most useful way of comparing companies. Top large-cap companies, which constitute a disproportionate percentage of passive index funds, are trading at near-bubble levels. Amazon (AMZN) trades at 190 times forward earnings. Netflix (NFLX) trades at 116 times forward earnings. Google (GOOG) and Facebook (FB) trade at far more reasonable earnings with estimates in the 25-30 times range.

But these companies aren’t growing fast enough to justify these valuations as a current investment. If they can grow faster, great, but even the latest tax reform won’t be enough to push a permanently higher level of growth to justify these valuations on an earnings basis.

It may be time to go out on top. Of course, that doesn’t mean it’s necessarily time to panic yet, however. It just means that, on average, the average stock is overvalued. There are still pockets of value out there, and plenty of individual companies whose share prices hasn’t gone along for the ride. We looked at two such examples just last week.

But finding individual companies that are still a bargain overlooks the broader point: stocks are near some of their highest valuations in history, only slightly below the tech and housing bubble valuations. That’s the bad news.

The good news is that, knowing where we are on the valuation pendulum, we can take some steps to mitigate the next potential swing to the downside.

For starters, the important thing isn’t to necessarily cash out of the markets entirely. But it is important to retrench into areas that are likely to hold up well—either by not falling, or by not falling as much as other areas of the market in a broad selloff.

The still-oversold commodity sector is an obvious candidate for your investment dollar now, particularly gold stocks. Gold held up better than stocks on average during the Great Recession, and a repeat selloff in the market over 10 percent may cause some fear-based trading into the yellow metal.

Given the long duration of the current bull market, cashing out of a position that’s fared exceptionally well may mean facing a large tax bill. Your best bet may be to simply sit through the next 12-18 month recessionary bear market and collect dividends along the way. That’s especially true for cases where you’re invested in companies with a history of dividend growth.

Add in a policy of covered call options to the mix, however, and you can more than double your income—and in a shaky market, options premiums will rise, but jittery and largely directionless stock prices will increase the odds that you can sell calls and keep the premium without getting called away.

The storm is coming. There are plenty of ways to prepare. Raise cash. Cycle out of high-flying tech stocks and into undervalued names. Keep the dividend payers, but start writing covered calls. You can watch the pendulum on a clock hit its apex and start to swing back. But not so with markets. It’s time to embrace the cautious side of cautious optimism, and take the riskiest trades off the table.

Investing isn’t about a binary event like being in a band or starring in a hit TV show or not. It’s a spectrum between being heavily invested and having more on the sidelines. We don’t have to go all-out, nor should we.

Markets are the ultimate hit, the ultimate show. It may go down for a while, but it won’t be long before it goes back to the top. Just be prepared for some leaner times and you’ll fare better than most.

Andrew Packer is a Senior Financial Editor with Newsmax Media. He currently writes the Insider Hotline investment advisory, serves as investment director for the Financial Braintrust, and writes the monthly newsletter Crisis Point Investor.

© 2019 Newsmax Finance. All rights reserved.

   
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AndrewPacker
Investing isn’t about a binary event like being in a band or starring in a hit TV show or not. It’s a spectrum between being heavily invested and having more on the sidelines. We don’t have to go all-out, nor should we.
beatles, breakup, teach, investing
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Friday, 23 March 2018 02:45 PM
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