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Should you be wary of bubbles?

When is the appropriate time for a growth investor with a longer termtime horizon (greater than five years) to consider selling out of someof their positions and become more defensive?

When is the appropriate time for a growth investor with a longer term time horizon (greater than five years) to consider selling out of some of their positions and become more defensive? When does the general market tell that investor they need to move to higher ground and add more fixed income products, or move to cash with a small or large portion of their portfolio? Investors often ask themselves this question. When the value of your investments starts to fall, should you buy more, leave the investment as is, or sell? I believe this is the most difficult decision for any investor to make.

If you were to exclude a company’s specific fundamentals and consider the broader market only, there are two scenarios I have been able to come up with that even a “bull” investor like me would consider selling.


The first scenario would be if analysts and economists could prove that a bubble was forming in a certain area of the market -- like the tech bubble in the years 2001 and 2002, or the most recent housing and credit bubble in the U.S. The risk with these types of bubbles is that when they burst, all of the benefits that were being experienced while the bubble was forming come crashing down to create a very large, possibly multi-year repair job in that particular part of the economy.


Bubbles in the market are created by overdone conditions in the marketplace. For example, currently we have been experiencing a massive rush into the bond market (especially in the U.S.) due to the stock market being so uncertain. This has caused pricing to go sky high and yields on the bonds to drop to levels not seen since recessionary times. Many have said that the bond market could be a bubble waiting to burst.

One thing about an inflated bubble in an area of the economy is that it's hard for investors to spot it. Usually, by the time individuals are able to spot this anomaly in the market or a sector of the market, it is already too late. Many try to identify bubbles in the market ahead of time, and are usually way too early or just wrong. A sell signal from this type of scenario is usually debated quite frequently and many more get it wrong versus those that catch the bubble before it forms. However, if an investor is able to spot a situation that is out of the ordinary before it happens, they can protect themselves accordingly by removing themselves in whole or in part from the equity markets.

The second sell scenario I’ve identified where even a longer term investor should hold back is when the market gets “toppy.” When everyone is buying into the stock market it is time to get nervous again. When you go to get your hair cut and the barber is telling you about some penny stock that his next door neighbour told him to buy because they had made a lot of money on it already, it is time to get nervous and start to pull out of the equity markets (stock market).


Another toppy signal is when you look at some of the largest deep value investors, and they are holding a lot of cash in their portfolios because they are not seeing any bargains out there in the marketplace. At that point, I believe it is time to take some money off the table. Most investors, however, do the opposite. They buy when everyone is buying and the market is going higher, and sell when the market is falling because they get too nervous. In essence, “buy high and sell low,” as we all know, the opposite is what we should be doing.

At this time I do not see any bubbles in the stock market. In fact. what I do see is a North American economy continuing to grow, albeit at a slow pace. The pace of growth should pick up as investors gain more confidence and the U.S. starts to create more jobs. Thus, I feel it is only a matter of time before we see accelerated growth in the stock market. If you can handle the short term volatility, I feel it is the best place to grow your money.

If you have any questions regarding the above article or are looking for an Investment Advisor to help you with your portfolio, please send me an email at asmall@dundeesecurities.com. I will be glad to speak with you!

Allan Small is an Investment Advisor with Dundee Securities Corporation, a DundeeWealth Inc. Company. This is not an official publication of Dundee Securities and the author is not a Dundee Securities analyst. The views expressed are those of the author alone, and are not necessarily those of Dundee Securities.

 
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