This Year Shows Why Risk Management Is So Important!

If anything should have become clear these last few months it’s the critical importance of sound risk management.

It’s a lesson that tends to be forgotten by most investors at the tail-end of bubbles and re-learned the hard way when the bubble pops.

We forget this lesson after many years without a reminder and as everyone around us seems to be getting rich off skyrocketing asset prices. So, we chase performance without an understanding of risk or the extreme prices we’re paying for those assets.

In fact, about a year ago I shared a quote from J.P. Morgan that perfectly addresses this concept, “Nothing so undermines your financial judgement as the sight of your neighbor getting rich.”

I had a lot of people last year asking if we should be more aggressive, questioning if we were doing the right thing by being relatively conservative.

I consistently answered “yes” to that question because if we were relatively conservative there was a reason for it. Either (1) they didn’t have the financial capacity for the potential losses that could ensue meaning a certain level of losses would jeopardize their financial independence, and / or (2) they didn’t have the emotional capacity for the losses that could ensue, and / or (3) most risk assets were / are extremely overvalued (as I’ve written about many times).

Many of the trendiest assets that were being chased by retail investors (cryptocurrencies, meme stocks, overvalued tech stocks) are now down 70% or more from their all-time highs. Broad market indexes are down around 20% on the year.

Some people will respond, “But many of those assets are still up a lot from where they started years ago.” Unfortunately, that misses the point. The money invested in those speculative opportunities is relatively tiny early on. Bubbles suck money in near the top causing wealth to vanish when the bubble pops.

The prevalence of this boom-bust cycle throughout history is why I rely so heavily on time-tested economic principles…namely, that an asset’s price must ultimately reflect the long-term cash flows provided by the asset. Continue reading “This Year Shows Why Risk Management Is So Important!”

Price/Sales is Better Than Price/Earnings…for forecasting future returns

Executive Summary

  1. If we’re going to use valuation metrics to make important financial planning and investment decisions why wouldn’t we use the most reliable metrics at our disposal?
  2. The Price/Sales ratio has a much higher correlation to actual subsequent returns than Price/Earnings.
  3. Price/Sales, and other reliable metrics, indicate the U.S. stock market is more expensive than it’s ever been in history.

Continue reading “Price/Sales is Better Than Price/Earnings…for forecasting future returns”

Quarterly Market Update: All That Glitters is Gold…

This has been a strange period in that both traditional bonds AND stocks are down around 7%-8% simultaneously. Historically, if stocks were down like this bonds would at least be holding up, if not appreciating, and vice versa.

A couple months ago I wrote a commentary about why we own treasuries in portfolios referencing the fact that since 1928, treasuries and stocks have only been down simultaneously in the same year three times! Historically, stocks and treasuries have been great complimentary, non-correlated assets. In fact, they have about a negative 0.40% correlation.

At this point, if nothing were to change for the rest of the year, we could have our fourth year in almost a century where both bonds and stocks are down simultaneously. Continue reading “Quarterly Market Update: All That Glitters is Gold…”

Quick Perspective on Market Volatility

I’m hearing some concerns about the stock market the last few weeks from the general public. After all, the U.S. stock market (S&P 500 Index) closed yesterday about 12.5% lower than it started the year.

I’ve been consistently warning about extreme stock market valuations that make severe, sharp drops more likely. But the experience so far this year is not yet that severe, sharp drop I’ve been warning about. In fact, the decline so far is quite unremarkable in the context of history.

Let me illustrate… Continue reading “Quick Perspective on Market Volatility”

The Distinction Between Stock Prices and Wealth

First, thank you to everybody who took the time to watch the news clip from yesterday and for the kind feedback I received from many of you.

This evening, as Facebook is down over 20% after-hours, I wanted to share an eloquent explanation of an important concept: the distinction between WEALTH and STOCK PRICE.

Dr. John Hussman wrote an interim special commentary back in November. Within it, there is a section that provides important perspective. It’s so well-stated I’m simply going to share it verbatim. The bolded parts are my emphasis. Enjoy. Continue reading “The Distinction Between Stock Prices and Wealth”