It’s time for a reckoning in bubble assets. Not since 1999 have I seen so much garbage trading at such crazy prices. That’s when the Nasdaq reached 5048 before declining 80%. That's when there were 100 stocks like Pets.com for every Amazon, all going up 20% a week. Just a handful of months later, Pets.com (along with countless others) was bankrupt, trading at 19 cents, and left to auction off its one remaining asset, its sock-puppet mascot—featured so prominently in a 2000 Super Bowl ad.
The Fed’s zero-interest rate policy—absolutely necessary to prevent a depression during the Covid crisis (and it did)—has unfortunately led to bubbles everywhere: shell companies, non-fungible tokens (NFTs), a gaggle of competing cryptocurrencies, etc…. Today’s speculators (and many hedge fund managers) are no different than the hapless day traders who lost their shirts in 2000. Now, like then (and as in every bubble since the Tulpenmanie in 1637, the original NFT craze), the speculators said the others “just don’t get it.” Well, there’s nothing to get when there’s no there there—“there” being intrinsic economic value.
So what should an investor do—and not do?
- Don’t try to time the market. If the Covid crisis taught us anything, it’s that no one can time the market. Those who sold in March, 2020 missed the near doubling of many assets over the next few months—paradoxically against the backdrop of some of the worst economic news since the Great Depression. Markets can’t be timed. To do so is to speculate, which is to gamble. It’s dangerous. Worse, it’s impossible.
- Don’t abandon quality stocks trading at a discount to their intrinsic value. Amidst the bubbles, there are countless assets trading at reasonable prices. International stocks, emerging market stocks, and U.S. value stocks are trading at reasonable valuations and have dividend yields over 2%. Although everything will go down reflexively when the bubbles burst, these valuable, quality assets should come back quickly and outperform over the next decade. But the contemporary versions of Pets.com will not. Ever.
- Maintain stock exposure to hedge against inflation. Stocks in aggregate are overvalued but there are vast swaths of value still available. Stocks are historically the best hedge against inflation, given that their earnings get repriced in inflated dollars. Moving entirely to low-interest bonds is a bad idea. Yes, you might avoid market declines...but you’ll receive little to no yield, lose money as rates rise, and fall victim to the ravages of inflation over time.
- Hold some bonds but keep duration low. Some bond allocation is necessary in all but the most aggressive portfolios—as protection against a market bust and possible deflation. Diversification remains the only free lunch in investing, and some fixed income and cash equivalents are always part of a good financial plan. But maintain a short duration to manage interest-rate risk. Long-term bonds are dangerous in this environment, as 2021 already shows us: The TLT (the ETF that owns long-term Treasury bonds) is down an astonishing 14% year-to-date. In the bond market, it’s looking like 1994 all over again.
- Keep six months of living expenses in bank accounts. This is financial planning 101. The pandemic proved the point. Enough said.
- Most importantly: maintain the proper allocation for your specific risk preferences, time horizon, and personal circumstances. Long-term success in investing is most correlated to keeping the proper asset allocation for the given situation. I never believe in taking on more risk than necessary to achieve one’s goals. Some investors have enough time or resources to recover from any temporary market setback; others no. An asset allocation should be tailored to the investor, not to any useless prognostication of short-term market movements.
As they say, it takes a whole new generation to forget the prior one's mistakes—in order to repeat them all over again. This is particularly true with markets. The reckoning will come. No one knows when. But it’s not a question of if. As in 2ooo, it will take just such a reckoning to wipe out a whole new swath of speculators. But those who buy quality, not hype, will prevail in the end.
This article originally appeared on Forbes.
