Deep Dive: This investing style could protect you from bubbles
If the stock market “bubble” warnings are making you lose sleep, chances are you aren’t as diversified as you should be.
A frequently cited danger is that large-cap U.S. stocks appear to be overvalued. Six years into the bull market, the S&P 500 Index SPX, +0.16% is trading for 17.6 times weighted consensus 2015 earnings estimates, among analysts polled by FactSet. That forward price-to-earnings ratio is up from 15.4 a year ago and is at its highest level since 2004.
For U.S. stocks, “it’s becoming what I would call a bifurcated market,” Art Nunes, chief investment officer at Northwest Asset Management’s Dynamic Investing Group, said in an interview. “The short- to medium-term trend for large-cap U.S. stocks is sideways and for losing price momentum.”
This S&P 500 chart illustrates Nunes’ point, as the 20-day moving average has been declining, and may dip below the 50-day moving average:
The S&P 500 is up 2.1% this year through Friday. Another possible drag for large-cap stocks is the setup for a rather weak earnings season, with S&P Capital IQ saying the consensus opinion is for a decline in earnings for the energy sector (which is no surprise in light of the oil-price drop) as well as the consumer staples, telecommunications services, utilities and materials sectors.
To be sure, you can expect to see the usual flurry of dull headlines crowing about companies ”beating” earnings estimates, but that in part reflects Wall Street’s usual game of lower estimates as we head into earnings season.
A possible long-term obstacle for the S&P 500 is the change in Federal Reserve policy, with the central bank ending its massive purchases of bonds late last year and the Federal Open Market Committee considering raising short-term interest rates. That is completely the opposite of what the European Central Bank and Bank of Japan are doing. The ECB began its 60 billion-euro-a-month bond-buying program in March, and negative interest rates on government bonds are now a reality in parts of Europe.
So the world remains awash with cash, but the flow is shifting overseas. This chart shows the performance over the past year for the MSCI World Ex-US All Cap Index:
This chart shows how the MSCI World Ex-US All Cap Index has performed against the S&P 500 and the Russell 2000 Index RUT, -0.02% which is made up mostly of small-cap stocks:
Based on his analysis of the rate of change for stock prices, Nunes said in an interview that he would “be adding to international stock holdings and a good broad brush way to do that is the iShares MSCI ACWI Ex-US ETF ACWX, +0.64% which mirrors the MSCI All-Country Index, but takes the U.S. out of it.”
When asked about specific sectors, Nunes said he was “doing some bottom fishing,” which included the energy sector. He did caution, however, that “oil stocks and coal are definitely in bear markets,” while adding that “they have been going through a bottoming process.”
(On the following page, read about the concept of the all-weather portfolio popularized by Ray Dalio.)