To be clear, nobody knows for sure when the current bull market will be replaced by a bear market. All anyone knows is that it will happen. There are signs that the final stages of the 8 ½ year bull run may be getting closer.
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Stocks of companies with strong balance sheets are outperforming stocks of weak companies. This seems counterintuitive, but it isn’t. You might think that when investors favor companies with strong balance sheets, that’s a sign the market is healthy. This is not the case.
In fact, investors are becoming more discriminating and in pursuit of high-quality stocks. Another potential sign of a pending bear market: The ratio of corporate debt to cash flow is growing as junk-bond yields are falling. This measure typically peaks as profits fall.
Behind The Scenes
All this is playing out against the backdrop of the end of accommodation by the Federal Reserve. Cheap debt financing is starting to fade and companies that have relied on this are beginning to fall off the radar of investors.
According to Goldman Sachs, while the signs related to the dominance of strong balance sheets are not at a critical stage, it is true that historically this phenomenon takes place when monetary conditions begin to tighten.
What To Do
One money manager has a model asset allocation consisting of 50% stocks, split 60/40 between growth and value; 20% municipal bonds; and 30% alternative investments, split 80/20 between hedged equity and structured products. This manager shops for structured products that offer as much as 50% downside protection with unlimited upside participation and an annual fee averaging 0.6% of invested assets.
Another adviser has his clients take profits on a regular basis from risky positions and shifts the proceeds into defensive investments. Some tech stocks are sold each month and the proceeds invested in less expensive stocks and Treasury bonds. This is a gradual approach designed to avoid a fruitless attempt to time the market.
What Not To Do
The worst thing you can do, of course, is to attempt to time the market. There are simply too many moving parts and too much interaction between traders and investors. During recent market cycles far too many investors were underinvested thanks to concerns about political risks. The relationship between stock prices and politics is complicated and recent events have clearly show the market sometimes just doesn’t care about political unevenness in Washington.
Valuation is important but far from a be-all/end-all when it comes to timing the market. Valuation can have an impact on returns over extended periods of time. Unfortunately, in the short run, rising valuation probably means increasing stock prices.
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Trends Might MatterCurrent market trends can be very helpful alternatives to trying to predict future market direction. No speculation requires – just observation. An uptrend could be defined as a situation when prices are above their 200-day moving average. Downtrends occur when prices are below the same moving average.
It’s worth noting that observing and reacting to trends I not failsafe. Overall, however, it does a decent job of distinguishing between bull and bear markets over time. One strategy would be to invest in an asset class when the long-term trend is up and sell when the trend is down.