Frothy Market Looking Very Scary

Okay, I know I sound like a broken record, but overbought markets can continue moving higher for weeks, months, even years.  It is virtually impossible to call exact tops or exact bottoms, and calling an exact top is not my mission.  My mission is to balance the risk/reward relationship, and the market, for at least the past 6 months, has not presented an attractive risk/reward ratio, so I have not invested.  Six months is a long time, and the S&P 500 has made 17 or so new all-time highs in that time-period.  However, even after the jump in the market over the past week or so, the S&P 500 is only up about 5.4% year-to-date.  That is not much of a return to assume the level of risk in the market at current levels.

Keep in mind that although the major indexes are adding what appears to be a lot of value, it take an increasing number of points to grow these indexes by the same percentage.  For example, at 1,000, a 10% increase is 100 points, but at 2,000, it takes 200 points to increase the index by 10% (twice as many).  Investors can fall into the euphoria trap – the market seems to be going up on a daily basis, and everyone is making money, so why not dump more and more cash into stocks?  Seems like a great idea until it’s not a great idea.

The other point I would like to make here is that when bull markets like the one we are experiencing happen, investors always say “it’s different this time.”  They say; “Just because previous bull markets that lasted this long ended in major corrections or crashes doesn’t mean it will happen this time.”  They point to technology, or population growth, or the integration of the global economy, etc., etc. to justify why it is different this time.  All I have to say to these sentiments is, it’s always different until it’s not different.  What I mean to say is, every time there is a bull market like this people say it’s different this time, but it never is.  There is always a major correction or crash at the end of it.  The question is, when will it come?  That I cannot say for certain, but I believe it is imminent.  That could mean next week, the end of summer, the forth quarter, or even early next year.  I am fine waiting, even if the S&P 500 tops 2,000 (that’s only 52 points from here, which is only 2.7% more upside from the current level of the index).  I certainly do not mind giving away 2% more to avoid taking a 10%, 15%, 20%, 25%, or even larger loss.

Corrections and crashes come without warning, and they are violent and sharp.  Gains that have been made over many months or even years can disappear in a matter of days or even hours.  The market looks very frothy to me, especially with the recent activity over the past several trading sessions.  I remain in cash and very, very concerned about this market.

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