When it comes to investing, I like to look at the facts first. I don’t want to be a permanent bull or a permanent bear when it comes to stocks. That’s how you develop a worldview that ensures you’re incorrectly invested when things go awry.
Since stocks mostly trend up over time, it’s good to be mostly bullish. I call it being cautiously optimistic. But the caution comes first.
When markets do correct, months or years of gains can disappear in days or weeks. It’s frustrating, and it tends to lead to poor decision-making. While you’ll come out ahead over the long haul by being patient during corrections, sitting around doing nothing when it seems like the world is falling apart is quite difficult.
The bigger challenge today is that most assets look overpriced and prone to a correction. Stocks trade at a premium to their earnings, sales and book value. In the past, such premiums have only been higher when they’ve definitely been in a bubble phase.
I’m not too worried yet. Many individual names have fared poorly in the stock market year-to-date, and many will continue to do so. It’s when companies should be selling off on poor corporate performance but don’t that the markets is getting too far into the greed phase.
Bonds are, generally, also trading at high valuations, as reflected by their low yields. That goes to show that this long-running bull market has a number of naysayers who want the safety of bonds. As a result, yields will likely remain low, even well into a stock market correction. While rising interest rates from the Federal Reserve should do something to move bond prices down and yields up, there aren’t any extreme values in this area right now either.
Those who argue that there’s a bubble in everything might want to take another look at the commodity space as well. That’s because oil is still about 50 percent off the highs it set in 2014 before it made a major crash. And gold is still trading a third lower from its peak price set in 2011, over six years ago. Those are just two widely-followed commodities. Many other commodities such as copper and natural gas, may have rallied a bit this year, but they’re also huge laggards.
There’s also a potentially new asset class that didn’t even exist 10 years ago during the last big financial crisis: cryptocurrency. It’s a new area that’s had a huge surge in interest year to date. It’s still relatively small in terms of market cap, but that could change. Until it does, it’ll have a lot of volatility to it, as the stock market initially had when some of the first stocks came into being.
In short, we’re not necessarily looking at a bubble in everything. There are clear pockets of overvaluation and undervaluation. That’s why I’m still cautiously optimistic.
As I mentioned last week, I’m still optimistic enough to make options trades. Those are outright bullish trades. I’m also a huge fan of using the options market to protect my existing wealth.
For instance, I’ve owned shares of McDonald’s (MCD) for years. It follows a pattern of making a big rally, then trading sideways for a prolonged period of time. It’s also been susceptible to some of the broader market’s periodic pullbacks in the past few years. Rather than just sit out the ups and downs while collecting the dividend, I’ve used the options market to protect the trade.
Specifically, I’ve sold covered call options against my position. That kind of bet has allowed me to use my existing shares to make some more income off of the trade. I didn’t have to sell shares and try to buy back later at a hopefully cheaper price, getting hit with capital gains and transaction costs along the way. Instead, I’ve tried to simply get some options premium out of the trade on par with the annual dividend yield.
By doing so, I’ve managed to essentially double my yield on shares without having to do anything as risky as buying shares on margin. It’s gone a long way to take the sting out of holding a position during a sideways or briefly correcting market. The best thing about covered-call writing as a strategy is that that can be used with nearly every stock. Smaller companies may have less options, but nearly every publicly-traded company with a market cap of over $500 million has some options available for your hedging needs.
Of course, during a market pullback, it’s really a time to add to your holdings rather than panic out of your existing holdings. That’s why I’m a fan of trades like selling put options or buying shares of unloved and out-of-favor names. It’s one of the hardest parts of investing, since emotions tend to run wild as soon as the paper gains you’ve been looking at turn to potentially ugly losses.
In terms of markets being in an “everything” bubble, however, there’s clearly not only plenty of values out there, but plenty of ways to profit from those trades as well. I’m not buying the notion that everything is in danger. I am buying the notion that hedging against risk is a good idea.
Besides using options trades on existing positions to hedge your risk, there’s nothing wrong with raising cash. That’s part of the appeal of holding some companies and writing covered calls. Besides the income you can make from selling options, if you continue to hold shares, you’ll continue to collect dividends as well.
Market research shows that, over time, dividend returns can account for nearly half of your investment return. Why? Because being able to reinvest that income is where the compound effect takes place.
That’s another reason to avoid fears of an “everything” bubble and instead work on finding ways to increase your income.
With more cash comes the ability to take better advantage of market opportunities, without losing out along the way from cashing out of your existing holdings.
Andrew Packer is a Senior Financial Editor with Newsmax Media. He currently writes the Insider Hotline investment advisory, serves as investment director for the Financial Braintrust, and writes the monthly newsletter Crisis Point Investor.
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