Stocks have been on a tear since the March COVID pullback, rising 103%! Several companies have soared more than 500%, including Tesla, Nautilus, Tupperware, and Moderna. ARK Funds, led by Cathie Wood, had three funds rise more than 170%. And don’t get me started on Bitcoin, Gamestop, or the Reddit traders. Despite the outperformance from a few sectors, I’m hoping we get a correction, and the sooner, the better.
Why do I want a correction? Am I violating my fiduciary duty if I wish for stocks to fall? After all, investors fear losing money or getting wiped out as they did in 1929. For some, it is their worst nightmare. I’m often asked when stocks will fall, and some people only call me when their account is down. Despite their concerns, I have not met anybody who has lost all their money from investing, especially if they own a globally diversified portfolio of stocks, bonds, and cash. Despite concerns about a correction, they’re normal and healthy.
By several metrics, the market is expensive. Shiller’s CAPE ratio is 34.7, the second-highest reading in 140 years. The previous high was February 2000, before the Tech-Wreck, where stocks fell 49%. Tobin’s Q metric is at its highest level in 76 years. The previous high? February 2000. Value Line’s three to five-year growth potential for stocks is 35% – a low number. Last March, their indicator touched 145% before stocks rose more than 100%. Last, the dividend yield for the S&P 500 is at its lowest level in two decades, 1.57%. In February 2009, it touched 4% when stocks bottomed following the Great Recession.
My anxiety rises when stocks enter the feeding-frenzy phase as they are now, and like they were in 1999. Social media is fueling the fire as some investors pick stocks based on memes or rocket emojis. It appears easy to make money trading stocks or options with a few clicks of the mouse, but it’s not the case. Yes, you can get lucky if you jump on the bandwagon at the right time, but over time, valuations matter – research matters. Price matters.
I look forward to corrections because I can buy great companies at lower prices. When stocks fall, investors panic. They don’t hold the line, and their diamond hands turn weak. A bear market is where you get the best prices. Also, during a correction, you will have little competition to add quality names to your portfolio. Others will think you’re crazy for buying stocks during a market meltdown, but if you want to create generational wealth, you need the courage to buy when others sell and sell when others are buying – short-term pain for long-term gain. Buy low and sell high.
Of course, stocks can rise forever and can remain overvalued for years. No one knows when the next correction will come, including me. But when it does, welcome it with open arms and a blank check. A friend once told me, “If you’re upset that your stocks are down and you want to throw a brick through my office window, tape a check to it because it’s probably a good time to buy!”
Some of my best purchases occurred during the depths of a bear market, including Amazon, Google, Microsoft, Disney, and Pepsi. During the Great Depression, Sir John Templeton bought 100 shares of every company trading below $1 per share. Most of the companies he purchased lost money, some remained stagnant, and a few were big winners. His strategy made him a billionaire.
How can you take advantage of a correction? Here are a few ideas.
- Create a shopping list of companies or funds you want to own.
- Keep your powder dry, and move some cash to the sidelines and wait for stocks to fall, and then pounce on your best ideas.
- Diversify your assets. A globally diversified portfolio of funds will limit your downside when stocks fall. Allocating money to bonds, international stocks, or alternative assets is a prudent investment strategy.
- Rebalance your accounts. Our models were rebalancing some accounts weekly during the March correction because the volatility was off the charts. Our models initially rotated from bonds to stocks because we were selling expensive assets (bonds) to buy cheap ones (stocks). As the market rebounded, our models rotated through all our asset classes.
- Sell your winners now as stocks trade to all-time highs. Lock in some profits.
- Write options (sell calls) against stocks you own to generate income and potentially sell at a higher price.
- Write options (sell puts) on companies you want to own at a lower price. Selling a put below the stock price allows you to generate income and potentially purchase your company at a lower price.
- Be patient and wait for bargains. Do not chase stocks and fight the urge to follow the crowd.
I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful. ~ Warren Buffett.
February 11, 2021
Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.
Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.
 Ycharts – 1881 to 2021.