Beware The Naked Companies

The markets peaked in early October, and since then something remarkable has happened. Investors have lost their drive to buy-the-dips.

Instead, we’ve transitioned to sell-the-pops, and that’s not a good sign.

For decades, investors typically drive stocks higher after a week of losses, treating such pullbacks as a chance to buy good companies at a discount.

In the years when that wasn’t the case the markets fell into bear territory, which makes sense. If investors aren’t willing to buy as stocks sink, then by definition equities will fall further.

This is interesting because the economy is humming along just fine. Unemployment remains historically low, interest rates are low and it looks like the Fed will hold off after December, and GDP, while not great, appears to be on track for 2% to 3% growth. We’re sort of back to the muddle-through economy that we’ve had since the Financial Crisis.

But that misses one big point…

Since the downturn in 2008 and 2009, the equity markets are up 250% to 300%, while the economy has expanded by just 50% in total.

The difference in growth rates meant that, at some point, something had to give.

Either GDP was going to rocket higher, justifying such lofty valuations, or stock prices were going to fall. Well, GDP isn’t at risk of shooting to the moon, so it looks like we’re in the midst of pullback.

Whether we’re on the cusp of simple correction or headed for a full-on bear market remains to be seen, but one thing seems obvious. The psychology has changed. We’re no longer pouncing on falling stocks like vultures. We watch stocks fall and then, nothing. We let them fall again. It’s as if we’ve had our fill and simply lost our appetite for risk.

As we look forward to 2019, I have a word of advice…

Avoid naked companies

I’m not talking about firms with no clothes, or those in questionable industries. I’m referring to those lofty, pie-in-the-sky estimate companies that are devoid of earnings but command nose-bleed valuations.

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