Market Report: Will Markets Melt-Up Before Meltdown?

The greatest pain trade in today’s highly speculative environment is if financial markets “melt-up before they melt down” (to borrow Julien Bittel‘s phrase). Bears feel intense FOMO as markets rally despite numerous overbought readings, and bulls face losses if they overextend their stay when the market eventually falls. This is a thought shared by Jeremy Grantham who published an excellent piece worth reading.

Summary

Here’s how I approach markets based on 3 different strategies & time frames. I diversify my portfolio into 3 strategies:

  1. Long term investors should be highly defensive right now. This speculative bull market may last another 6 months or even 9 months, but in 2 years time, long term investors will be glad they did not buy today.
  2. Medium term traders should go neither long nor short. Wait. Risk:reward doesn’t favor long positions right now, while shorting into a speculative rally can end in disaster.
  3. Short term trend followers should continue to ride the bull trend because no one knows exactly when it will end. In a highly speculative environment like today, the most profitable traders are short term trend followers who trade markets with strong animal spirits. If you are a short term trend follower, you must use stops.

Several important factors suggest that we’ll see a significant correction in 2021. Jeremy Grantham’s estimate is that this will occur in late-spring or early summer. In the meantime, short term bulls should continue to ride the uptrend.

The bearish case for contrarian traders

“Buy stocks because they’re cheap relative to bonds”

One of the most popular and sound arguments to buy stocks last March was “stocks are cheap relative to bonds”. If we compare the earnings yield on stocks (inverse of Price/Earnings ratio) vs. the yield on bonds (interest rates), we can see just how cheap stocks were:

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