I am getting more and more worried about the current state of the stock market.
Yesterday, one of the main U.S. indexes, the NASDAQ Composite, turned positive for the year.
Meanwhile, the S&P 500 and the Dow Jones Industrial Average posted their best month since 1987.
And all of this is happening in the face of terrible economic data and mounting uncertainty.
With everyone betting that stocks will continue their upward momentum, is this the time to be a contrarian?
Let’s find out.
The Real Economy And The Stock Market Are Dangerously Far Apart
I understand that not all stocks are rising in this environment.
The rally has mostly been driven by technology and healthcare companies, which represent about 45% of the S&P 500 index.
But I’m still worried that many of those stocks are not discounting the economic impact correctly.
Just look at how much worse off we are today than twelve months ago.
First, the current unemployment rate is projected to be 14%. One year ago, that number was only 3.6%. One out of ten Americans that had a job before this crisis doesn’t have one anymore. That’s tens of millions of people cutting their spending budget to zero.
Furthermore, GDP growth, which in May 2019 was 2.0%, is now -4.8%. This will make it incredibly difficult for the millions of unemployed to find new jobs.
Finally, there’s the 10-Year Treasury Rate. This is the instrument the largest players buy whenever they sense there is risk in the financial markets. The lower the yield on this bond, the higher the risk. Since last May, it has declined from 2.45% to 0.64%.
At the same time, the stock market valuations are 20% higher than they were in May 2020, when there was no recession on the horizon. At the time, the S&P 500 was trading at 17 times its forward earnings. Today, it’s at 20.3 times.
There’s something wrong with this picture.
I think that regardless of the record economic stimulus launched in March and April, the discrepancy between the stock market and the real economy is too big.
The risk/reward ratio in this market is tilted significantly to the downside. And that’s something you should pay attention to.
How To Play This Market
So, the question, as always, is how to play this market?
Just because everybody is betting that the stock market will continue to rise, it doesn’t mean that they’re wrong. But, it also doesn’t signal that you should join them. Don’t invest because you’re afraid of missing out.
So here’s what you should do.
If you’ve been listening to my advice over the last two months and have loaded up on quality names, then you should hold on to those names. I’m talking about stocks with robust balance sheets and excellent products, such as Google, Facebook, and Microsoft.
You should not, however, be adding to those positions. If anything, I advise you to trim some of your best performers. There’s nothing wrong with taking profits at this point. You will have to keep some powder dry for the inevitable correction when it arrives.
And that goes for everyone. So, I repeat. Keep some powder dry.
If, however, you’re just starting to buy stocks now, or are looking to reposition your holdings, then I have the following advice—play it safe.
First, consider holding gold stocks in your portfolio.
The combination of terrible economic data, uncertainty surrounding the coronavirus, and the fact that we’re in the election year, should keep the market volatility high.
Making this precisely the type of environment where the precious metal can thrive.
Moreover, I suggest you consider investing in healthcare stocks.
This sector is not as dependent on the underlying economy since health is one of the costs consumers spend on no matter what.
Moreover, because we’re dealing with a health crisis that experts agree will drag on well throughout the next winter, companies in this sector can expect their revenues to increase at a faster pace than the rest of the market.
And finally, the aging population makes healthcare one of those long-term megatrends, which will continue to grow well beyond the coronavirus outbreak.
If you’re looking for healthcare candidates, I talk about my favorite stock in this month’s issue of True Retirement Wealth.