What a month we’ve had so far.
The S&P 500 has rallied by 30% since its lows.
The NASDAQ Composite is 8% higher today than it was a year ago.
And the VIX, the so-called “fear index,” has declined by nearly half.
Judging by stock market signals, you might expect the coronavirus crisis to be over tomorrow.
But we all know that’s not the reality.
Sure, cases have peaked in some parts of the world, and healthcare facilities in some parts of some countries are now in better condition to handle this pandemic.
But is the economy really ready to restart?
What about all the job losses and the looming recession?
I understand we’ve received record amounts of economic stimulus from the government, but does this justify the meteoric rise in stock prices?
In my opinion, that’s not what’s going on.
I believe there’s danger lurking around the corner.
Stock Valuations Are Pointing Towards A Decline
The thing that worries me most about today’s market is that it’s so darn expensive.
At the end of last year, S&P 500 earnings were $140 per share.
If we assume that earnings will fall by 10% this year (and I believe that’s a conservative estimate and think a decrease of 20% is possible), we’ll be looking at $126 per share.
Meaning the market is now trading with a Price-to-Earnings (PE) ratio of 22.35, the same level as in Q4 of 2019.
If we take a more realistic position and project that earnings will decline by 15% this year, then we’re looking at an S&P 500 PE ratio of 23.50… the same level as in February 2020.
Do you see what I’m saying? The market is saying stocks today are worth as much as they were at the height of the last bull market.
Call me pessimistic, but I don’t believe those valuations are justified.
I think that makes stocks way over-priced and vulnerable to a sharp decline.
How I’m Repositioning My Portfolio In This Market
I understand what I’m saying may sound confusing, given how optimistic the market has been behaving over the last 30 days.
But from an historic perspective, a rally like this is nothing out of the ordinary.
During bear markets, it’s not uncommon to see wild swings to the upside as investors try to figure out the new normal.
These rallies, however, are typically short-lived. Moreover, they tend to collapse just as quickly as they rose.
I will admit, though, that there is some justification for stocks to be acting as they have been. The government stimulus to counter the crisis we’re living through has been unusually swift and extensive. It is for that reason that I don’t believe stocks will fall below March 23 lows.
Nonetheless, I’m still of the opinion that the market rallied too far too fast and that we will soon see a decline.
And that’s a scenario I want to be prepared for sooner rather than later.
Which is why yesterday, given the epic rally in stocks, I decided to sell some of my positions.
Don’t get me wrong. I’m still invested. Except that now I also have dry powder at the ready should the market decline.
I recommend you consider doing the same. Trust me. It makes sense.
Sure, you’re giving up some upside potential.
But by taking 20% to 30% of your money off the table, you should still be making decent gains if the market continues to rise.
And, if it falls, you’ll suffer fewer losses… and you’ll get a chance to re-invest at lower levels.