March 4, 2021:
We’ve gotten this question a few times: a bursting bubble in US growth stocks will likely drag everything down for a while; why not just sell out and wait for this to unfold?
It’s a reasonable question, and we would love to be able to avoid a downturn if we thought it could reliably be done. But while this approach sounds good on paper, there are a lot of ways it could go wrong.
First, while we think the evidence points pretty strongly to a bubble in US growth stocks, there are no sure things in financial markets, and there is no guarantee that this bubble will deflate in the typical manner.
Even if it does, we don’t know how long the bubble will last, and what will happen in the meantime. It could keep going for a while yet, and during that time our favored stock investments could do really well. We wouldn’t want to miss out on a powerful rally in reasonably-valued stocks because we were trying to time the market.
In fact, the “sell everything” strategy would already have missed some major gains in the non-bubbly areas of the market. US growth was clearly (to us) in bubble territory by the beginning of September 2020. Since that time, developed international and emerging market value stocks – our favorite areas of the global stock market – are up over 26%. (1)
There’s just as much uncertainty on the way down. Once the downturn starts, how do we know it’s all clear to buy back in? If markets start up again, is it the end of the crash or just a temporary bounce before the decline resumes? If we guess wrong, we could miss out on much of the post-crash rebound, which is typically the most powerful part of the bull market.
To make matters even more complicated, the areas of the market that started out reasonably priced will likely endure smaller and shorter declines than the bubble areas. The chart below shows one dramatic example from the burst of the tech stock bubble: US small cap value stocks, which were scorned during the bubble and had become quite cheap, actually rose during the tech-induced crash.
This is an unusual case – typically everything falls at least somewhat during the panic phase of the bear market. Even then, the lower-valued investments usually hold up better and recover more quickly.
All in all, there are a lot of ways to trip yourself up when trying to time markets. We think it’s better to stay invested in the reasonably priced areas of the market, and to be prepared to endure – and take advantage of – any market decline that happens along the way.
We have written a separate article describing the investment approach we’re taking during the current US growth stock bubble.
1 – Total return. Source: stockcharts.com (tickers FNDF, FNDE)