By Robert S. Bacarella| June 29, 2021
When the “check engine light” in your car flashes on, you know you have a problem that needs to be addressed. In many instances the light may not indicate a serious problem, but you have to determine what’s behind the warning or face potential catastrophe.
That’s the case for the stock market right now. Although there’s no sign of an imminent collapse—or “bubble” bursting—warning signs have flashed on. These include extended valuation levels, excessive market volatility, historically high government debt levels, the potential for higher corporate taxes and the continuing draw of very speculative investments such as cryptocurrency and social-media-promoted “meme” stocks.
It is easy to get caught up in the euphoria, thinking it is different this time, and that high prices lead to higher prices…until one day it doesn’t and a collapse occurs. So, don’t ignore the check engine light! Instead, get ready for the inevitable. After all, it’s not “if” but rather “when” the bubble will burst. Historically, when it does burst, markets have typically experienced declines between 34-48% and have taken, on average, five years to recover.
So, what do you do?
Have an exit strategy! Start by classifying investments as either core holdings or trading positions. For your core holdings, you should consider rebalancing by trimming positions to realize profits and build cash. For trading positions, the most important thing to do is to realize profits. You don’t want to be the last one holding a meme stock when the bubble bursts! At a minimum use stop-loss orders to hedge your positions.
In these inflated markets, don’t make the mistake of ignoring the warning light! Don’t let greed draw you away from giving the “check engine light” the attention it’s due.