WAITING FOR THE CRISIS
One of our forum members https://t.me/c/2369633760/1 shared a concern: “To be honest, I get the feeling that all this growth driven by AI development is bound to pull back for a while. It’s been slightly overvalued; the outlook is good, but there’s still a lot of work to be done to ensure a return on all those billions invested. I think the topic is a bit overheated.”
I’ve been thinking about this, too. I’d like to share a couple of thoughts on the subject and encourage a discussion.
Is the market overheated right now?
It seems so. For example, NVDA stock is trading today at a P/E ratio of 56. That represents less than 2% in annual earnings per share relative to its price. At the same time, you can buy risk-free Treasuries yielding 4% per year. In other words, the risk premium for investing in stocks is negative. Of course, this is not normal and is very risky. And, of course, it’s a consequence of high - and often unfounded - expectations of a breakthrough in AI returns.
Does this mean we’re in for a stock market crash reminiscent of the dot-com crisis of 2000? Not necessarily. And it’s also worth remembering that back in 2000, the entire market did indeed crash, of course. But it very quickly became clear which dot-coms were legitimate (they bounced back quickly) and which were fakes and part of a bubble (they vanished into thin air).
How to protect yourself
And yet: how can you protect yourself from another such severe market downturn? I have two simple ideas. I’ll share them:
- There are “eternal values” that make sense to include in your portfolio, even though they won’t deliver record returns. Examples: VISA, Johnson & Johnson, McDonald’s, Chevron, and the like. These are large-cap, stable companies in their maturity phase - well-known brands. They won’t show record profit growth, but their fundamentals won’t collapse either. Many of them pay decent dividends. That’s important, too - it’s a steady cash flow. Of course, the word “eternal” is an exaggeration. Every company will eventually go out of business. But you can rest easy for about 10 years. Furthermore, the stocks of such companies are low-volatility: during periods of crisis, they stabilize the portfolio. They also offer another important factor for portfolio stabilization: low correlation with growth stocks. Therefore, when you’re feeling anxious, it’s a good idea to include such “eternal values” in your portfolio.
- Cash. “In moments of doubt, during days of agonizing deliberation,” it’s a good idea to increase the cash portion of your portfolio. If and when the market dips, you’ll have the means to buy excellent companies at a good price. Cash won’t lose value!
A balanced portfolio
As for the traditional approach to portfolio stabilizers - bonds, gold, etc. - I’m very skeptical about it: the returns are significantly lower than those of “eternal values,” and the correlation with growth stocks is problematic.
That’s why, for me, a balanced portfolio consists of growth stocks, “eternal values,” and cash (in money market instruments). There’s also quantitative evidence supporting the wisdom of this approach, but I’ll save that for another time. As for the balance between these asset classes and their specific composition - that really depends on each individual investor’s preferences, budget, and personal circumstances.
I’d love to hear your thoughts on what to do while waiting for a market correction. Leave your comments here: https://t.me/c/2369633760/1
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