The Markets Can Remain Irrational Longer Than You Can Remain Solvent

·4 min read

I am starting to get straight-up bearish on the broader market. I know I have been skeptical of the stock market recovery since it began, but the recent surge in COVID cases and a flatlining in economic activity gives my current skepticism backing. The only thing holding up the equity markets at these seemingly unsustainable levels is the hope of another fiscal stimulus package, vaccine/treatment optimism, and a phrase that I’m sure we have all heard enough of: “don’t fight the Fed.”

The market bulls and bears are fighting a battle between the S&P 500’s 3,150 and 3,000 levels, while the tech-driven Nasdaq 100 continues to hit new highs. The world has seen years of digitalization packed into just a 6-month timeframe as our reliance on technology explodes amid this pandemic. This prolific digitalization, combined with the extended low-interest-rate environment, has made growth-driven innovators more valuable today than ever.

Be Fearful When Others Are Greedy

The concern that analysts like me have with this relentless tech rally is that these stocks’ valuations are being pushed to their highest levels since the dotcom bubble. The equity markets are pricing in the best-case scenario in the stock market, and I would be very cautious at the levels we are trading at today considering the unprecedented amount of economic uncertainty we are facing.

COVID daily cases are hitting the highest level we have seen since the pandemic began, and Dr. Fauci has said that the daily case count could reach 100,000, more than double what we are seeing today. If this were to happen, economies would be forced to reverse the economic reopenings that all 50 states are working towards. Increasing economic limitations would unquestionably be devasting to the stock market.

I’m preparing to purchase SPY (SPY) put options with expirations 1 to 2 months out to hedge my portfolio against the risk I perceive in the equity markets. I am just waiting for my oscillators to indicate an overbought market. Remember, if you do purchase puts, keep a sharp eye on them and have predetermined levels you are prepared to sell at. Below are the levels at which I am planning to scale out.

The first two blue circles represent levels where I would start to scale out of my put options, and the red circle is the level at which I would begin being a buyer of the broader equity market (if we can get there). Patience is the key to a successful investment strategy.

Stocks I’m buying on a pullback include Sea Limited (SE), Splunk (SPLK), Twilio (TWLO), Alibaba (BABA), and Square (SQ). All these companies are positioned to change the world in their respective innovation-driven industries.

Like the famous economist John Maynard Keynes said, “the markets can remain irrational longer than you can remain solvent.” So be cautious and flexible as market conditions evolve.

The Takeaway

Keep an eye on the rising number of daily COVID cases and further restrictions that states may enforce. Also, watch out for more talk of fiscal and monetary stimulus. The big two-day FOMC meeting at the end of the month could move the market as it did following the June meeting.

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