The US stock-market has continued to do well in recent months, despite high valuations, but contrarian investor Ned Davis of Ned Davis Research is wary. While he agrees that we are not currently in “as big a bubble as 1929 or 2000”, he does think that “if you look at any other market top… you’d have to say we are in the very late innings”.
Another warning sign is that “we’ve got debt at a very high level”. This is a hurdle both financially and psychologically for the market, because when debt gets to excessive levels, “there’s repayments, there’s debt service, there’s lower credit scores and also people just feel trapped”. Davis also fears that passive investing has grown “overly popular”.
There is nothing wrong with passive investing in itself, he says. But the fact that it leads investors to buy all of the stocks in the market with no “regard to whether they are low quality [or] high quality” means that poor-quality stocks get pushed “to higher and higher heights”, which makes for “an unstable situation”.
Davis suggests that one solution for investors is to focus on having less money invested in the US and “somewhat more in other countries with better valuations”. Another idea is to “take some of the risk out of your portfolio by buying more value stocks with strong dividend yields”.
Indeed, he is so sure that a market correction is coming that he recommends “buying put options on the stockmarket right now to protect yourself on the downside” (put options allow investors to make money when and if the market falls in value), especially since they are the cheapest they have been “in many years”.