Key Points
- Equity investors get a preview of market fragility
- Inflation risks remain tilted to the upside
- Consider a measured reduction in risk exposure into year end
A Market Showing Classic Late-Cycle Behavior
Market tops often form during periods of near euphoria when equities appreciate rapidly, and investors feel pressure to participate despite mounting downside risk. Several indicators now point to this type of environment.
The Buffett Indicator, which compares total equity market capitalization to GDP, recently climbed to a record level near 200 percent. The previous high was roughly 145 percent during the 1999 cycle.
The CAPE index is near 401, also close to a record. Market concentration is off the charts, and forward P/E ratios for the S&P 500 suggest 0% annual returns for the coming five-years2. Yet at peak optimism it’s exceeding difficult to feel the urgency to de-risk.
It’s helpful, then, to have weeks like the one we just experienced to help see into the future. Investors knew that NVIDIA was a flagship earnings report this week. What they didn’t expect was a dramatic drop after great results and an improved outlook. The source of further losses once declines begin isn’t economic data or earnings, it’s momentum itself. Losses beget more losses. Nvidia’s reaction highlights the anxiety embedded in today’s valuations. Building behavioral portfolios recommends embracing optimism, but addressing contingencies. This strategic approach within bubbles allows investors to play both the possibility of further, potentially parabolic gains, or a market collapse.
Our Managed Risk strategy is currently in a risk-on mode. We are roughly 12% above the strike price of our protective put, we have stopped-gained out of the call options, and we have sold put spreads. That means that based on our current positioning, we may get full or event greater than full market participation into-year end, when we roll the strike of the put to close to the market. If markets move lower next week, the strategy will move into a risk-off mode, and we expect it to have decreasing down-market correlation.
As December tends to be strong month for stocks, de-risk into year end.
The Period of Fed Lowering May Slow
Currently, the markets indicate a 63% chance of the FED lowering in December according to Bloomberg. So even that event is uncertain. In 2026, inflation that is growing by 3% year over year may limit further reductions. That means that the tail wind provided to bonds by the Federal Reserve may slow or stop.
High yield bonds, offering spreads near 3.2 percent, continue to present a yield advantage over core investment grade bonds. Investors who use an adaptive fixed income framework, such as our High Income Strategy, can maintain overall bond exposure while adjusting to potential scenarios of rising rates or persistent inflation.
Current Toews Positioning
- The High Income strategy shifted defensive this week.
- Our trend following hedged U.S. equity strategies are 2/3 equities with remaining 1/3 hedged using put options.
- International equity exposure remains fully allocated.
- As noted, Managed Risk is maintaining a relatively risk-on posture.
Felipe
For more about our behavioral portfolio, check out my new book, “The Behavioral Portfolio,” launched on March 25!
https://www.amazon.com/Behavioral-Portfolio-Managing-Portfolios-Investor/dp/0857197444
All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.
This market update is intended to provide general information only and should not be construed as an offer of specifically tailored individualized advice, and no representation is being made as to whether the information provided herein would be beneficial for any or for a specific Employer Benefit Plan or investor.
For additional information about Toews Asset Management, please visit our website, www.toewscorp.com. 8626423 YK
(1) https://www.multpl.com/shiller-pe
(2) Source: https://am.jpmorgan.com/us/en/asset-management/protected/adv/insights/market-insights/guide-to-the-markets/