Stocks Hold Significant Risks even at Fair Value

Stocks Hold Significant Risks even at Fair Value
April 28, 2014 phillip_toews_1p9l0e9h

Investing platitudes (allocate, rebalance, repeat) about stocks betray the high risks and limited time horizons for the bulk of investors. The reason has everything to do with the way we price stocks.

Small businesses, not listed on exchanges, sell for low multiples (example: 4 times earnings). But when companies grow and eventually go public, valuations average 15 times earnings. Instead of valuing companies based on historical income streams, the focus changes to projected growth. And there lies the problem.

Discounting cash flows for periods as long as 15 years effectively adds leverage to current market volatility. As a result, even small changes in projected rates of earnings growth justify stock rallies or market implosions . For a stock priced at 100 currently trading at 15 times earnings, a decline in projected annual growth from 4% to 2% would justify a 24% loss.

During crises, when pessimism causes investors to dramatically lower or eliminate growth prospects, losses can be even more extreme. We all understand that growth projections are just predictions that hold little bearing to reality and can change as the political and economic landscape shifts. The takeaway from this is that there is no floor under stock prices at fair value. Portfolios are priced based not on tangible assets, but on market optimism or pessimism about the economy. As fast as markets can become pessimistic, stock prices can fall.

Has the Stock Market Reached a Top?

Toews portfolios began the year fully invested . In February our system exited and then re-entered international stocks during a temporary downturn. We finished the quarter partially out of US stocks due to market losses near the end of March. After the quarter’s market gyrations, global stocks ended up largely flat.

Source: Morningstar

We hold divergent perspectives about market prospects for this year. First, market momentum can be a powerful force to drive stocks higher. After big gains in 2013, investors have an increased appetite to invest. With interest rates still low, bonds or bank CD’s are pitiable competition for stocks.

Yet, the S&P 500 has now advanced over 200% from its low in 2009 and is due for a market correction. As the Federal Reserve reduces market stimuli, it makes investment alternatives to the stock market more competitive, and creates resistance to economic growth.

Toews Set to Exit at the Sign of a Downturn

In mid-April, our models completed their exit from US stocks, although we currently hold exposure to developed international and emerging markets’ equities. We remain poised to continue exiting stocks and bonds if markets turn lower. Should that happen, we hope to avoid the bulk of a subsequent market decline. If this is achieved successfully, it creates an opportunity to buy near market lows and participate in rebounds. As a result, it may be possible to produce positive returns even when the market is losing money or moving sideways.
The path to navigate these markets and address possible significant declines is straightforward but requires constant vigilance: 1) stay committed to equity markets, historically the best performing asset class to help protect against inflation and 2) hedge your equity portfolios against losses. Both are pillars on which the Toews system is built.


Prior performance is no guarantee of future results. There can be no assurance, and individuals should not assume, that future performance of any of the portfolios referenced will be comparable to past performance. There can be no assurance that Toews will achieve its performance objectives.

This commentary may include forward-looking statements. 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 commentary is intended to provide general information only and should not be construed as an offer of specifically-tailored individualized advice. Please contact your investment adviser, accountant, and/or attorney for advice appropriate to your specific situation.

This document refers to the performance of the majority of Toews portfolios to illustrate the effect of Toews management on US and intl. stocks and high yield bonds. Performance of individual accounts varied based on the client’s investment risk profile and their specific investment funds. For your individual account performance, please refer to the enclosed quarterly statement or the quarterly statement recently sent to you. In addition, not all model portfolios were referenced in this letter. It is not, nor is it intended to be, a comprehensive accounting of Toews asset management. There are other portfolios that Toews manages that performed differently than what is referenced in this letter. For a complete list of GIPS firm composites, their performance results and their descriptions, as well as additional information regarding policies for calculating and reporting returns, please go to Toews Corporation acts as the investment advisor that implements the asset allocation and models for each of the portfolios. Investors cannot invest directly in an index.