InvesTech Research: Momentum or Safety?

09/07/2020 5:00 am EST

Focus: MARKETS

James Stack

Founder, InvesTech Research

There are two ways to invest in today’s stock market. The first is to climb on the exuberant momentum train by clamoring over the Wall Street darling stocks and opening a day trading account, notes Jim Stack, a leading "safety-first" money manager and editor of InvesTech Research.

Alternatively, one can recognize the dangers and take a more conservative and selective course, while keeping a defensive cash reserve on hand… to compensate for the elevated level of risk. Seldom in stock market history has the concentration of “performance” been so narrowly focused on so few stocks.

Our InvesTech Gorilla Index contains fewer than 0.2% of the stocks traded on the NYSE or Nasdaq exchanges, yet the majority of gains in investors’ portfolios are coming from these over-hyped, overvalued, momentum stocks.

Prior to the COVID-19 triggered bear market, speculation was already running high as the confidence of market participants was bolstered by the Federal Reserve’s easy-money policies.

In November we warned about the sudden stampede of unprofitable Unicorn IPOs, while we detailed the lemming-like rush into the most expensive momentum stocks in February. Yet what we were seeing before the crash appears to be dwarfed by today’s market excesses.

Yet one more sign of the underlying euphoric psychology is the current surge of stock trading activity. Nothing exemplifies the recent rise of day traders like the growth of Robinhood, the first commission-free online trading platform, which has drawn a mass of young investors with little to no experience.

The ease of trading on this new platform and the fear of missing out on Wall Street’s boundless profits is driving casino-like behavior among new and inexperienced investors.

There are ample reasons for this stock market to move higher in coming weeks, many of them based on technical strength. Yet caution is warranted.

Although the 5-week bear market was steep, it did not clear the decks. Speculation and overvaluation have been quick to return in several areas. While we are seeing opportunities to invest and potentially step up allocation, it is important not to go overboard.

Along with a multi-trillion-dollar stimulus package from Washington, the Federal Reserve’s trillions of monetary injection have put a finger in the financial and economic dike. But the price paid has been huge.

Between the public’s expectations for more stimulus and the investors’ perceived guarantee against bear market losses, the Fed is in a no-win position. In essence, we feel they have merely postponed a day of painful reckoning.

Personally, I do not like the word “bubble” even though we used it in the late 90s in relation to the stock market, and again starting in 2005 to describe housing.

Only in the aftermath – following the severity and duration of decline – can a bubble be clearly identified. And in the meantime, those enthusiastically frolicking in the speculative frenzy will defend to their dying breath that a bubble doesn’t exist.

An investment strategy today can still be prudent, defensive, and profitable. Therefore, we continue to maintain a diversified portfolio while avoiding the momentum stocks and capitalizing on the gold sector’s hedge against the Federal Reserve’s monetary malpractice.

There are a great number of uncertainties ahead, including the election and its possible impact on consumer and small business confidence, that we will discuss in upcoming issues.

With over a half dozen COVID-19 vaccines already in phase 3 trials, we should expect announcements before year-end that could buoy investor hopes (and expectations) even higher. However, that does not mean this is a low-risk market or that we should abandon our defensive safety-first philosophy.

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