Three Hidden Land Mines in a Lofty Market
By Christine Benz at MorningStar
Savvy investors well know the pitfalls of investing after the market has enjoyed the kind of rally it has over the past five years. Reams of Morningstar data corroborate investors' tendency to put money to work in asset classes, categories, and individual funds after they've generated explosive returns, leading to poor take-home gains for the investors who, in essence, buy high and, later, sell low.
That scenario may well be playing out yet again in the "great rotation" right now, as investors have switched their attention from bonds to stocks in earnest. Meanwhile, equity valuations aren't what they once were. Although some investors–including Oakmark manager Bill Nygren and Morningstar's analyst team–don't believe stocks are crazily overvalued at current levels, there's no shortage of less optimistic signals. The Shiller P/E, which encompasses earnings over the past 10 years to help smooth out cyclical swings, is trading significantly above its historical average, and fund managers like Steve Romick (Fund Manager of the Year in Morningstar's allocation category) say they're finding little to buy right now.
Extremely strong market environments can prompt investors to jack up their portfolios' risk levels when, in hindsight, they should have been doing the opposite.
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