Stocks around the globe have seen more than $3 trillion wiped off their valuations so far in 2016.
Now, I’ve been in the investment business since the 1980s, and I’ve witnessed every large market decline since the 1987 crash.
And right now, investors are making two major mistakes that will cost them profit opportunities in the months and years ahead.
Mistake #1: Pouring Into Index Funds
The first big mistake is that investors are pouring money into index funds.
Data from Morningstar for 2015 shows that investors pulled $207.3 billion from actively managed funds and put $413.8 billion into index funds.
This is ironic because, in 2015, actively managed funds outperformed index funds for the first time since 2012.
Investors need to realize – and quickly – that the investment climate has changed. Index funds are only good when the investment clime is ideal – falling interest rates, a booming global economy, and plenty of liquidity.
After all, a tide of liquidity and good news lifts all boats.
But when the market looks like it has in 2015 and 2016, the only thing index funds will get you is an assured loss. The dirty little secret of the stock market is that there are often long periods – perhaps as long as a decade – when the tide goes out, and overall market returns are flat or even negative.
We’ve been in a benign period for so long, investors have simply forgotten – and they’ve piled into index funds at just the wrong time.
In the current climate, the words of legendary investor Sir John Templeton should be remembered: “If you buy the same securities everyone else is buying, you will have the same results as everyone else. By definition, you can’t outperform the market if you buy the market.
I believe we’re in a period in which you should look to outperform the broad market. That means choosing very carefully where you invest your money.
Mistake #2: Eliminating Overseas Exposure
I discovered the second mistake while forcing myself to watch CNBC for the first time in seven years. I quickly realized that CNBC remains must-miss TV, if investors want to get ahead.
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Guest after guest, not to mention the on-air personalities, urged people to stay U.S.-focused and to get out of overseas markets. Jim Cramer for instance, said, “I want nothing to do with China.”
Let’s ignore for now the lack of diversification aspect. As I’ve often said in these personal finance articles, you wouldn’t go grocery shopping in just one aisle, so don’t do it with your portfolio, either.
Here’s the problem with a domestic portfolio: The U.S. economy is slowing. Just look at the Russell 2000 Index of small-cap stocks, which are focused almost exclusively on the domestic economy. It’s already in bear market territory, down 23% from its peak.
Plus, CNBC wants investors to dive into U.S. equities when their valuations are at all-time highs versus other global markets! Again, the valuation is this extreme because of the very benign conditions the U.S. market has faced. But that’s now changing.
John Templeton famously said, “People are always asking me where the outlook is good, but that’s the wrong question. The right question is: Where is the outlook most miserable?” To me that means emerging markets and even commodities.
It may be too soon, but I’m looking for a “reversion to the mean” for financial markets around the world. In other words, the strong will get weak and the weak strong. Such a reversion would be tough for investors focused solely on the U.S.
The S&P 500 is currently 87% above the long-term trend line from 1871. Take a gander at the chart below:
Now, the market won’t fall 87%, especially since I believe the Fed will do a volte-face, abandoning rate hikes and coming to the rescue with whatever is necessary. Still, investors will likely get more bang for their buck by investing elsewhere.