Street Analysis

In a previous post, we called out the stock market topping out, enumerated the reasons behind the recommendation of exiting out of the market completely, a rare recommendation for certain, and made a case for the proper risk management. In a nutshell, it is all about the prudent risk management, nothing more, nothing less.

In terms of the next steps, let us start with the options that one can have and the most optimal way to get off the market ladder depending on one’s risk appetite and understanding:

• Option 1: Do Nothing or stay put in the stock market
  • This option is highly advised against due to the nature of risk it entails in this highly frothy, bubble and tulip mania kind of market. It represents the maximum amount of risk and maximum probability of a major loss
• Option 2: Gradually exit out of the stock market
  • Gradual reduction in the exposure to equity (stocks) such as 5% to 10% reduction each week and be out of the market completely in about 10 to 20 weeks (3 to 6 months). This option still represents a lot of risk, however, the beauty of it is that you are gradually and materially reducing your risk exposure, if you are not comfortable pulling out of the market altogether
  • Cut down the equity (stocks) exposure substantially. For example, if 100% of the portfolio is in stocks then cut it down to no more than 20% to 30% in just one-go
• Option 3: Partner with Warren Buffett and invest in Berkshire Hathaway (BRK.A / BRK.B) stock
  • If you are hesitant to exit out of the stock market entirely or partially then the next best option is to stand next to Warren Buffett by investing in Berkshire Hathaway. The reason? He has amassed $347 billion in cash on the company books by the end of the Q2-2025. It is a ‘b’ with the billion, not the millions and right there and then it speaks a humongous story. He is an investment legend that no one has ever beat and hard to envision anyone doing so anytime in a near future. One of a kind, if not a rarity on this earth! In fact, he is the only person amongst the top 10 richest in the world who has created wealth by investing, not by creating a business or company
  • Berkshire stock is expensive at approximately twice the book value relative to its own past historical valuation of around one-time book value as it has risen out of its normal territory along with the market. Yet, it is better to be in a company of Mr. Warren Buffett than Mr. Madman Market
  • If and when the market crashes and it will do so badly as the madness lasts even longer then Mr. Buffett will be there ready to pick up the badly bruised pieces and profit handsomely with his huge cash hoard. One can reasonably bet that he will double his money in 5 to 7 years with his wise investments provided that investors are fortunate to have him around on this earth since he is already 94 years old and soon to be 95 late this month. Market crash or fizzling out – one of the two possibilities is a question of ‘when’, not a question of ‘if’
• Option 4: Asset class change (Bonds, Commodities) / Bond Ladder for 5 Years
  • Now, we are speaking of the real portfolio diversification. I am no big fan of commodities either, however, in light of what is happening in the stock market right now, commodities are probably a much better bet than the stock market. They need to be part of the ‘super-diversifier’ investment strategy anyways. Gold has already proven its worth, as always, and risen accordingly as it is the most reliable “store of value”, not as a major wealth generator, however
  • The best approach is to invest in short to intermediate bonds. Longer term treasuries such as 10 or 30 years need to be frowned upon due to not so small probability of U.S. debt default and a real high probability of major rise in the interest rates due to extreme mismanagement of uncle Sam’s affairs. Long term bonds that are supposed to be a safe haven if and when the stock market crashes, can crash as well alongside with it, not just in sympathy though due to real adjustment and alignment of the financial assets with the ground reality – the worst of all possibilities, yet a realistic and a probable one
  • Generally, if the stock market falls, the bonds rise in value due to fall in the interest rates (to pump up the economy) and the balanced portfolio can offset the losses in one asset class (equity) with the gains in the other asset class such as bonds. However, that is a highly improbable phenomenon now at least until the stock market is back on the even keel, a pipe dream
  • Create a bond ladder by investing one fifth of the funds with the maturity of 1, 2, 3, 4 and 5 years. Then, repeat the process each year by reinvesting the proceeds as each 1-year bond matures into a 5-year bond. The strategy is pretty straight forward, provides some semblance of stability and the great peace of mind
• Option 5: Cash account
  • Parking all of your funds in a cash or money market account is even a better option than the bond ladder approach, the safest option and the highest peace of mind. No financial market risk until the storm passes – stocks or bonds. This is not the time to be brave, rather it is a time to hunker down and get in the bunker. There is no market timing here. It simply is about prudent risk management and preserving your capital. We truly live in the unprecedented times from all angles – economic to political and out-of-the box thinking is required to save the self

Now, the cost benefit analysis:

• Option 1: Stay in the market
  • Projected 5 and 10-year return is in 0 to low single digit percentages given the high valuation of market. We can certainly and easily envision another “lost decade” like it had been from 2000 to 2010. The excesses (understatement) of last 15 years shall need to give a way to the moderation at best and heavy indigestion or paralytic sickness at its worst
  • Can the market go up for a couple more years and deliver higher returns? Yes, absolutely, it can just like it has done so in the past few years. However, if it does, it means it will only get more and more uglier later. Sooner it corrects itself by taking a strong pill, better it shall be for the economic health. Overall, I would not count on anymore double-digit gains going forward that has become an unfortunate norm and people have to come to expect it rather, unfortunately, of course, unreasonably
  • In theory, the stock market can always keep expanding the valuation ratio as long as irrational investors are willing to pay even more irrational prices. The game of musical chairs can go on as long as the music plays and the party goes on as long as the punch bowl is full
  • Against the upside which is literally next to nothing given the backdrop of extremely stretched valuations, the potential for catastrophic losses is huge
  • In other words, the risk-reward equation is highly skewed here and the investor reward is unacceptably asymmetric. Over the really, really long run (over multiple decades time period), the stock market tends to deliver the investment return in the neighborhood of 8 to 10%, however, the next decade is highly likely to be the “lost decade”, let us say from 2025 to 2035 delivering low single digit percentage returns at best, if not near zero returns
• Option 2: Gradual exit out of the market
  • The effects are much more subdued or diminished compared to option 1 for the costs as well as benefits both, however, it certainly is a step in the right direction of a prudent risk management
• Option 3: Partner with Mr. Buffett
  • He is a master maestro and will conduct the business as usual as he has always done to uplift all of the Berkshire shareholders’ financial stature. The only thing we need to do is to pray for his good health and longevity. He often says that with age, he gets better! To that extent, he even says that any investor shall get better over time with the accumulated knowledge base
• Option 4: Bonds and commodity mixture or bonds ladder
  • This option shall likely generate the returns in the neighborhood of about 5% to 6%. We rather accept this subpar returns and sleep well at night over participating in the market madness and risk our capital…that is until the Mr. Market changes his mood and offers better opportunities to invest in the stock market
  • Mr. Buffett often says that Mr. Market is a manic-depressive personality and goes thru extreme mood swings. As a result, he often offers great deals when he gets depressed while at other times, he exhibits the manic behavior. The shifts between these periods of excessive optimism and unwarranted pessimism are what we need to keenly watch for and capitalize on, certainly not be the victim of by keeping a really long-term perspective at the forefront and not get caught up in the emotional ups and downs of the market
• Option 5: Cash or money market
  • This option being the safest of all options clearly gives the lowest return, though, the highest peace of mind and most prudent risk management prospect of all. It is reasonable to expect around 4% annual return in the cash or money market accounts. Many thanks finally to the rise in the interest rates from the criminal level of near zero interest rates as had been manipulated by the Federal Reserve for so long. Thankfully, the wealth transfer from poor and middle class to the rich class is being questioned now by the interest rate markets

In a nutshell, one must play with the current market at his/her own peril. As they say “this is not your grandfather’s market” and it is really scary out there and warrants making some bold move, even bolder than staying in the market…

Next time we can cover the topic of time horizon and risk tolerance along with the investor types as it will be a natural progression to speak to that in light of what has been discussed thus far.