How To Avoid The S&P 500 Herd Mentality Problem

Today’s markets are different. Understanding why can save your retirement portfolio.

There has been a lot of talk about “herd mentality” lately. And I am not talking about politics. The herd mentality I refer to is taking place in the investment markets. Specifically, there is a level of group-think around the broad stock market, particularly the S&P 500 and Nasdaq NDAQ , that creates a tenuous situation for a wide swath of investors.

If you are loaded up on equity index funds in your 401k, you may have a problem. If you are a “buy-and-hold” investor, you probably have a large dose of S&P 500 Index funds, ETFs or securities that track that index closely.

In all of those cases and many like them, the issue is this: you own what everyone else owns. That can be quite gratifying for a while. But when it turns, regardless of the reason, it’s like George Costanza of “Seinfeld” fame, pushing through a room full of children to get to the door. Why? Because there’s a fire, and everyone wants out.

For those of us who focus on outcomes instead of the false security that comes from doing what is currently popular, this is a time of great opportunity. We can never know for sure if the next major move in the stock market will be up or down.

However, we can prepare for both scenarios, and protect capital as a top priority. And, we can be flexible about what decisions we make, and when we make them.

This is how risk has played out in the S&P 500 Index so far in 2020. I use many indicators to evaluate reward and risk at all times. But for simplicity, see the bottom part of this chart. It depicts one of the more common technical indicators.

What do I see? That just as in February, the momentum of the S&P 500 has turned. More importantly, it is doing so from a very high level. It will take more than a few days of messy downside market activity to push the S&P 500 from its current “heavy” state to one where it simply gives way, as it did earlier this year.

Is this an all-out alarm to go and sell everything you own? Absolutely not! But it should alert any investor to the possibility that, after a groundswell of support that rallied the stock market in historical fashion for nearly 6 months, something is changing. How you personalize that possibility is up to you.

The first chart showed you daily prices since the start of 2020. You know, the year we’d like erase from our memory.

The chart below goes back a decade, and shows weekly prices for the S&P 500. What it tells me is more important to gain perspective on what might be happening now.

See that MACD indicator on the lower part of this chart? It appears to be “rolling over.” But that happens from time to time, and it does not always mean a big bad bear market decline is upon us. However, in this case, what I notice is from where that indicator has begun its decent.

That is, the market is rolling over from the most “overvalued” level it has reached in the past decade. In other words, this may be more than just a “dip.” In fact, it should not go without notice that this indicator reached a more expensive point than even last February. That should be a cause for an investor to pause.

The bullish counter to this? As you see in early 2020, the S&P 500 hit its most undervalued level of the past decade. So, it’s only natural that the next phase of the market cycle would drive it abnormally high.

I think there’s some credence in that. However, I think it just serves to drive home the point I made at the start of this article.

Specifically, the market is now prone to fly faster and stronger in BOTH directions, up and down. What does that mean to you? Well, especially if you are nearing retirement, or already retired, your portfolio’s value will flop around a lot more than it has been doing for the past decade.

If you have an iron stomach, perhaps you can just ride it all out. But if you have accumulated most of what you want for retirement, or you just hate taking big steps backward, pay attention here. While there is always profit potential in the big stock indexes, what differs over time is how much risk of major loss is attached to that upside potential. As things stand today, that risk is starting to elevate meaningfully.

This is where the hedging techniques I have discussed frequently in this column can be helpful. After all, markets always provide areas to profit. The difference now is that, as in February and March, those areas may not be the ones the herd is chasing.

Comments provided are informational only, not individual investment advice or recommendations. Rob Isbitts provides Advisory Services through Dynamic Wealth Advisors

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