How to Invest During a Stock Market Bubble

WITH THE STOCK MARKET hitting record highs, some investors may be worried that equities could soon face a crash…

“There are certainly many signs the stock market could be getting out over its skis and a correction may be looming,” says Jim Paulsen, chief investment strategist of The Leuthold Group.

He points to several factors driving that thinking, including the Russell 2000 small-cap index more than doubling from its lows last year, extremely high valuations compared to historic norms, significant fiscal and monetary stimulus in reaction to the pandemic, price surges in heavily shorted stocks, and cryptocurrency prices being more volatile than usual, among several other events.

Now some investors might be wondering if a market bubble is forming – or ready to pop. Market corrections are inevitable, but a popping bubble can wreak serious financial damage along the lines of the 2000 dot-com bubble bursting and the 2008 financial crisis.

Predicting market downdrafts is nearly impossible, and long-term investors are best served staying in the market. Yet riding out those breaks is tough, even for seasoned professionals. “I’m a risk-averse type of investor myself. I don’t have the stomach for 20% to 30% drawdowns; I just can’t do it,” says Jon Burckett-St. Laurent, senior portfolio manager at Exencial Wealth Advisors.

There’s no magic bullet position that allows investors to stay in the markets and never lose money, but investors can minimize their losses. To do so, investment professionals offer five strategies:

  • Buy an equal-weight fund.
  • Develop a barbell portfolio.
  • Buy dividend-growing stocks.
  • Use options-based strategies.
  • Take some profits.

Buy an Equal-Weight Fund

Stock markets such as the S&P 500 are market-cap weighted, so big companies like Apple (ticker: AAPL) have a greater influence on price than smaller companies. Another way to rank companies is in equal measure, meaning every constituent has the same weighting, regardless of size. Exchange-traded funds such as the Invesco S&P 500 Equal Weight ETF (RSP) measure the performance of the S&P 500’s companies in equal weights.

Sam Stovall, chief investment strategist at CFRA Research, says during the tech bubble of 2000-2002, the S&P 500 equal weight lost less than half of the market-cap weighted index. While equal-weight investors still lost money at that time, it was significantly less than what a market-cap weighted investor experienced.

Stovall says investors who are concerned that the market is being narrowly led higher by growth and tech stocks could consider an equal-weight investment if they worry that a fall in these stocks could cause a sharp correction similar to 2000-2002.

Develop a Barbell Portfolio

Investors who buy individual stocks can use what Stovall calls a “barbell portfolio,” owning both last year’s winners and losers. This is a strategy he likes to use at the beginning of the year. Owning last year’s performance leaders is akin to letting winning stocks ride and buying last year’s losers is similar to buying low to hopefully sell high. The barbell portfolio contains 10 stocks or subindustries each of both the winners and losers, for 20 holdings total.

Stovall says, historically, by owning both, this portfolio strategy has outperformed the broader market on both a percentage basis and a frequency basis, meaning the frequency of advances is positive. He says in 2000, the barbell portfolio was up 1.5% versus the S&P 500’s loss of 10%; in 2001, the barbell strategy fell 4% and the broader market declined 13%; and in 2002, the barbell portfolio lost 19% while the S&P 500 fell 23.4%.

For a 2021 barbell portfolio, a few of the best performing subindustries of 2020 included…

Continue reading at US News & World Report