Now is a dangerous time for your clients. More than eight and a half years have passed since the last bear market. On a total return basis, the S&P 500 has doubled its pre-2008 high. Add to this a growing sense of optimism and a lack of negative volatility this year, and many clients may be feeling a little giddy. At my firm, fearful questions seem to be far less common than those pondering the next big opportunity. I’m not arguing markets are euphoric—I don’t believe they presently are. But I suspect that a time of euphoria is approaching. And when it comes, your clients will be prone to making huge tactical errors—abandoning well-diversified portfolios for baskets of highflyers or mere speculations. Your chance to forestall this is now.

As the legendary investor Sir John Templeton famously said, “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” Presently, it seems to me U.S. clients and the American investing public have both feet squarely in optimism. It’s refreshing in one sense: This bull market has been so unloved for so long that few felt any sense of hope or warmth, despite strong positive returns.

But it’s frightening in another. With the arrival of optimism comes the specter of euphoria—the punch-drunk point reminiscent of 1999 or early 2000, when lifelong fixed-income investors were day trading high-tech stocks and trying to jump into hot IPOs. When cable news networks seriously debated whether “bust” had been eliminated by the internet, it left the U.S. economy and stock markets to only “boom.”

For the advisor experienced enough to recall this period, it should conjure bad memories. Many investors had wildly unrealistic expectations of returns, comparing diversified global equity and fixed-income portfolios to the tech-heavy Nasdaq, which, according to FactSet, rose 256% between October 8, 1998—the end of the Russian ruble crisis-driven correction—and the dot-com bubble’s peak on March 10, 2000. Even big returns like the S&P 500’s 45.4% or the MSCI World’s 50.3% over this span pale in comparison, according to FactSet data.

Over the same span, the S&P 500 information technology sector swelled from 14.1% of S&P 500 market capitalization to nearly 35%. (Exhibit 1)

But this wasn’t enough for many investors, who couldn’t stomach owning anything but dot-coms and tech-related firms. Highflyers only. Many chucked exposure to “old economy” stocks in favor of “new economy” boosting portfolio tech holdings way beyond what was rational. Most advisors who stayed disciplined and recommended against loading up on technology probably lost at least a few clients. We all know what followed: The bubble burst. The Nasdaq fell—78% from March 10, 2000, to October 9, 2002.

The time to prepare clients to avoid bubble behavior—chasing huge returns and concentrating portfolios—is now. If you wait for euphoric greed to arrive, you will have waited too long—underestimated emotions’ ability to override logic. Too many advisors think such emotions only apply to irrational fear of losses. Not so! Be sure you don’t fall into that trap.

The best advisors never forget to counsel for what’s to come. Now is the time to remind clients that portfolios shouldn’t be a collection of highflyers, all soaring in unison. Your clients will occasionally hate it, but you must maintain some exposure to areas of the market you aren’t optimistic about. This counterstrategy is your fallback position in case your expectations prove faulty. That is what euphoric techies eschewed in 2000. Moreover, it’s equally true for advisors who use index funds. As I noted, technology’s weight in broad indexes swelled dramatically in 2000. I recommend monitoring how changes in underlying indexes are affecting your clients’ exposure.

Euphoric times also make many forget that investing is a long-term journey. It isn’t about returns in the next week, month, quarter—or even year. It’s about progressing along a path likely to reach your clients’ goals. That’s a tough sell when folks are hearing neighbors brag about juicy returns and are being encouraged to jump into the next “hot stock.” You have to plant the seed early. Educate. Follow up with communications focused on maintaining a long-term view—those that remind clients the stock market isn’t a get-rich-quick scheme. Remind them markets move in cycles. Lather, rinse, repeat.

First « 1 2 » Next