What Current Market Conditions Means For You
We've established two things in the prior two articles:
Valuations are at 1999 levels
Last time this happened, basic index funds had negative returns for a decade while some value strategies doubled or tripled
Now the important part: what does this mean for your money?
Markets are expensive and frothy in parts. We need to be invested in a defensive way.
What "Defensive Positioning" Actually Means
When we talk about defensive investing, we mean following a defensive investment process. It's easier to own. It provides better returns over full market cycles. It provides more resilience.
Defensive positioning means buying companies at reasonable prices instead of expensive prices. It's not about avoiding stocks. It's about avoiding expensive stocks.
The portfolios we manage have a large allocation towards evidence-based strategies with a valuation focus. We're not shooting for the stars in the good years, and that’s how we become less likely to shoot ourselves in the foot. History shows these strategies tend to match the market in good years and outperform in bad years. This approach helps avoid lost decades and keeps clients invested for the long term. The best investment strategy in the world doesn't help if it's such a roller coaster that you sell out during a downturn.
The Evidence-Based Approach
Why focus on valuation? Because these strategies have performed when it mattered:
2000-2009: Up significantly while S&P 500 lost money
Japan's lost decades: Up 2-3x while Japanese indices went nowhere
1970s stagflation: Positive returns while growth stocks struggled
They match the market in good years. But they've consistently outperformed in bad years. For someone approaching retirement, that's the trait that matters most.
The Tactical Component
We also maintain a tactical allocation. Right now, this focuses on companies with fortress balance sheets and other valuation-based strategies that may differ from our core holdings.
This isn't "set and forget." When conditions change, the tactical allocation adjusts. But the principle stays constant: look for value and quality, not hype and momentum.
What About Basic Index Funds?
Basic index funds have had two lost decades out of the last five. They buy momentum by design. The largest energy holdings came when oil was most expensive. The largest technology holdings came just before the dot-com crash, and again right now.
As stocks get bigger, index funds buy more of them. This creates more of a roller coaster ride. Evidence-based funds focused on valuation have shown a performance edge over the long term.
The Bottom Line
We may not know where we're going, but we need to make sure we know where we are.
Where we are: expensive growth stocks at 1999-level prices.
What history shows: at these valuations, basic index investors have lower expected returns over the next 10 years, and could potentially face a lost decade.
What works: avoiding expensive stocks, focusing on reasonable valuations, letting the upside come to us.
By focusing on downside risk first and staying patient and disciplined, the upside will come to us. That's how real investors stay comfortable and achieve their retirement goals.