A buy-and-hold client recently asked me about the performance of his diversified portfolio. Compared to the S&P 500’s performance over the past couple of years, almost any diversified portfolio is going to look bad. And unfortunately, the S&P 500 is the most often used form of comparison, even though it is only one part of one asset class in one country, and therefore a very poor one. Hopefully, I did a good job informing the client that although the S&P 500 is performing well, and he has significant exposure to it, the S&P 500’s stocks are overall very overpriced, and that in the long-run, he will be glad he is diversified when the U.S. stock market falls in price.

I remain concerned about the status of the U.S. stock market and almost all bond markets. At the risk of sounding like chicken little, now is a time of caution. As Jesse Felder pointed out in a recent article, the S&P 500’s price/revenue ratio is well above any time in recent history, insider sales are the highest in quite a while, and the U.S. bond market has the highest sensitivity to interest rates in the past 20 years at a time when interest rates are low and expected to rise. We are also near a real estate bubble in many parts of the country. As a result, diversification is key, which means holding assets such as international stocks and commodities such as gold. The odds of any one asset class plummeting in a given year is not as low as we’d like, but the odds of all of the major asset classes declining at the same time is much less likely.

So enjoy the bubble now, but make sure that your portfolio, risk tolerance and overall strategy is prepared for a rude awakening.

-Richard

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