Can The S&P 500 Really Go To 3700?
By Roger Nusbaum, AdvisorShares ETF Strategist
Jeremy Grantham drew some attention for believing that a serious melt up in asset prices is underway. In reaction to Grantham, Rudolf E. Havenstein (this is a historical figure, so it is an anonymous account) jokingly Tweeted that old people should own the cryptocurrency Ripple, a Chinese internet stock, one of those companies that changed their names to include the word blockchain and then set fire to any cash left over.
To say I thought it was hysterical would be an understatement but it makes a useful point about proper diversification in the context of risk management.
A portfolio that has 10% in each of the FAANG stocks is probably up a lot but is extremely vulnerable to the next downturn. That’s is not a prediction but often when the cycle turns, it is the hottest names that get hit the hardest. It doesn’t invalidate any of the businesses necessarily but by the same token there is nothing that says all of them must survive either.
Risk management of position size and diversification is not about predicting that a company will go out, if you thought that you wouldn’t own it any more, but safeguarding against being adversely affected if something dreadful does happen. There’s a line between simply having a drag on your portfolio from a soured holding and a meaningful capital impairment.
If Grantham is right about a melt up, then it is possible it has a long way to go. There was a comment in passing in Barron’s about the S&P 500 going to 3100 in 2018. Would another 15% on top of the 21% in 2017 on top of the 13% in 2016 constitute a melt up or would the be more gains past that? Grantham thinks the S&P 500 going to 3400-3700 in this cycle is possible. That will only be knowable in hindsight, but position management is always appropriate.
While I like 2-3% weightings for individual stocks I wouldn’t too worried about something that grows to 5% by virtue of strong performance. I would not let something get to 10% however. You can draw your own conclusion of course about correct sizing but clients feel the pain of large declines far more than the joy of large gains (well known behavioral observation) and an advisor would ideally mitigate some of that pain by taking a disciplined approach to pairing something back that has grown disproportionately large within the portfolio.
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