Most investors are familiar with Buffett's famous rule for investing successfully. An eye on the downside is, in many cases, more important than making sure you have high upside potential. In fact, recent research has shown that investors who ensure that they limit their bear market losses do better on average than investors who only focus capturing every percent of upside in bull markets.
This columns goal is to make sure that you abide by rule number one (never lose money) and to never forget it. By analyzing bear cases of industries, economies, and individual companies, investors can get insight on what risks to look for in potential investments. Understanding why you shouldn't buy a company will allow you to both avoid poor investments and solidify your bull rationale.
Like I mentioned before, one bad investment can wipe out the gains of multiple good ones. Each "Rule Number One" article will analyze the bear case for a security or class that is possibly overvalued, allowing you to preserve your capital and invest in only winners.
Future articles will analyze specific companies, but for now, lets look over some reasons on why the market as a whole may be overvalued. One of the best, but highly contested, metrics of determining market valuation is sentiment: buy when others are fearful and sell when others are greedy. When the market hit its lows in March 2009, investor sentiment had never been lower. From there, the market raged higher over 50%. At the peak before the downturn, a bear was a rare site on Wall Street.
Here are a few metrics to look at how investors feel today:
- The bears on the Investors Intelligence survey have finally fallen below 20%. Of all the signals that these sentiment surveys throw off, the bears falling below 20% on the II survey seems to be one of the most reliable sell signals.
- Rydex traders recently set a record for being positioned the most bullishly ever.
- Put/Call Ratios are setting short-term records