Monday, August 30, 2010

A cautionary tale for bubblicious portfolios

What chart is this?

I am sure that a lot of you are thinking that it must be some internet stock.

Well, it could be: the chart resembles many which peaked in the 1999-2001 period. I recently looked at the stock prices for Microsoft (MSFT) - it peaked around $59 back then, and is currently in the $25-$30 range - about half its peak value. Intel (INTC) peaked in the $75 range, and is now in the $25-$30 range. Cisco (CSCO)? $77 then and $21-$28 recently.

But no, this is not from the tech sector. This is a cautionary tale of how inflated prices can get in one, or many, sectors during a bubble.

No, this is the behemoth drug maker Merck & Co (MRK). which peaked around the same era at $94 and is now in the $35-$40 range. You can pull up the charts for the other pharmaceutical giants, then and now, like Pfizer (PFE), Abbott Labs (ABT), Novatis (NVS), etc. and find the same cratering effect: most of these still haven't reached the halfway point of their bubble prices.

Have some things changed for both sectors? Sure - but not nearly to the extent implied by both a lost decade of price appreciation and, worse, price declines that could have eviscerated some over weighted portfolios.

One thing remains constant - investors, whether buying single companies or weighing into sectors via ETF's etc., have to be very cautious on the flavour of the year. Avoiding the most popular sectors, especially after several years of popularity, can be one of the best things you can do for your portfolio's health - and can help you get a good night's sleep too.

Disclosure: No positions.
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Garage Guy said...

This is an interesting correlation, but what is the causation? A generally overzealous investing public?

Jay Walker said...

Overvaluation is the primary cause. Investors become too enthusiastic about growth prospects, usually, and overpay. When growth inevitably slows across a sector, valuations become more rational.