This week, financial pundits have been having a field day pondering the next move in the markets. Wednesday's bounce brought out the bullish crowd, who were quickly replaced by the bearish crowd. Both groups were very sure of their predictions, and both had about the same coin flip of a chance of being right. A review of market prediction history shows that those who get one move right spectacularly usually get the next moves wrong in an equally spectacular fashion. They were not prophets. They were just lucky.
Was this week's selling a dip or the start of a big bear move? We have had a long and sustained up move. Private equity investors such as David Rubenstein of Carlisle Group (GC) have told us that asset price levels were frothy, and good ideas were hard to find. The table would appear to be set for a decline, but this has been true for the better part of a year. The market could decline, or it could just continue to focus on zero rates and resume climbing.
There are stocks I certainly do not want to own if the market does roll over, and I would make sure I do not any of them right now. The stocks that are trading at high multiples of earnings and asset values, with a heavy concentration of institutional ownership, will be those that lead the decline if there should be one. Overpriced stocks are the first ones the big funds throw out of the portfolio. A sellout will follow.
This morning, I ran a screen and looked for stocks with high multiples and insider ownership. The large-cap REITS have a huge presence on the list. If you own stocks like Vornado Realty Trust (VNO), Avalonbay Communities (AVB), Simon Property Group (SPG) and Public Storage (PSA), consider taking your gains in these issues. They all trade at more than 30-times earnings, and more than 80% of the shares are owned by institutional investors. If we start to see widespread market decline, the exit doors in these names are going to be pretty crowded. Most of the REIT ETFs are heavily weighted towards these larger REITs, and they would be hurt by selling in these higher valuation names.
A few technology names look dicey at current levels as well. Adobe Systems (ADBE) sells at 141-times earnings, and institutions own 92% of the shares. Autodesk (ADSK) is trading at 72-times earnings, and the big funds own 92% of the outstanding shares. Healthcare technology company Cerner (CERN) has a PE of 48 and an institutional ownership of 82%. Red Hat (RHT) is trading with a PE of 60, and fund ownership is 95%. If a hungry bear emerges, these funds have a long way to fall, when the selling begins.
A total of 180 stocks in the screen trade for more than 30-times earnings and have institutional ownership of more than 80%. I do not want to own these in a rising market, given that valuations are higher and everybody already owns them. I definitely do not want to own them in a falling market, as they will see heavy selling volume when managers begin to cut exposure to equity markets. Anyway, none of them are cheap enough for me to give them a seconds thought, to begin with.
Paying attention to the valuation levels of the stocks in your portfolio, ETFs and mutual funds can help you prevent serious carnage, if a bear market does make an appearance.