GO
Loading...

Guard against downward stock moves: Pro

Siegfried Layda | Getty Images

Jim Iuorio appeared on Larry Kudlow's show on CNBC this week and said something profound. To paraphrase, Jim said that bubbles don't happen while people are talking and worrying about bubbles.

Rather, he said, bubbles happen when people deny them and struggle to reassure themselves that things could not be better and that there isn't any real downside. Bubbles occur when investor arrogance is at its height. I actually wrote a book about this called "The Arrogance Cycle."

Stock prices have risen dramatically, and valuations appear full.

(Related video: Stock market bull says sentiment 'too high')

Alan Greenspan talked about "irrational exuberance" in 1996 when the Dow Jones Industrial Average had just touched 6,000.

He was saying that stocks were expensive,and he wasn't wrong. He wasn't wrong in his value judgment, but he was horribly wrong if he thought investors, collectively speaking, would care. The Dow was at 8,000 eight months later and rose to 11,500 over the following few years.

There is a great lesson in this.

Markets often go to excess, and trends often last far longer than most expect. We have been through these periods in the past and have learned two important lessons: These moves cannot be timed, and you'd better understand what you own and be sure it is high quality.

Janet Yellen's nomination as Chair of the Federal Reserve was approved by the Senate Banking Committee this week.

(Read more: Bubble? It's hard to find one yet)

While the minutes from the October meeting show a clear inclination to reduce or taper the Fed's $85 billion in monthly bond purchases, Yellen is clearly dovish.

She has been clear that low rates and an accommodative posture will be with us a long time. While the Fed's messaging is muddled, a move toward tapering is inevitable, and markets don't like it. This is a negative for bond prices and will likely result in a deliberate flight from more speculative stocks.

While investors may miss some of the upside because of a more defensive posture, we are mostly focused on guarding against downside moves.

(Related video: 'There's bubbling everywhere': Cramer)

Former Citigroup Chairman and CEO Chuck Prince famously said of an earlier bubble that 'the party may have gone on too long, but as long as the music was playing, you had to get up and dance!'

Several financial firms collapsed or nearly collapsed when that music stopped. While the musicians don't sound tired at present, we want to make sure we have a seat when the music stops. Though it may be quite awhile from now, the music always stops.

Our strategy is simple and consistent. We strive to own shares of companies with solid balance sheets, high returns on equity, strong cash flow, consistent earnings increases, and experienced management teams.

Mae West said, "Too much of a good thing can be wonderful." We hope that things continue in wonderful ways for a long time to come, but we will be ready when they change.

Featured

Contact Commentary

  • CNBC will consider commentary on a variety of topics, including investing, Wall Street, politics, international affairs, the Federal Reserve, health care, technology, careers, entertainment and more. We want a variety of viewpoints – especially those that are different from something you’ve read on CNBC.com.

    Send op-ed pitches to commentary@cnbc.com. Put the words OP-ED in the subject. Articles should be between 600 and 700 words. All submissions must be exclusive to CNBC.com. Please also include a 1-2 sentence bio of the author and a Twitter handle for the author or company. Please remember these are opinions and should be in your own voice, not in the voice of your PR person or in-house legal consultant!

    We apologize that due to the volume of submissions, we may not be able to respond to every email. If we have not responded within 5 business days, please feel free to submit the op-ed to another publication.

    Who is the commentary editor?
    Cindy Perman is the commentary editor for CNBC.com. She has worked in online news for more than a decade. She also writes the "There Must be a Pony in Here Somewhere" blog and is the author of the book “New York Curiosities” (2013, 2nd edition). Follow her on Twitter @CindyPerman.