“There are so many lights flashing red I am losing count” – Neil Woodford
2017 was an easy year for investors. Global markets were remarkably calm, and key indices such as the S&P 500 and the FTSE 100 performed well.
However, 2018 could be more challenging. In my view, certain areas of the market look dangerous right now. Investment success this year may be less to do with what you invest in and more to do with what you avoid.
With that in mind, here’s a look at four bubbles I’ll be steering clear of in 2018.
Bitcoin exhibits all the classic symptoms of a dangerous investment bubble. Not only has its rise been stratospheric, but every man and his dog are talking about it. Taxi drivers, hairdressers, you name it.
It’s a recipe for disaster. Bitcoin’s price movements are incredibly volatile. In the latter half of December, the cryptocurrency fell from $19,300 to $12,600, a decline of 35%. Proceed with caution.
Next up, the FAANGs. That stands for Facebook, Amazon, Apple, Netflix and Google.
These five stocks enjoyed extraordinary gains last year. All five rose spectacularly. But several now look extremely overvalued. For example, Amazon trades on a P/E of over 300. Netflix has a P/E of 200. That looks like bubble territory to me.
Directors such as Bezos, Zuckerberg and Cook are all dumping huge quantities of stock right now. Executives don’t sell at the bottom. The smart money is getting out.
If you own international exchange-traded funds (ETFs) or mutual funds, it’s worth checking to see how much exposure you have to these overpriced stocks.
S&P 500 ETFs
Speaking of ETFs, the flows into S&P 500 trackers over the last year are concerning.
In 2017, investors pumped around $50bn into the three largest S&P 500 ETFs. Over a three-year period, inflows amount to around $100bn. That’s a huge amount of capital.
Investors have become lazy. Everyone now owns the same basket of stocks. And guess which stocks are sitting at the top of the index? You guessed it. The FAANGs. Apple has a near 4% weight in the S&P 500, with Google, Amazon and Facebook contributing another 7%.
The result is that right now, many investors have significant exposure to some of the most overpriced stocks on the planet.
As a product of the last decade, we have no idea how ETFs will fare in a major bear market. The ETF inflows have been orderly, but will they be as orderly if markets head south?
Expensive small-cap stocks
Lastly, as always, it’s worth being careful with overhyped small-cap stocks.
I’m talking about stocks such as Boohoo.Com and Fevertree Drinks, which trade at eye-watering valuations, as well as companies such as Sirius Minerals and Versarian, which are not making any profits.
While it’s no doubt possible to make big money with these kinds of stocks, it’s also possible to lose large amounts of capital if sentiment changes. Don’t overexpose yourself. Risk management will be important this year.
For higher returns in 2018, avoid these investing mistakes
Cutting out large losses can make a big difference to your overall investing returns over time. After all, if a stock falls 50%, you need to make 100% to break even.
With that in mind, if you're serious about generating stronger stock market returns, I'd urge you to read the report The Worst Mistakes Investors Make.
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Edward Sheldon has no position in any shares mentioned. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. The Motley Fool UK owns shares of and has recommended Alphabet (A shares), Amazon, Apple, Facebook, and Netflix. The Motley Fool UK has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool UK has recommended boohoo.com. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.