The smart money appears to be taking profits

Top investors are selling, convinced record share prices for stocks including CBA are not justified by underlying profits.

Some investors think there’s too much hot air in surging share prices. Picture: iStock

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When sharemarkets crash, most people immediately want to know how and why it happened.

But when the market is soaring, the opposite occurs. Nobody asks hard questions.

This week the ASX 200, the S&P 500 and Nasdaq all hit new records.

Sharemarket analysts call it a “melt-up”. It refers to an unexpected rise in the price of shares primarily driven by investment sentiment, rather than the fundamentals.

You could say it’s when sharemarkets soar for no good reason.

Our sharemarket is not breaking records due to the underlying listed companies doing record business.

In fact, company profits on the ASX are going backwards.

The Australian reported recently that ASX 200 companies, in aggregate, are expected to report a 1.7 per cent drop in profits for the current financial year, down 18 per cent from peak estimates.

Weak profits are the outstanding reason this market surge is unconvincing.

But there’s plenty more.

There’s tariff walls appearing between the world’s great trading partners, the persistence of inflation, the extraordinary levels of global debt, and the erosion of standards in the US market typified by Donald Trump’s attacks on the Federal Reserve.

“There’s just nothing in the hard data that shows there is a big correction coming,” Rob Waldner, chief strategist at Invesco, told The Wall Street Journal this week.

Which is true.

But then again, anyone who has watched market reversals over a long period knows that markets can suddenly turn downwards with little warning.

Nassim Taleb’s “Black Swan”, the event nobody sees coming, is never in the hard data, but it is never far away.

Selling CBA

In our market, the overheated nature of this year’s sharemarket is captured perfectly by Commonwealth Bank of Australia.

CBA is the nation’s biggest bank and the largest stock on the ASX. As a result, it is a bellwether for local share investors.

Its shares are up about 40 per cent over the past 12 months, but the bank’s last interim profit was up by 2 per cent.

CBA is the canary in the coal mine. It’s the stock to watch for wider trouble. It is the ASX version of chip maker Nvidia, where the business is very good indeed, but the stock price is in a parallel universe.

Put simply, CBA’s crazy price is just a manifestation of a market where the accumulation of gains is now a threat.

If we look back over the past 12 months, Australian shares (including dividends) delivered 14 per cent in an economy where GDP is ambling along at 2 per cent. It doesn’t add up.

No wonder wealth management experts describe the sharemarket as a bubble in search of a pin.

Moreover, history suggests that every year the market brings in above average returns, we move closer to an inevitable sell-off.

The superstitious investor might also add that we are edging towards the notorious final quarter of the year, the northern autumn when most of the major crashes have occurred, all the way back to 1929.

No surprise, then, to hear the world’s greatest living investor, Warren Buffett, is being fearful when others are greedy. He’s selling into this market, particularly bank stocks.

Buffet took money off the table before every major downturn in the market and he is doing it again now.

As everyone wonders what the pin for the bubble might be, Buffett and other value-focused investors are not waiting for the inevitable downturn. They are doing something about it now, and it’s called rebalancing.

In fact, there are signs that major Australian investors are already rebalancing, too. Even though the ASX has been surging, CBA shares have fallen 10 per cent over the past five trading days. There could be several factors behind this sell-off, but investors rotating out of shares will definitely be one reason.

Selling out of shares when you feel you should be buying is never easy. It takes discipline.

Speaking on The Australian’s The Money Puzzle podcast this week, investment adviser Doug Turek says investors have never been so exposed to the sharemarket.

“And it’s kind of been a good strategy, a lucky strategy, not to have been a disciplined re-balancer in the last few years, because rebalancing is taking profits off the table and parking them in the underperforming assets,” Turek says.

“And just riding up this return would have done well. But when you have a downturn, you’ll be very grateful you took some profits and put them elsewhere.”

Sharemarket records are all well and good, but the best investors sell at the top and buy at the bottom. In this market, there are now clear signs that smart investors are making their first moves to rebalance by selling bank stocks.

Buffett is clearing out of US bank stocks such as Citigroup and Bank Of America.

On the domestic market, major players are shifting major money out of CBA.

It’s not necessarily take the money and run, it’s more take the money and park it somewhere smarter than an overheated sharemarket.