Neil Woodford says we're in an investment bubble

When expert portfolio managers such as Neil Woodford speak, it's worth listening. And his latest update is definitely worth a read if you have a spare five minutes. The UK's most famous portfolio manager has a warning for investors - we are in a bubble.

Lights flashing red

In an article released earlier this week, Woodford explains that a decade on from the Global Financial Crisis, the "biggest monetary policy experiment in history" has resulted in "inflated asset prices and inflated valuations." He says investors have forgotten about risk.

Woodford points to Bitcoin trading above $10,000, the low levels of volatility in the market, and the large inflows into smart beta ETFs, commenting: "There are so many lights flashing red I am losing count."

The stretch between value stocks and growth stocks is also of significant concern to the fund manager. He believes the difference between the performance of value stocks and growth stocks today, is "greater than at any stage in stock market history."

Woodford points out that a consistent feature of bubbles is that there is always an area of the market which falls out of favour. He believes that domestically-focused UK stocks are a good example of this at present, and that his funds are well positioned to capitalise when the bubble bursts, which it "inevitably will."

Is Woodford right?

While Woodford's performance this year has been poor, the fund manager has a track record of getting big investment calls right. He avoided the dotcom boom, preferring to invest in unloved 'old economy' stocks such as the tobacco giants at the time. He outperformed the market when that bubble burst. Similarly, he avoided banks in the lead up to the GFC.

I believe his latest concerns are valid. While UK equities don't look excessively overvalued in my view, many other asset classes do.

For example, looking at US equities, the FAANG stocks (Amazon.com, Facebook etc) have all surged considerably higher this year. Many are trading at eye-watering multiples. Meanwhile, top-tier executives such as Mark Zuckerberg and Jeff Bezos are offloading stock like no tomorrow. Executives don't sell at the bottom of the market. A correction may not be far off.

Cryptocurrencies such as Bitcoin also look to be in a bubble, in my opinion. I wrote about Bitcoin last week when it was trading at $10,000. Now, it's at $12,000. That kind of fast-paced gain just reaffirms my view.

What should investors do?

In the current environment, there are several things you can do to protect yourself. The key is to act now, before it's too late.

First, examine your portfolio. Have big gains affected your asset allocation? Do certain stocks or assets now make up a significant proportion of your wealth? If the answer is yes, consider rebalancing your portfolio.

Second, think about taking some profits. Are you sitting on large paper profits from investments that have performed well? If yes, don't be afraid to bank a little profit. As they say, "no one ever went broke taking a profit."

Lastly, be prepared for market volatility. This means having some cash on the sidelines ready to deploy if markets experience a correction. Market volatility is only a bad thing if you're unprepared. If you have capital in reserve when share prices are falling, it can present fantastic investment opportunities.

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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. The Motley Fool UK owns shares of and has recommended Amazon and Facebook. 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.

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