Hopium (noun): A fictional narcotic that enables investment traders to cling to wishful thinking despite evidence to the contrary.

Wall Street rose today, on renewed hopes that the U.S. and China would reach reconciliation on trade. The Dow Jones Industrial Average, the S&P 500, and the tech-heavy Nasdaq all closed in the green. But the fundamental dangers that bedevil this market haven’t simply vanished.

Investors today seized on reports that the U.S. and China are restarting tariff talks. However, just because a meeting has been tentatively scheduled for later this month doesn’t mean anything will come of it.

We’ve repeatedly seen such overtures collapse. It seems to me that investors have been hitting the “hopium” pipe. Meanwhile, we’re witnessing a bubble with uncomfortable historical parallels.

During the go-go Eighties, President Reagan was eliminating regulations. He was cutting taxes. Wall Street’s animal spirits were racing. The bull market seemed boundless. Sounds familiar, right?

It all came crashing down on “Black Monday,” October 19, 1987. In a single day, the Dow plunged 23%.

At the time, I was an analyst at Venture magazine, a financial publication in midtown Manhattan. Married with a three-year-old daughter, I was struggling to make ends meet in the most expensive city on earth.

I got the bad news, right before Christmas.

One December morning, about two months after the crash, the publisher hastily called a staff meeting and announced: “The magazine is broke.”

The crash had decimated ad revenue; Venture soon went bankrupt. Not only was I unemployed, but my portfolio had gotten crushed by the market collapse.

I eventually got a new job. But it took me several years to rebuild my portfolio. I learned a valuable lesson: always have a portfolio protection plan in place.

How would YOU fare in a market crash? You’d better have a plan.

The “story stocks” that currently garner gushing praise on CNBC aren’t immune from a downturn. In fact, they’ll probably serve as the catalysts.

Consider the five-stock “FAANG” coterie — Facebook (NSDQ: FB), Apple (NSDQ: AAPL), Amazon (NSDQ: AMZN), Netflix (NSDQ: NFLX), and Google parent Alphabet (NSDQ: GOOGL).

FAANG drove the stock market’s first half gain in 2018. As the second half unfolds, “long FAANG” remains the most crowded trade on Wall Street. However, the recent sell-off in Chinese Internet stocks is a wake-up call.

Last Wednesday, Tencent Holdings (OTC: TCEHY) posted its first earnings drop in 13 years. Shares in Tencent are down by roughly a third from their record high close in January.

Chinese Internet stocks Baidu (NSDQ: BIDU) and Alibaba (NYSE: BABA) also have declined in recent days, amid concerns of slowing Chinese growth. Even Silicon Valley darlings Netflix and Facebook have swooned, after posting weak operating results.

Live by FAANG, die by FAANG…

The S&P 500 has largely recovered from its 11% correction in February 2018, but the climb back has been choppy.

As the breadth of the market narrows, the leadership groups get smaller. When the leaders start to falter, the rest of the market tends to follow.

Today’s risks mirror those leading up to the dot.com bust of 2000, when wonderment at gee-whiz technology was clouding judgment and pushing valuations off the charts. As we’re seeing again today, investors were making absurdly optimistic growth assumptions.

Facebook’s 20% plunge on “Black Thursday,” July 26, could be a harbinger of more bloodletting to come. FB went south after management issued nightmare guidance, wiping out $120 billion in market value in one day.

Another red flag: the rapid growth of exchange-traded funds (ETFs) has occurred in tandem with the market rally that began about nine years ago.

Many investors have never gotten a serious chance to see how ETFs function on the downside. Robo-trading would likely accelerate losses.

The overweighting in ETFs of market stars like FAANG, a demand which has boosted their prices, could exert intense selling pressure on these stocks during a decline.

During the February plunge, tech stocks got hit the worst (see chart, compiled with data from Statista):

During my adult career, I’ve witnessed iconic brand names completely vanish, including E.F. Hutton, PaineWebber, Arthur Andersen, General Foods, Compaq, MCI WorldCom, Enron, Bear Stearns, TWA, Pan Am, and Eastern Airlines.

Nothing is guaranteed to last forever, even the market dominance of FAANG.

Consider this: General Motors (NYSE: GM) sports a market capitalization of $51.3 billion. Facebook’s market cap is nearly 10 times larger, at $501.7 billion. GM is the world’s third-largest carmaker. Facebook makes, well, nothing.

My advice is to pocket partial gains from your growth stock winners, especially large-cap tech stocks. Transition toward reasonably valued stocks that do well in the late stages of an economic recovery.

As the recovery matures, the energy and materials sectors, whose prospects are closely tied to the prices of raw materials, tend to outperformed as inflation builds and the late-cycle economic expansion sustains demand. Indeed, energy and materials stocks led gainers today.

The time to protect your portfolio from herd-like panic is ahead of time. Take it from a guy who learned the hard way.

Monday Market Wrap

• DJIA: 25,758.69 +89.37 (0.35%)
  
• S&P 500: 2,857.05 +6.92 (0.24%)
  
• Nasdaq: 7,821.01 +4.68 (0.06%)
  

Monday’s Big Gainers

• Cheetah Mobile (NYSE: CMCM) +22.64%

Mobile Internet firm posts strong earnings.

• Amneal Phamaceuticals (NYSE: AMRX) +12.87%

Bioetch announces licensing agreement.

• Huami (NYSE: HMI) +7.92%

Wearable device maker beats on earnings and revenue.

Monday’s Big Decliners

• Lannett (NYSE: LCI) -60.56%

Generic drug maker loses big distribution deal.

• Cardlytics (NSDQ: CDLX) -10.62%

Digital marketer’s revenue growth lags.

• Rimini Street (NSDQ: RMNI) -6.64%

Enterprise software developer loses copyright dispute.

Letters to the Editor

“Do you see a correction ahead? If so, when will it occur?” —James K.

Trying to precisely time the market is a fool’s game. But as I’ve just explained, the FAANG stocks face a reckoning, which would drag down the broader market. Investors should elevate cash levels and shift allocations from momentum to value stocks.

Questions about FAANG? Drop me a line: mailbag@investingdaily.com

John Persinos is the managing editor of Investing Daily