Woman Around Town’s Editor Charlene Giannetti and writers for the website talk with the women and men making news in New York, Washington, D.C., and other cities around the world. Thanks to Ian Herman for his wonderful piano introduction.
You would have to reside on Pluto not to notice the buckets of ink spent on warning investors that Armageddon looms as the stock market edges higher. It may well be that the market will correct—markets generally do at some point—but that doesn’t preclude profiting in the long run by adhering to solid investment principles.
What’s driving the stock market’s momentum? No matter which side of the political aisle an investor is on, few can dispute that the business climate has improved dramatically. Cutting the stranglehold of regulation has helped. In the aftermath of the Great Recession, legislators eager to ensure another one didn’t happen soon rushed to correct a financial services operating landscape that was fraught with abuse. Although their intentions were laudable, the execution, in terms of hoops companies where forced to jump through to comply with the rules, were time consuming and expensive. For example, employees who had no access to sensitive customer data often were forced to sit through training programs, periodic reviews, and be tested on protecting that data. A couple of hours out of a day, compounded by several training sessions a year, starts to adds up in lost productivity. More examples abound, all of which incur extra costs in hiring compliance personnel to enforce them. As some of the regulation was rolled back, savings have accrued to companies’ bottom line.
Prospects for passage of a tax bill have also helped buoy investors’ expectations for a stronger business environment. We the people pay for high corporate taxes, in terms of lower wages for workers, higher prices on the goods we purchase, and lower after-tax returns for investors, as a recent article in the Wall Street Journal points out. Although some may argue that the proposed tax bill benefits the wealthy to the detriment of the middle class, few can rebut the argument that higher wages that corporations can pay as a result of lower taxes will harm anyone.
Finally, inflation remains low, barely touching the Federal Reserve’s stated target of 2%. That means interest rate increases (barring an unforeseen geopolitical or domestic situation that could make them spike) will be modest and gradual for the near term. And because rates are low, investors have few options for investing, other than the stock market.
So, even though the stock market is high, it may have good reason, and at the top of the list are investors’ expectations that a better business outlook may make it continue. But that doesn’t mean there isn’t risk. Investing always carries risk, and the savvy investor knows how to mitigate it. So let’s review some solid investing principles that can help protect a portfolio and assuage concern about potential loss.
Diversify
Crafting a portfolio with non-correlated asset classes is a key to long-term investment success. Various investment styles perform differently. Examples: small cap stocks often benefit when the economy is coming out of recession; dividend-paying stocks are an alternative to bonds that pay low interest rates. So a mix of assets, each performing differently depending on economic conditions, is a good strategy over time. Yes, there have been times when all asset classes fell (i.e., during the Great Recession), but investors who stayed the course not only recouped their losses but went on to participate in the market’s surge.
Don’t try to time the market
It’s tough to do it, and it can be a fool’s game. That’s because the investor has to make two decisions: when to get out and when to get back in. The annals of investing are replete with examples of investors who thought the market topped, sold out, only to watch it hit a new high, meaning buying back in cost them more. Although taking profits is never a bad thing, it gets expensive to buy back in when the market is moving up. Selling high and buying high is not a good formula.
Remember that stocks outperform over time
But the operative word is time. Investment returns seldom go in a straight line, and there will be periods when equities lose money, such as when a ‘flight to quality’ draws investors to the certainty of the fixed income market during periods of market duress. But those periods tend to be short, which is why it’s vital to rebalance a portfolio on an annual basis.
Have patience: What goes up goes down, and then back up (usually)
Investors who withstood October 19, 1987 saw their portfolios plush again a few months later. After the Great Recession in 2008-2009, it took a little longer, but the reward was higher. When the stock market begins to drop, many run for the exit, thus locking in losses that a bit of patience could have turned to profits. When panic sets in, its human nature to follow the herd, but that’s precisely when investors should exercise restraint. A portfolio comprising good companies with solid earnings will right itself in time.
Understand risk
A good rule of thumb is to contemplate a market drop of 20%. An investor who can weather that kind of loss for however it takes for the market to right itself is vastly different from one who shudders when the market brooks a triple-digit loss (even though that loss equates to just 1%). When a sell-off occurs, no one knows how deep it will become or how long it will last. It takes fortitude to stay invested. Those who aren’t comfortable in a volatile environment may be better off having a larger fixed income allocation, even though interest rates are low. At least their money will be there, and that can be a big source of comfort.
Keep some powder dry
Investors with cash at the ready can buy good companies on sale during a market correction. So although it’s a good idea to stay invested, a 5% – 10% allocation to cash means having some buying power. If the market were to drop by 15% – 20%, that’s an automatic 15% – 20% profit for investors who have the wherewithal to act, assuming the market turns around and reaches its previous high. Most times it does, and moves up even further.
In summary, the stock market is at a record high. In times past, “irrational exuberance”—to coin Alan Greenspan’s prophetic phrase—has been a precursor to a correction. And 2008’s market freefall began the worst recession most investors can recall. But investing is a function of understanding where opportunities lie and selecting among the choices available. The safety of fixed income may be where some investors feel most comfortable, and so long as they can live with low returns, that may be the answer for them, based on their circumstances and goals. For others who can accept the risk that investing in stocks entails, a strategy of diversification, exercising patience, and keeping some cash on hand to take advantage of a correction may be their answer.
*This article is meant as entertainment and is not to be considered investment advice. Consult your accountant or investment advisor before making any investment decisions.
As the stock market has recovered from its February 11 low (and posted a modest gain), many of us wonder what lies ahead. Given the Federal Reserve’s recent decision not to hike interest rates now, low-risk investors are looking elsewhere for return, and many are questioning whether the stock market is their only option.
At a recent economic forecast presentation hosted by Denver-based AMG National Trust Bank, insights were offered that could be a guideline. Themed, “growth with a speed bump”, the speakers were careful to point out both the positives and negatives that may be in store. On the plus side, consumer spending, which accounts for around 67% of our country’s Gross Domestic Product (GDP), looks to be running in the range of 3%. Add to that figures for rising home prices, low energy costs, an improved labor market, and expectations for GDP growth ranging from 1.5% to 3.2%. (Although that figure may be a tad optimistic: Other analysts put it at 2%-2.5%).
On the other side of the ledger is declining business investment, particularly capital spending in the energy industry, which has seen sharp declines. A few other risks could cloud the picture: high domestic inventories, an increase in foreign imports, and weakening credit standards. High inventories mean that businesses won’t produce goods while they are drawing down inventories. Increased foreign imports mean we are buying more from other countries than from our own US manufacturing base. Deteriorating credit standards are reflected in troubled real estate and construction loans, which may compress banks’ interest income and margins. These things combined make for a somewhat murky outlook.
The credit picture is further complicated by high-yield debt, currently yielding around 7%. Although improved from the higher rates seen in December and January (primarily because of an improving picture for oil prices that caused those bonds to rally), the spread between these rates and the risk-free rate of the US 10-Year Treasury remains fairly wide compared to a couple of years ago.
So what does this mean for investors? First, valuations for stocks are high: A current price/earnings ratio of 17 (versus the long-term average of 15) for our stock market suggests that it may be tough for the market to have a significant rise. According to another analyst, Vinny Catalano, President of Blue Marble Research, either interest rates need to drop or earnings have to accelerate for stocks to rise much more. Interest rates can’t drop much (they are already low: just .50%), and first quarter earnings for 2016 are expected to decline by more than -7% over last year, and fall another -2% for the second quarter versus a year ago, before turning positive for the third and fourth quarters. These forecasts amount to a projected overall increase of a mere 1.49% for the year. Not exactly a rosy scenario.
But the outlook for European stocks may be better, given their lower market valuations. The European Central Bank (ECB) also recently expanded (and extended) its quantitative easing program, by which it will purchase more bonds, thereby putting more money in circulation. The ECB also introduced negative interest rates (that encourage savers to spend), and the Eurozone is enjoying a strengthening currency.
The outlook for oil is not clear. Although its price peaked at $41 per barrel before retreating slightly to around $39, it still represents around a 50% increase from the $26-per-barrel low reached in February. As a commodity, oil prices are determined by supply and demand, and several factors have affected both sides of the equation. Demand from emerging markets (China, among others), has contracted, and at the same time, we have more supply from US oil producers. As low prices prompted domestic producers to cut back production, Saudi Arabia and other global producers continued to pump to preserve their market share. In addition, now that we have an agreement with them to remove sanctions in return for their adopting a more acceptable nuclear policy, Iran is now a factor, and is expected to add substantially to the supply. Given these facts, oil may trade between $40 and $60 per barrel—higher than the rock-bottom low we saw earlier this year, but still a far cry from the $82-per- barrel-price of 2014.
For the time being, talk of recession seems muted, given the improving economic data and how well the stock market is performing. But economists do draw some interesting parallels. According to their findings, recessions that occurred during a bear market (defined as a drop of 20% or more), typically lasted 500 days. Contrast that scenario with historical trends for recessions that occur outside a bear market lasting around 136 days.
So how can we use this data to our advantage? Most professional investors view market timing to be a fool’s game, because it demands making two correct decisions: when to sell out, and when to buy back in. A more prudent stance is to have a well-diversified portfolio that is in line with your comfort level with risk. In the short term, it is tough to get meaningful return in bonds, as the US 10-Year Treasury yields under 2%, and once interest rates begin to rise, capital will be risk (as bonds with higher rates are more attractive to an investor). That reality has spawned much ink in the financial press about how standard equity/fixed income asset allocations for conservative investors and retirees may be passé´. It has also pushed many investors to invest in the stock market without adequately understanding, much less being comfortable with, the added risk.
Risk has many connotations, among which are the degree to which you can “sleep at night”; the likelihood that your portfolio will lose value; and the possibility that you may need to make withdrawals to cover retirement living expenses at a time when the market is in decline. Depending on the severity of the decline, you may have insufficient time for your portfolio to recover, meaning your assets could be substantially depleted while you still need income. That degree of equity exposure may be uncharted territory for you, and you should understand the risk. One study showed disastrous results for a portfolio that was invested entirely in stocks for the 15-year period 2000-2015.
Building a portfolio with a mix of different types of equities, including those in international developed countries, along with some exposure to bonds for stability, may be a more acceptable strategy. Stocks with dividends are one option, as typically—but not always—dividend-paying stocks do not suffer as much during a market selloff. Another option is to select a balanced fund with a mix of both equities and bonds. Although investors generally purchase bonds for their income characteristics, fixed income investments also stabilize a portfolio, as the underlying capital is a loan to the corporate issuer. An issuer with solid credit is unlikely to default on the obligation. Having bonds in your portfolio will help preserve your capital should the market suffer a decline.
You also should realize that in an election year, fiscal policy and market behavior can have an impact on how your portfolio performs. When election campaign rhetoric is leading the charge, the outcome may be beyond your control. But you can control how you react, and having a properly diversified portfolio is one way to counter the chaos.
The recent decision by the Federal Open Market Committee (FOMC) to leave interest rates unchanged flummoxed many analysts and investors alike. Even more puzzling was the decision to change the expectation from four rate hikes to only two for the balance of 2016. Core inflation is the Fed’s driver for continuing its gradual glide path for normalizing rates, and it has stated that it wants to see inflation at the 2% range before raising rates again. It is. Core Inflation in February rose to 2.3% on an annual basis. As one writer punned in MarketWatch, core inflation causes many of us angst, since it strips out the costs of food and energy. But most readers will attest that food has soared, and although energy is well below the highs of recent years, oil prices have risen more than 38% off their February 11 low, and drivers are paying higher prices at the pump.
Even without food and energy in the equation, most people agree that prices are rising—and doing so much more rapidly than a Core Inflation year-over-year rate of 2.3% suggests. My own anecdotal evidence: medical premiums rose 18%, dry cleaning climbed 12%, my cell phone bill spiked 16%, and professional dues went up 10% in the last 6 months alone. To be fair, dues at my private club were raised a mere 3%, but it was still more than the core inflation rate.
The Fed’s theory is that declining unemployment will eventually cause wages to rise and propel consumers to spend. That’s what’s supposed to happen in a robust economy. But, it hasn’t played out that way—at least not yet. First, much ink has been expended on the real unemployment picture. The labor participation rate has hovered around 63% since 2012 (it was over 66% in 2006, prior to the Great Recession). Another piece of anecdotal evidence: a colleague who has been consulting in financial services marketing for five years (while looking for a full-time gig) was just told that the position he applied for, and for which his stellar credentials qualify him, isn’t going to him: The company wants to hire someone who is already employed. That is why my colleague, and countless others who’d like to be working, can’t find a job. Will further declines in unemployment change that picture?
So, if the Fed’s decision hinges on inflation (which already is above 2%), then there must be another reason for holding off on normalizing interest rates. Could it be that the economy is still sputtering? The devil is in the details—and the data. Retail sales were off by -.1%, on the back of a -4% drop in January, which was revised downward from a positive .2%.
The Fed had plenty of data to act. They should have. One economist friend, responding to the question of whether the Fed would make a move, quipped, “The idiots should, but they won’t.”
