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Every day, financial news sites and channels provide a steady stream of conflicting opinions and predictions that often leave investors feeling confused, frustrated, and paralyzed. Don’t believe me? Please allow me to elaborate.
In addition to reading a wide range of investing and personal finance pieces each day, in the evening I often browse a site called RealClearMarkets.com to make sure I take a look at some of the interesting and/or important articles I might have missed during the day. RealClearMarkets.com is basically a consolidator of articles from a number of other sources. You might want to take a look at it just so you can see what I mean.
When I review the list of approximately 50 headlines, I always find it interesting to see how many compelling yet contradictory articles and videos are in one spot, one right after another. It’s common to see one claiming one view, with another of the exact opposite view right below it. China is imploding/China is still a sleeping giant, Gold is headed much lower/Gold will touch new highs by the end of the year, The stock market is about to re-visit the lows of 2008/The stock market is pausing before reaching new highs by year end, Stick with large cap U.S. stocks/America’s best days are behind us and one should look abroad for better investing opportunities, A bond catastrophe is upon us/Don’t believe the bond bust hype, Inflation is about to run rampant/Deflation is the new worry, Emerging market stocks and bonds are to be avoided at all costs/The long term secular growth story of the emerging markets is still very much intact. Good grief! What’s an investor to do?
We’ll continue to see these contradictions, but one does not need to feel paralyzed by them or compelled to decide which one is the better path to follow. The truth is that they all have elements of truth and quite often are written by some very bright people. This month marks my 27th year in this business, and I have seen investors get caught up wrestling with these contradictions in each and every one of those years. Please let me offer an alternative.
Rather than struggling to decide if this is the right or wrong time to hold stocks or bonds in your portfolio, or which types of each to hold, how about always holding a portion in stocks and a portion in bonds, along with an adequate cash reserve for emergencies or opportunities that may arise? Of the portion devoted to stocks, hold U.S. and foreign (including emerging markets), small and large cap, growth and value, and also some REITs (both foreign and domestic). Of the portion destined for bonds, hold those of the highest credit quality (which tend to hold up relatively well when the stock market severely declines), and those with short- to intermediate-term maturities (which have lower interest rate risk in a rising rate environment).
With regard to cash reserves, the rule of thumb in the financial planning community is to maintain enough to cover 6 to 12 months of living expenses, depending on your situation, but often these targets tend to be on the low side. My experience has been that during periods of severe market or personal financial stress, nothing provides peace of mind like cash. Nobody ever complains about having too much cash on hand during these times. And when opportunity knocks, it’s nice to have plenty of cash on hand to take full advantage. Even when yields are as low as they are now, cash is king. The purpose of your investment portfolio is to deliver returns in excess of inflation over time. Cash is for liquidity, flexibility, and peace of mind.
The appropriate mix of these various asset classes, of course, depends on your individual circumstances and objectives. A big part of my job as an investment advisor is to help clients establish and maintain this mix in the face of unrelenting alarmist news headlines.
If all this advice sounds like nothing more than common sense and things we’ve all heard before, you’re right. But interestingly enough, many people tend to get caught up in all the predictions and hype out there, and they tend to ignore or forget these time-tested principles. As Paul Merriman once said, “There is a Grand Canyon of difference between what people know they should do and what they do.”
If you are tired of feeling confused, paralyzed, and frustrated and would like to jump off the financial news treadmill, I invite you to contact us. If you are not quite there yet, I wish you luck and a quiet mind as you continue down your path. We’ll be here when you need us.
Bear markets can get ugly. Unfortunately they will, just as they have in the past, continue to plague the markets. You can prepare for their arrival and understand how your investment plan dictates navigating through them. The hard cold facts of bear market history provide direction.
For those unfamiliar with the term, a bear market is not a simple market correction, which is more benign and happens with greater frequency. It’s a peak to trough loss of more than 20% in the broad equity markets. In total there have been 13 bear markets since the end of the Second World War. That is one every five years or so.
Here is the promising part: In May of 1946 the S&P 500 was at 19.3, and at the end of March, 2013 it was at 1570. In total, over 81 times higher than where it started 67 years ago. And, this number excludes dividends, which historically make up around 40% of the total return.
So the question is not of avoidance, but one of preparation and acceptance. Accept that in the next 30 years we can expect to experience several bear markets. Embrace the fact that they will be temporary setbacks to a long-term trend of rising prices. Finally, prepare a plan that fits your unique set of circumstances.
For investors in the accumulation phase, take advantage of bear markets. Fight the inclination to sell investments in fear and do what you would do at any other sale – buy more stocks at their newly discounted prices.
For those in retirement, formulate a flexible income plan. Include a cash cushion in this plan that allows your portfolio to stay dormant during the tough times and to thrive as the stock markets resume their long-term ascent. Most importantly, do not let a temporary setback ruin your long term plan. And remember that over time, equities are the best hedge for inflation, which is so important for the long-term viability of your portfolio. Life expectancies are increasing and fixed-income investments (aka bonds) are just that, fixed.
There is always going to be some perma-bear forecasting the death of equities and a market optimist predicting a new era of exponential returns. Neither of them knows the specifics of your retirement plan and they rarely understand that “this time” is never different. Do not get enamored of prognostications based upon remote possibilities. Rather, work with your advisor to build a plan around the historical probabilities of the markets and your unique retirement needs.
As the S&P 500 reaches new highs, it is interesting to think about the volume of bad news we have faced over the bull market of the past 4 years. We were subjected to what seemed to be an epidemic of economic challenges, from the fear that Troubled Asset Relief Program (TARP) would lead to runaway inflation, to the debt ceiling debate and the “fiscal cliff” we were sure to tumble over at the beginning of the year. There was news of more global concerns over the world, with new challenges faced in feeding and providing fresh water for the ever growing global population, which now exceeds 7 billion people. There have been many headline stories building a case for a grim outlook of the future. It seems to me that the good news is usually more subtle and harder to find.
I recently picked up a copy of “Abundance – The Future Is Better Than You Think.” The authors, Peter Diamandis and Steven Kotler, make a case for optimism. They present a neurological reason for why we are more sensitive to bad news than we are at recognizing opportunity. Fear has served the human race well in many ways for many years; it activates our limbic system, which manages our “fight or flight” circuitry. Diamandis and Kotler then look at how we have solved problems of scarcity in the past, and examine amazing advances in science and engineering that are being made right now.
This book presents a different perspective than we are bombarded with in the daily news, and I think it’s worth reading. Diamandis and Kotler explore some very exciting new technologies that are making giant strides against some of the world’s biggest challenges, like scarcity in access to energy, clean water and good medical care.
“I’m not saying we don’t have our set of problems; we surely do. But ultimately, we knock them down” -Peter Diamandis.
Before finding the book, take a few minutes out of your day to listen to his inspirational and educational TED talk here.
There are many things in short supply, but uncertainty is not one of them. Three economists1 have compiled an index of uncertainty, which is comprised of newspaper coverage of policy-related uncertainty, expiring federal tax code provisions and disagreement among economic forecasters. You can see the trend in Figure 1 below. The index peaked with the debt ceiling imbroglio in late 2011, fell in the early part of 2012 and then rose again.
Throughout the year there has been a great deal of focus on a number of worrisome issues, including the U.S. deficit, debt ceiling and the fiscal cliff, high unemployment, and the European debt situation. Reflecting all this angst, investors through November withdrew a net $88.9 billion from actively-managed U.S. stock mutual funds (net of inflows into U.S. stock exchange-traded funds).2 Yet for 2012, stocks were up nicely.
How could stocks have gone up while uncertainty increased? While many people naturally worry about the past and still feel burned by previous sharp plunges in stock prices, the stock market is forward looking, incorporating the perceptions of millions of investors. While national economies are still relatively sluggish, actions taken by the U.S. and European central banks to combat economic weakness are having a positive impact.
Housing, while not rosy, is seeing some welcome improvements, with 6.9% of U.S. consumers planning to buy a house in the next six months, the most since August 1999.3 Confidence among U.S. homebuilders reached a 6 ½ year high in December.4 U.S. sales of previously occupied homes increased to their highest level in three years in November.5 And home prices rose 4.3% in the twelve months ending October 2012 in the S&P/Case-Shiller 20-City Composite.6
Another positive, with major longer-term implications, is the widespread development of hydraulic fracturing (or fracking, the process of extracting oil and natural gas from shale rock). The International Energy Agency projects the U.S. will become the largest global oil producer by around 2020, and a net oil exporter by around 2030.7 While there are important environmental issues associated with fracking, including potential contamination of local water supplies and massive use of water in the process, electricity produced by natural gas gives off 43% less carbon dioxide versus coal. Due to a combination of increased use of natural gas, the weak economy and more fuel-efficient cars, America’s emission of greenhouse gases has fallen to 1992 levels and is expected to continue to fall.8 So, like any energy source, there are costs and benefits. Cheaper energy will lead to more manufacturing being done in the U.S., which is good for the economy. One analyst estimates the U.S. will add three million new jobs by the end of this decade due to the natural gas industry.9
Waiting for that perfect time to invest when there is no uncertainty could lead to cash unproductively sitting on the sidelines. Investing only after good news also means buying stocks after they have gone up. A good example of this is the S&P 500 going up by 2.54% on January 2, the day after the fiscal cliff legislation passed. Another example is the MSCI EAFE index of developed countries in Europe, Australasia and the Far East, which increased 6.57% in the fourth quarter, reflecting the relative lack of bad news, and some stabilizing events, in Europe.
While uncertainty is an uncomfortable fact of life, it is easier to handle by following a well-formulated diversified investment plan that invests in stocks and bonds, the allocation to which incorporates your risk tolerance and long-term needs.1. Scott Baker, Nicholas Bloom and Steven J. Davis at www.PolicyUncertainty.com. 2. Wall Street Journal, “Investors Sour on Pro Stock Pickers”, 1/4/13.
From time to time, a piece of economic news will surface that leads people to question whether it is really a good time to be invested. The announcement of round 3 of quantitative easing (QE3) was one such news item that worried some of our clients (interestingly enough it added optimism to others), and it provided us at Merriman with a great opportunity to reiterate why we think making large changes to your investment portfolio based on economic news is a bad idea.
The evidence is overwhelming that markets are not predictable. If you had asked me for a reason to stay in the market in, say, 1999 or 2007 when economies looked extremely healthy, I could have given you a long list of reasons. But what followed each of those years was a sustained drop in stock prices. On the other hand, if you posed the same question in 2002 or at the end of 2008, there was hardly any good economic news to point to. And what followed? An incredible market rally that recouped market losses much faster than anyone expected. Selling and buying based on our read of the news has a high risk of whipsawing us in and out at the worst possible times.
There are always a host of positives and negatives weighing on the markets. It’s important to remember that economic news, and everyone’s expectations of its impact, is already factored into current market prices. We believe the academics’ argument that the sum of everyone’s expectations is far more accurate than the predictions of any one “guru.”
The risks of high levels of debt, uncertainty around upcoming tax changes (known as the “fiscal cliff”), and continued weakness in Europe may drive prices lower. While current trends, including a dramatically improving housing market and declining unemployment, may drive prices higher. We believe the best way to capture growth over time is to stay invested in a portfolio designed to satiate your appetite for growth while staying within your tolerance for risk, and rebalancing when your portfolio’s mix has materially changed.
If you feel like the risks have become overwhelming, there are some additional things you should consider before deciding to throw in the towel. You need to think ahead to your next move. What will you do after going to cash?
There is risk in not being invested in the markets: First and foremost, cash provides no defense against inflation. Your money may need to be defended against inflation for a long time, and cash does not provide a good defense. Beating inflation is one of the main reasons we advise people to stay invested through retirement.
If markets drop, when will you get back in? Each of the last two market rallies began well before any good news was to be found. Waiting for good news meant missing the bulk of the market gains. On the other hand, if there is a continued market rally after you sell – if markets grow faster than you expect – what will you do then? My experience is that it is very difficult for investors to get back in the market at higher prices; there tends to be a very real fear that the next challenge will cause a decline after having just missed an unexpected rise in values. We have found that over time, disciplined rebalancing has been a better way to buy lower and sell higher than “timing” based on your expectations of the future.
Our strategy is based on the academic philosophy that the future is unpredictable and our clients need to be able to stay the course through unexpected events and drops in the market in order to reap the benefits this strategy has to offer.
Simply being invested is not good enough; you have to be invested the right way. We feel that massive diversification with exposure to large and small companies in both U.S. and international markets, with a healthy allocation to bonds, is the best defense against a range of risks affecting your retirement portfolio.
If you’re ever feeling doubts about your investment strategy, I highly recommend speaking to your financial advisor right away. Rather than moving to cash, it may simply be time to re-evaluate your appetite for risk and returns. An adjustment to the percentage of your portfolio allocated to bonds may be enough to ease your mind.
In the meantime, here are some additional online resources you might find encouraging:
Liz Ann Sounders, Chief Investment Strategist at Charles Schwab published a piece in August that presents both the challenges facing the economy and the positive forces that are at play.
This piece from Marlena Lee’s presentation at the Institute of Advanced Financial Planners Annual Symposium in Vancouver presents research showing that even as the market continues to be volatile, history shows that equities are the best way for clients to earn the returns necessary to meet their goals.
During periods of significant volatility in the capital markets, investors can lose patience and/or perspective and draw the conclusion that long term risk/return dynamics no longer apply because somehow “it’s different this time.”
I’ve been in this business for over 25 years, and time and again I have seen investors come to this conclusion, making big portfolio shifts because of it, only to regret these decisions later.
I vividly recall conversations with folks in the 1980s who insisted that Asian stock funds should constitute the bulk of one’s portfolio since America was in decline and Asia was rising. In the1990s, it often was very difficult to have meaningful conversations about asset allocation and thorough diversification when so many genuinely felt that all they needed was a few technology stocks or technology stock funds. In 2008 and early 2009, few had the stomach to trim their nicely performing government bond funds and add to their stock funds during the worst stock market environment since 1932.
In each of these examples, the phrase ‘it’s different this time’ crept into many conversations. Obviously, none of the above decisions worked out well.
At Merriman, we’ve always maintained the portion of clients’ accounts invested in stocks at 50% US and 50% foreign. This has served our clients well for many years. We invest this way because the US represents less than 50% of the world stock market capitalization, and because maintaining this kind of allocation can serve to increase returns while lowering overall portfolio risk.
Lately, foreign stocks have been significantly underperforming US stocks, and this has been causing some people to ask if maintaining our desired 50/50 US/foreign split still makes sense. And once again, we are starting to hear the ‘it’s different this time’ comment again. It is human nature to think this way, but history would suggest that one should not make a big shift in allocation because of it, other than some routine portfolio rebalancing.
Keep this in mind: While it’s always a different set of circumstances driving the capital markets, rarely is it wise to conclude that a paradigm shift is at hand and make major portfolio shifts in response. As legendary investor Sir John Templeton used to say, “The four most dangerous words in investing are ‘it’s different this time.’”