“You’ve got to know when to hold ‘em. Know when to fold ‘em. Know when to walk away. Know when to run.” — Kenny Rogers, country music singer
“Go on take the money and run.” — The Steve Miller Band, American rock band
Risks around stocks have risen considerably, and even long term investors should now substantially underweight equity exposure. Due to the unique characteristics of this stock market, my best advice is to now treat it as if in the onset of a bear market, regardless of near term price action. At this point in 2014 many warning signs are flashing red—the bond market is signaling weakening growth and greater risk of default, while stock market breadth has deteriorated with many stocks, including small cap and foreign indices, exhibiting extended weakness, while fewer, very large stocks were supporting the market until the recent sell off. The risk versus reward of stock exposure has become too high for an even normal stock allocation, let alone the aggressive allocation most currently posses. It’s time to under weight stocks by taking money out of the market or hedging equity exposure with relation to key technical levels.
The financial markets at the start of 2013 remind me of a giant game of Jenga, where players build a tower out of wooden blocks and then take turns pulling out blocks until the increasingly unstable structure eventually collapses. Today, the stock market is climbing towards new highs on a foundation of cheap money that is anything, but stable. Unfortunately, all that cheap money means investors have little choice, but to play this game. The term of the moment to explain the recent rally in the stock market is “moving out on the risk curve.” As central banks have embarked on a new round of money creation to purchase bonds and push yields down, investors are being driven into selling bonds and CDs to buy riskier stocks. Participating in the stock market rally has become one of the only viable options for investors to keep up with inflation, as central bankers try to force money to flow into more risky investments associated in their minds with driving economic growth. In the process the government is doing retirees no favors.
In my August post I recommended investors do nothing in terms of stocks. In my view as we end the year, stocks still represent a good value in terms of dividend yields versus bonds, and an investment portfolio should hold a healthy portion of stocks. The S&P 500 index of large cap U.S. stocks is yielding more than ten year Treasuries. So despite the volatility I didn’t argue for selling, but neither did I argue for aggressively adding to stock positions given legitimate concerns about European debt issues. I found it worrisome that the earlier stock rally had broken down, and plausible that a volatile stock market could move any direction—higher, lower or sideways. And for the year it basically did move sideways. But the value and lack of good investment alternatives in my mind argued for doing nothing and holding onto positions.
Prospects are excellent for a positive year in the stock market in 2011. Odds are good also for that strength to carry over into 2012, although it’s a bit early to prognosticate on next year. This bull market is still relatively young and should have further to run. Although I am no fan of the accommodative monetary policy of the Federal Reserve believing it led to the housing bubble and is fueling rises in commodity prices today, I am also quick to admit that in the near term it is a positive for the stock market. “Don’t Fight the Fed” is a popular saying among investors for good reason. The economy is growing, stock prices are rising and these trends will likely continue for a time.
In hindsight it’s ironic that the economy of the nineties was described as the Goldilocks economy—not too hot, not too cold, but just right for high employment and strong growth. Ironic, because the real moral of the story people should have heeded is that there is no free lunch. And, like in the Goldilocks’ fairy tale, three unfriendly bears emerged. If the nineties was the Goldilocks economy then the period we now find ourselves in of both weak growth and employment might best be described as the three bears economy. Since 2000 there was the baby bear of the dotcom bubble, the mamma bear of the residential real estate bubble and the daddy bear of the government debt bubble—corporate, consumer and now government-led bubbles of unproductive and hence unsustainable spending.