Article Contributed by Thomas Chavez of Alternative Capital Advisors
According to PIMCO’s co-founder, and co-chief investment officer, Bill Gross, stock investors should reconsider the age old “buy and hold” investing mantra, because “consistent annual returns are a thing of the past.” This advice might be a tough sell to legions of investors who have ardently followed conventional wisdom for decades, and reaped huge returns. With stocks still hovering near record highs, why should anyone pay heed to the sage advice offered by one of the world’s most successful fund managers?
Another Liquidity Fueled Bubble or Confidence Inspiring Bull Market Driven by Organic Economic Growth?
Since the stock market bottomed in March, 2009, the S&P 500 has gained more than 170% through December 31, 2013, placing it 5th among bull markets over the past eight decades. And while most investors are delighted by the stock markets remarkable performance, many are perplexed by the apparent disconnect between stock prices, and underlying economic fundamentals.
Even as stocks have soared, many Americans are struggling through the worst post-recession recovery in U.S. history. Traditional economic metrics, such as employment, housing, sales revenue, and GDP growth rates have been anemic, and a record 47 million Americans are now receiving food stamps. These fundamentals paint a more sobering picture of the current state of the U.S economy than do stock prices.
So, how does an investor reconcile the relentless charge higher in stock prices against the backdrop of a sluggish economy……with falling wages, and the labor force participation rate at the lowest level since 1978?
The answer is that stocks today are driven more by monetary and fiscal policy than organic, fundamental, economic growth.
In November 2008, with stocks plummeting, the global economy collapsing, and short-term interest rates already reduced to ZERO, the U.S Federal Reserve Bank (The Fed) embarked on a new, and unprecedented monetary experiment……printing money out of thin air to purchase junk assets, Mortgage Backed Securities (MBS), and U.S. Treasuries, among other things. They came up with a very sophisticated name for this program….calling it Quantitative Easing, or QE.
At the beginning of 2013, the Fed announced QE 4, which raised the rate of asset purchases to $85 BILLION PER MONTH, or $1.020 TRILLION annually.
By the end of 2013, with a staggering $4 TRILLION on its balance sheet, the Fed announced that it would begin to “TAPER” asset purchases by $10 BILLION, to $75 BILLION per month, or $900 BILLION annually.
Since QE began, risk assets, such as stocks, have benefited greatly from the trillions in stimulus, but the overall economy has not performed nearly as well.
Now, with the Fed attempting to slowly normalize monetary policy, there are a number of important questions that investors should ask:
Can the U.S. economy continue to show positive growth?
Will the meteoric rise in stocks come to an end?
Can real estate prices continue to rise without the benefit of trillions in Fed stimulus?
Can the Fed navigate the end of QE without a significant disruption to the economy or financial markets?
The answer is that nobody is quite sure how this will end, but what we do know is that that the Fed’s exit from QE will be complicated and fraught with risk for investors.
Rapid normalization, such as occurred in 1994, could crash asset markets, and risk a hard economic landing. On the flip side, no exit…or exiting too slowly, will create yet another asset bubble, which will ultimately burst, and crash the financial system.
As Ben Bernanke’s reign at the Fed ends to a chorus of extravagant praise, it’s worth noting that the same type of praise was heaped upon Alan Greenspan, “The Maestro” at the end of his 20 year term at the Fed. A mere two years after his departure, views of the Greenspan monetary era were very different, as the credit boom he did so much to create turned into a mania, which turned to panic, and ultimately became the financial collapse the world is now struggling to overcome.
Sometimes a Picture Is Worth a Thousand Words.
The charts below provide an historical snapshot of the risks investors should evaluate before making strategic adjustments to their portfolio.
Chart 1= 30 Year Treasury Bonds: After a bull market spanning nearly 3 decades, is now the right time to buy and hold treasury bonds? In which direction are long-term rates headed next?
Chart 2 = 13 Week U.S. Treasury Notes (Yield): Short-term rates have fallen near ZERO. Sooner or later, short-term rates will rise. They certainly can’t move any lower.
Chart 3 = S&P 500: On December 31, 2013, the S&P 500 touched an all-time high of 1849.44, up more than 170% from the March 2009 low of 666.79. Is this yet another bubble driven by the Fed’s easy money policies, or does the market reflect strong economic fundamentals? In the absence of QE can stock prices remain at these lofty levels?
Re-balanced Your Portfolio Lately?
When was the last time you addressed this prudent strategy? Many investors only consider this practice after a sharp market decline. However, re-balancing should occur in times of both over or under performance in any asset class.
One view of recent events is that the stock market will continue to show positive returns year after year ad infinitum. Another view is that markets are generally not well behaved and do not generate consistent, steady returns year after year.
Are stocks overvalued and due for a major correction? No one is absolutely certain, but there are a host of reasons to watch this unprecedented run-up in the global equity markets with caution. Among them are, the Fed’s move to normalize monetary policy, slowing growth in China, and the recent turmoil in emerging economies.
Therefore, now may be an opportune time to re-balance your investment portfolio. Re-balancing is primarily about risk control; making sure your portfolio isn’t dependent on the success or failure of one investment, asset class or style.
Modern portfolio theory suggests that adding alternative investments, such as managed futures, can reduce portfolio risk and enhance returns. This simple allocation adjustment could help to improve your overall long-term results.
If you feel that now is a good time to reassess your investment strategy, please feel free to contact us.
Alternative Capital Advisors provides clients with educational resources and quality alternative investment solutions to help them achieve optimal portfolio diversification.
Contact us directly at (888) 525-8227 or through email at [email protected]