4/8/2014 7:30 PM ET|
4 reasons to brace for more volatility
The last five years have been anything but typical for stocks. Here are 4 factors that point to a bumpier market ahead, and 4 ways investors can prepare for it.
It's hard to believe, but the bull market is now five years old. From the lows in March 2009, the Standard & Poor's 500 Index ($INX) has advanced over 180 percent in what is now one of the longest and strongest bull markets in history.
Given this extraordinary advance, it is tempting for investors to rest on their laurels, expecting more of the same going forward. However, I would caution against such complacency as the next five years are likely to look quite different than the last. Let's review some important market factors.
Valuation: It's not 2009 anymore
Stocks were unquestionably cheap in March 2009. Economist Robert Shiller's P/E 10 or "CAPE" ratio, which looks at real price-to-earnings ratios of the S&P 500 over a decade, was a low 13.3, meaning stocks were priced to deliver above average returns going forward -- and this is precisely what occurred.
Fast-forward to today and you have the opposite setup. The Shiller P/E 10 ratio now stands above 25, well over its historical average, with stocks priced to deliver below-average returns going forward. Although this is not a short-term signal of market performance, this valuation metric has been one of the best predictors of long-term returns.
Sentiment: The "wall of worry" is gone
In March 2009, bearish investors outnumbered bulls by over 20 percent in the Investors Intelligence Sentiment Poll, which is a collection of forecasts by investor newsletter writers. Few people were expecting positive returns for equities in the year ahead. Entering this year, we saw the polar opposite. The bulls outnumbered the bears by over 45 percent in the same sentiment poll, which is an extreme reading historically.
Sentiment is an important factor to monitor because at sentiment extremes, the market often moves in the opposite direction of the crowd. Our studies confirm this, as forward returns are best when there is a high level of bearishness in the Investors Intelligence Poll. When there is a high level of bullishness -- as there is today -- few are left to buy, and forward returns tend to be below average.
Entering the late stage of the economic cycle
In March 2009, the U.S. economy was also at the tail end of the worst recession since the Great Depression. Equity markets often post their best returns at the end of a recession and beginning of a new expansion, and we saw just that in 2009.
In June of this year, the economic expansion will hit five years, or 60 months. According to the National Bureau of Economic Research, the average expansion since World War II has lasted 58 months. We are therefore long in the tooth of this expansion.
That is not to say that this cannot be an above-average expansion, but that we are more likely to be closer to the end of the cycle than the beginning. This is important, as the most severe and lengthy bear markets are historically associated with a recession.
In the early spring of 2009, the Federal Reserve was still in the early stages of implementing what would become the most aggressive monetary policy in history. Fast forward to today and interest rates are still at or near zero and we are on the third round of quantitative easing. The Federal Reserve is expected to continue to wind down this latest round of quantitative easing this year, at which point the focus will shift to potential changes in the federal funds rate.
Though we'll never know exactly how much easy monetary policy contributed to stock market gains over the past five years, few would deny that it has been an important psychological factor. Without this psychological support system in place, investors should at the very least expect to see higher volatility in the markets. When the first round of quantitative easing and the second round of quantitative easing were wound down in 2010 and 2011, we saw just that. Volatility rose in those years and we witnessed sizable corrections of 17 percent and 21 percent in the S&P 500 index.
Investors need to understand that the last five years are not a typical five-year period and that the next five years are unlikely to look the same. Given the prospect of increasing risk and volatility in the equity markets going forward, investors should consider taking some of the following steps:
1. Rebalance your portfolio. Given the extraordinary stock market gains, investors are likely holding a higher percentage of equities today than their risk tolerance dictates. If they haven't already rebalanced their portfolios by reducing equity exposure and increasing exposure to other asset classes, now would be an appropriate time to do so.
2. Increase quality. Now is not the time to swing for the fences by choosing speculative names. Increasing exposure to high quality, larger-cap names that tend to hold up better during periods of market stress is a prudent move given the above factors. Additionally, as many experts view U.S. small-cap valuations to be among the highest in the world, lightening exposure to this area of the market could help reduce volatility going forward.
3. Go abroad. Although U.S. stocks are near all-time highs and at the higher end of their valuation spectrum, this is not true across the globe. In many emerging markets in particular, stocks have declined over the past three years and are at the lower end of their valuation spectrum. Increasing exposure to these areas could help boost long-term returns.
4. Raise cash or look to alternatives. There are few asset classes that can offer true protection during a volatile period for equities. Cash and uncorrelated alternative investments are two areas for investors to consider, especially for those investors nearing retirement who cannot withstand a large decline in their portfolio.
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VIDEO ON MSN MONEY
1)Global Debt has increased 40% since the Great Recession
2)China's Economy in Free fall
3)Japan's Debt to GDP ratio plus increase in sales tax to 8%.
4)Russian is doing what America would do if in the same position
5)Record Student Loan Debt
6)Real Wages have not risen for over a Decade
7)National Debt is out of Control
8)Margin Debt is at Record Levels
9)We never solve the problems which caused the last Great Recession
You're an idiot .. Why are the stocks low and still falling in the other countries?
Their governments haven't intervened in their stock markets the way ours have..
Why , because "They're Broke"
We are heading down the path of reality.. The DOW will drop..
Is it the end of the world NO..
What a joke about bthe recovery of the economy since 2009. The Middle Class has been wiped out. In 2000 the average Middle Class worker made $55,000+ Twelve years later they made $56,000 +. OA whole $1,000 more or a raise of $80 a year.
If the Super Rich Billionaires did not have to own the peasant / Former Middle Class, then we would have a super demand peroid for everything. See when you increase your income $1,000 over a 12 year period your buying power goes down by the 33% inflation over thgose same 12 years. So Americans are getting by on 30% less income than in 2000.
Lets outlaw the Billionaires owning ALL Memeners of Congress. Oh wait a minute... John Roberts and his Billionaire Superme Court says... NO WAY. The Billionaires get everything and the Middle Class can just die off.
Good luck trying to grow an economy when you consumers are making 30% less / are broke..
Lets have Publically paid elections versus priovately owned Members of Congress, Lets have term limits on these Members of Congress / Clowns / Criminals.
Enough of Everything goes to the Billionaires and the other 99% get beaten down more and more. Enough.
Well I would like to know when has there ever not been any Corruption on a Grand Scale in America and Globally. In Ukraine, the Corruption and inequality is far worse then in America. Detroit is Bankrupt yet we refuse to give them discount Loans but rush to give out massive Guaranteed loans to a Bankrupt Ukraine. We give Israel, which is one of the most Economically successful places, well over $5Billion in free Welfare Money each and every Year. Ditto for countless other entities across the Globe.
The Bull Run before the Great Recession was Built off the housing ATM and Banks creating $500-700Trillion in FAKE/Scam Banking Derivatives. The Current Mother of all Bull Markets has been Built off the Temporary Stability caused by the Global Feds Printing to Infinity.
We continually hear posters always yapping about the state of the Economy yet really not having a Clue to what the Economy actually is. Nor do they really care about whom has benefited the most at the expense of those seeing the least. We have this massive Right to Work far Harder for Far less Push sweeping American and the Globe yet most of the support you see on websites is literally for the top 1% parasites. That tells you about all you need to know concerning the type of Folks that 24/7 patrol Websites and their posting Boards.
I'm surprised there hasn't been more of a fall-out regarding the brokerage firms using High Frequency Trading (HFT) algorithm programs that intercept trade information and buy shares of a stock before the regular trader (or smaller investment branch offices) can. Then they sell these shares to the individual or office at a price that's a few pennies higher per share. This has been going on for several years. A recent book titled "Flash Boys" details this behind the scenes activity that's happening (unknown to many investors). While that kind of activity may not be illegal, it certainly is unethical. It rigs the stock market in favor of these companies that have their computers on the stock market's trading floor and use these HFT programs. In essence they are literally stealing from other investors, by hijacking trades and affecting the price per share that smaller investors have to pay. This sure doesn't put the stock markets on a level playing field for all investors.
Just one more sign of the behavior of larger investment corporations fixing the system in their favor at the expense of millions of other stock traders. I was in the investment industry for a little over two years and frequently was asked by many clients, "Why do my trades seem to take longer to go through"; or "I placed a limit order for this stock at such-and-such a price, and it went through at a higher price". Now I know (at least a part of) why my customers' trades were slowed down, or the price was noticeably higher than they expected. Huge profits are being made by these brokerage firms, and the average investor is picking up the tab for that. This is so wrong.
Let the U.S. forces us to pay for Obama Care up front and I am sure that you don't get to pay for your electrical use during the year at the end of the year.
If you go months ans years without paying your electrical bill NO WAIT the electrical company will cut off your electricity within 10 days of not paying them. I know because I paid my electric bill and they lost my electric payment even though Chase said they got the payment and told me that they would cut off my electricity in 10 days if I did not pay and I had already paid
Big Businesses in America get away with things the US says Russia should not get away with.
I demand the US government crack down on these evil and bad practices of US businesses.
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