Following the 2nd week of August, we highlighted for you a statistic which captures a sense of the volatility which the equity markets have experienced this month. Things did not get any better during the week of August 15-19th, as the S&P 500 Index declined 4.7% for the week – the fourth straight weekly decline! As of August 18th, the S&P was down 9.3% since January 1, 2011.
We know that, for decades, investors have been repeatedly told that the only way to stay ahead (of inflation) is to invest in equities. However, with memories of the steep decline of equities in 2007-08, and the volatility we’ve seen in August, what should investors do now?
I had the privilege of talking with Thomas Howard, C.F.P., Chairperson of the Illinois Financial Planning Association, who lives and works in Northwest Suburban Chicago. I shared with Tom the illuminating fact that August 10 of this year marked only the fourth time in financial history on which the yield from 10-year U.S. Treasury notes was LOWER than the dividend yield on the S&P 500 Index! Tom became animated and launched into an enthusiastic narrative which suggested that, depending upon one’s risk tolerance, resources, and financial needs, now would be a great time to start buying equity in profitable, dividend-paying companies. Tom pointed to the activity which invariably occurs following steep declines – namely that institutional investors and major retail traders begin finding compelling values and start buying up stocks, counting on those “buys” to soon move higher and line their portfolios profits! Tom indicated that he has already started moving the funds of more aggressive clients from T-notes into stocks; and as more conservative clients call him asking whether re-balancing into more equities would be appropriate, he says, “Yes, but only if you can handle the rocky ride.”
Tom agrees with many other financial professionals who feel that U.S. Treasury Securities are over-priced (as indicated by the historic yield “crossing” referred to above). Therefore, one way he is re-balancing portfolios is by reducing exposure to U.S. Treasury Securities (including TIPS) and increasing investment in equities and international bonds. It is a certainty that imbalances within the investment world will move toward “normalcy” – so the “expectancy” of returns for equities and international bonds will, relative to treasuries, be very positive!!
We briefly discussed the major cause of the seemingly chaotic volatility seen so often thus far in August – “program trading” and “high frequency trading”. Both of these phenomenon are controlled by major institutions and hedge funds, which seek out short-term value discrepancies within the market which will net them quick and easy profits. We both agreed that these practices are real, and exacerbate volatility; but we also agreed that we do not have any easy “answer” to the issues involved. All we know is that the movements to the downside always “feel” steeper and faster than movements to the upside.
Finally, although Tom makes it a practice to not recommend individual securities during interviews, he did suggest that interested investors should explore mutual funds or ETF’s which invest in multinational companies with strong balance sheets and which pay dividends. These equities offer some currency diversification (the dollar has depreciated over the past two years), reasonable income, and opportunity for growth. In addition, he recommends floating rate funds whose returns are tied to “hard commercial assets”