The financial media makes me laugh. Their narrative today, as our stock market plunges, is that stocks are reacting to the free fall of China’s equities market. Ideas like this are part of the reason American investors’ portfolios continuously get beat up in the markets. We should be talking about the fundamentals.
I’ve been predicting a sizeable correction of the stock market since the beginning of the year. This was a very foreseeable event in my opinion as I watched the Fed end its money printing operation known as Quantitative Easing and start hinting at a rate increase. Haven’t people noticed that the whole phony recovery is based off of artificially low rates?
Six years ago I started tracking the Fed’s moves on a weekly basis. Since that point, their balance sheet has quadrupled (filled with treasury securities and mortgage backed securities). The Fed Funds rate has dropped to .25% and remained there indefinitely. This might not mean much to the casual observer, but what it means to financial professionals is that we have an economy completely distorted by the actions of an organization that controls our money supply and our banks interest rates. In fact, their power is so great, that their monetary policies has manipulated interest rates in the bond and real estate markets as well.
To be blunt: our economy is addicted to low interest rates and cheap money. Like an addict with his drug, the U.S. stock market needs its monetary “high”.
Investing is often misunderstood by our culture. What some perceive as investments, act more like speculations. Investing means there is a reasonable expectation of return based off of ones analysis of markets, industry and financials. What I’ve seen in the stock market this year is a huge over-evaluation that has been dismissed by the financial community.
In my June report to clients and e-mail subscribers, I noted that the vast majority of S&P 500 companies were reporting two consecutive quarters of falling earnings. Yet at that same point, the stock market was flirting with record high prices.
So why did prices climb so high? Since the Fed start tinkering heavily with interest rates, investors began losing traditional investment options like treasuries, bank products and bonds. For the better part of the last three years, the yield on the 10-year Treasury Note has underperformed the stated rate of inflation in the Consumer Price Index (which is a grossly inaccurate measure in my opinion). In other words, investors who put $10k of their own savings in a treasury note, would actually lose money by the deterioration of dollar purchasing power.
These terrible yields on fixed income securities left investors with only a handful options: either pursue junk or low-grade bonds with higher yields, or chase after stocks. And to no surprise, the stock market over the past several years has had a large inflow of cash chasing those higher returns.
What to Do?
Every time there is a large correction, people become worried and make irrational decisions. If your portfolio is based off of careful analysis of the marketplace and fundamentals, I advise you to weather the storm. However, for those that were blindsided by the current market performance, here are some general tips that I give to clients:
1) Diversify your portfolio into multiple asset classes. I talk to people all the time about precious metals, real estate investment trusts and other assets commonly overlooked. Just owning stocks, even if they are in a mutual fund, isn’t proper diversification.
2) Don’t be afraid of cash. With inflation, keeping money in cash is a guaranteed loser. But sometimes, parking your wealth in cash protects you from larger declines that come from market volatility.
3) Invest overseas. Granted, most of the world’s advanced economies are also addicted to money printing and low rates (Europe, China, Japan, etc). However, there are still markets out there will less intrusion and more freedom that are worth while.
4) Dividends are king. When I believe turbulent times are ahead of us, I choose stocks that have stood up to the test of time. Blue chips that pay generous dividends are great investment vehicles. The performance of some of my favorite companies in this arena, have had less declines in past market corrections than their counterparts.