I thought I would share some of my notes.
First, here's the question that's sure to be asked:
"Should I be buying stocks now? What are you telling your clients?"
Yes. Here's why:
- Stocks are the only game in town if you are truly interested in "maximizing real returns" (John Templeton's phrase). Bond yields are at 60 year lows, and current Fed policy guarantees that cash promises to earn essentially nothing until 2014;
- If you believe - as I do - that there is a reasonable chance that the S&P will be at least 35% higher by the end of 2014 (please see yesterday's Random Glenings post), then trying to time the market is a futile exercise. Yes, the market will doubtlessly experience corrections in the next three years, but the longer term prospects look positive;
- Actions by the Fed and the European Central Bank have stabilized Europe. Comparing the euro crisis to the financial crisis of 2008 is misleading - no one expected Lehman to go under. The euro risks are already priced into the market;
- Bearish sentiment is pervasive. The press is full of stories about how vulnerable the stock market is, and domestic equity mutual funds continue to see outflows into bond funds. Auto maker Ford Motor just moved 80% of its pension fund into fixed income, even though the plan is $15 billion underfunded - they decided they just couldn't handle the volatility of the equity markets.
- It's never been more expensive to be defensive.
Clients appreciate the strong relative performance of their accounts on both the stock and bond fronts;
However, they are frustrated as to what to do now. Rates are low, and no matter how skilled the bond manager, the absolute returns will not likely be as strong as the last few years. Stocks could potentially offer opportunity, but after 5 years of volatile markets and essentially no gains, adding to positions is difficult.
Here’s what we’re saying:
1. The value of active bond management is magnified in a low interest rate environment. Bonds can and should play a role in a balanced portfolio both to offer income as well as stability, but active duration management may be more important than it has been for years – the margin of error is so much smaller. Put another way, bonds are not “riskless”;
2. Stocks offer better total return opportunity over the next few years but the path will not be smooth. The list of potential problems is long, and largely relates to unpredictable geopolitical events. Still, valuations on most sectors are more compelling than they have been in years, especially versus the alternatives;
3. “It has never been more expensive to be defensive.” The goal of true investment management should be to maximize real returns. Even though inflation is low, it is still positive, and staying in cash means loss of real purchasing power;
4. Alternative investments could help However, even this sector is not a panacea, since it too will be volatile, and a longer term perspective is important;