Synopsis:

Consistently predicting the direction of the stock market over the short term with a high degree of certainty is unlikely.  By comparison, market risk and economic risk are quantifiable.

 

If an investor does not need to tolerate significant risk to achieve his or her investment objectives, has a short investment horizon, or is unwilling to tolerate significant fluctuations in the value of his or her investment portfolio, it may be appropriate to adopt a more conservative approach when the level of risk is well above historical levels.

 

At the present time market and economic data suggest the level of risk associated with investing in stocks, corporate bonds and long-term treasury bonds is higher than usual.

 

As a result, it may be an appropriate time for investors who may be tempted to sell during a bear market, or who plan to remain invested for a shorter time frame, to reduce the level of risk in their portfolio.

 

Discussion:

At any given time there are very smart market commentators and portfolio managers who have completely different ideas of what’s going to happen next in the stock and bond markets.  This leads to just about every possible outcome being predicted at all times by at least a few astute market observers.

 

As a result, whenever there is a change in the stock or bond market’s direction, there will always be at least a few well-respected market commentators and advisors who correctly predicted the market’s change of direction in advance, and many well-respected market commentators and advisors whose predictions proved to be dead wrong.  Complicating matters is the realization that even when a forecast comes true, the reason it does so can be for totally different reasons than the rationale that led to the prediction.

 

There are two important conclusions that one can reach from the foregoing observations:

 

  1. Identifying whether a market prediction is going to be right or wrong is nearly impossible; and

 

  1. Determining whether a market prediction was right as a result of luck or skill can be harder still.

 

In our view, placing a great deal of reliance on predictions when making investment decisions is foolhardy.  This does not mean, however, that studying economic and market data is a waste of time.  To the contrary, careful analysis of economic and market conditions can lead to important insights as to the degree of risk presented by different types of investments.

 

It is also important to recognize that (i) markets can continue to move higher for a long time after market risk is high, and (ii) lowering market risk lowers expected future returns, regardless whether risk is reduced by adopting a more conservative asset allocation, a more conservative investment strategy, or with the acquisition of option contracts.  This is the price of greater safety.  Thus, if an investor can say with great confidence that he or she will stay the course for several years even in the face of a drawdown of 25% or more, then he or she can expect higher returns over the long term by staying the course.

 

In conclusion, in our opinion, when market and economic statistics indicate market risk is elevated, lowering a portfolio’s susceptibility to a bear market may make sense for risk intolerant investors because doing so reduces the temptation to sell investments during a bear market, or guards against the need to do so to raise cash when prices are low.  We are also of the view that the level of risk currently present in certain market sectors is elevated and may warrant a risk-adverse investor temporarily adopting a more conservative asset allocation or investment strategy or purchasing option contracts that provide protection against a stock market decline.

 

 

Important Disclosures:  Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly from The Market Commentator℠, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio.  Due to various factors, including changing market conditions, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in The Market Commentator℠ serves as the receipt of, or as a substitute for, personalized investment advice from The Milwaukee Company™.  Thank you.