Our financial models going forward continue to show a high risk – low return environment going forward based on current valuations for the U.S. Stock Market. With Price-to-Sales and Price-to-Nominal GDP valuations higher than at any time in history – other than 1998-1999 prior to the dot com bubble.
Therefore we continue to suggest following strategy number one to improve long-term returns by switching to a more conservative portfolio. If you’re an aggressive investor – move to a growth portfolio, if you’re a growth investor move to the balanced portfolio etc, until company earnings catch up to current stock market valuations.
If you’re investing in target date funds through an employer it’s as easy as switching to a target date fund that’s nearer in time. For example, you can move your funds from a 2040 retirement target date fund to a 2025 retirement target date fund, or move your funds from a 2025 retirement target date fund to a 2010 retirement target date fund.
Strategy number one during market extremes such as this has been one of the easiest and most effective ways to reduce overall portfolio risk while increasing returns.
Retail investors however, are once again doing the exact opposite, just like they did prior to the 2000 and 2008 stock market crashes. They’re doing the opposite of what we’re suggesting – putting a higher allocation in stocks as opposed to income funds. This is partially due to an increase in investor confidence because of the relentless bull market and what we feel is the irresponsible act of the FED keeping interest rates artificially low for an extended period of time (thus penalizing savers and income investors), investors continue to take on more risk.
Although we can’t predict what will happen in the short-run, we can look at long-term probabilities to help you make sound investment decisions based on your goals and personalities. Again, we don’t predict the future; we only look at probabilities going forward. It’s up to you to decide how much risk you want to take over the next 3-5 years. Based on current market conditions, it appears that taking on a more conservative portfolio will provide long-term rewards.
Federal Reserve: In December, the US Federal Reserve dropped its “considerable time” language and changed it to “patient” in regards to the prospect of future interest rate hikes. This may be the first step in signaling a tighter monetary policy somewhere in mid-2015, while still allowing an out should things change. The FOMC insists however, that the new guidance doesn’t mean it plans to raise rates next year.
In her post-meeting press conference chairwoman Janet Yellen stated: “This new language does not represent a change in our policy intentions and is fully consistent with our previous guidance.” She also said; “In particular, the committee considers it unlikely to begin the normalization process for at least the next couple of meetings.” Based on those statements, the April 2015 meeting will be the earliest timeframe for a rate increase.
If the market continues to perform well, expect the FED to increase rates, albeit slowly similar to 2004-2006 barring any unexpected inflation surprises. If the market collapses or there’s further pressure in Europe the FED may delay raising interest rates until 2016.
Oil Prices; The drop in oil prices is expected to add an additional $1,000 to consumers’ pockets if rates stay this low for an extended period of time. That’s great news for everyone. However there’s a dark side as well.
If Brent Crude drops below $50 a barrel it’s expected to put significant pressure on high debt oil companies and countries such as Russia and Venezuela that rely on oil for a significant portion of their GDP. High debt U.S. oil companies will eventually go out of business if prices don’t climb. In addition U.S. oil companies are delaying new drilling projects and spending on plants and equipment. Eventually they’ll have to start laying off employees. There’s also a ripple effect of lower energy prices slowing down alternative energy projects.
A bigger concern is the affect overseas and the current state of the European economy. Europe is fighting slow growth, deflation and the possible defection of Greece from the Eurozone. Japan has entered into a recession, Russia is predicted to enter a recession and growth in China has slowed. This will have a direct impact on U.S. companies as almost 50% of the sales for S&P 500 companies come from overseas.
The bond market has priced risks in the market and is predicting an economic slowdown with yields nearing historic lows in a flight to safety.