Tag Archives: income

Can You Deal With A Stock Market Downturn?

Sometimes we’re late to interesting polls, but hey, they’re still interesting. Back in November, Gallup and Wells Fargo polled people to ask them how well they could stomach a “significant” market downturn, publishing the results on January 22nd . Or note, they defined significant as 5-10%. The results were quite confident: Gallup/Wells Fargo Downturn Poll Some wacky lines there – 87% of stockholders were at least moderately confident in their portfolios, and 82% of investors overall. People in a better position to actually handle downturns with smaller returns – those who don’t hold stocks – were only 61% moderately or better confident. Should We Trust Our Peers at their Word? In a word, no. These are interesting results, for sure, but I see lots of problems here – not just the fact that a significant downturn is defined as only 5-10%. The most recent recession saw drops an order of magnitude larger – in percentage terms (!) – of over 50% in major indices. We lost major financial institutions over a hundred years old, investors panicked, and maybe 10% of people (that’s a stretch) were confidently buying at any opportune time, let alone not panic-selling everything they owned. (We played around with what a “significant” drop might actually be in the past, but found you can be more than a few years early with your calls in some circumstances and still weather a downturn.) So let’s concentrate on our peers’ answers themselves. Do you really think this poll accurately reflects how people would react in a downturn? No, neither do I. You’ve got something of a Lake Wobegon effect going on here – you know, the “fictional” town where everyone was above average. In reality, stock markets have a tendency to over-correct – markets historically oscillate somewhere between ridiculously overpriced and a bargain (of course, identifying those periods is, perhaps, impossibly hard except in retrospect). That’s because previously confident people are selling into a downturn – “locking in losses” – and buying only when the stock market has come back “buying the highs!”. In fact, identifying actual investor results backs up those statements to a degree you’d almost think impossible. Dalbar releases studies on actual investor performance in the markets versus price (or dividend reinvested price) returns, and the results are crazily disconnected: through November 2015, in the order of earning 5.5% on S&P 500 funds in the last 20 years, versus stated returns around 9.85% . (We have a calculator so you can see dividend reinvested returns for the S&P 500 and the Dow Jones Industrial Average). Okay Smart Guy, What Then? For the average investor – and, Wobegon aside, we’re all probably closer to average than we tell ourselves – the best move is to set it and forget it. Consistently, when we do have market downturns, it turns out that many investors have actually overestimated their intestinal fortitude. For a typical person, the best move is to set your portfolio during market doldrums , with a mind to setting in up in such a way that you won’t mind too much if there is a massive move to either the upside or downside. As for re-balancing, it’s best if you go in with a plan, and openly rebalance at a standard time – and, if you can, avoid doing it that often. Believing in your portfolio is one thing, but investing during mania or a crash is no formula for a successful long-time plan. So, make the case. Would you be prepared for a significant downturn without selling most of your portfolio? Why, or why not?

How To Look At Negative Yields Inside A Portfolio

Negative yields on bonds are no longer unicorns. In Switzerland, Germany, Denmark and several other European countries, government bonds are trading at negative nominal yields. Recently, the Bank of Japan announced it is adopting negative interest rates. For investing, there are four potential reasons that can illustrate trade-offs between different investment strategies as a result of negative interest rates. First and foremost, negative yields could simply be a consequence of active monetary policy (with the expressed goal of stimulating economic activity) in a world where bond supply and demand is not balanced. Central banks in major developed economies have amassed close to $12 trillion in government bonds since 2004, and still remain a source of demand of close to $3 trillion a year. Meanwhile, the net issuance of government bonds of about $2.5 trillion has been on the decline since 2013. This demand mismatch is likely one of the reasons there are $6.3 trillion in government bonds outstanding trading at a negative yield. This represents about 10 percent of total outstanding government debt worldwide, estimated by McKinsey to $58 trillion. Second, negative yields could potentially be correctly forecasting a sharp economic slowdown, which, as a consequence, could lead to an increase in defaults (both corporate and sovereign) in the future. Paying up now and receiving less nominal money in the future can be profitable if the price of goods has fallen sufficiently. Third, negative yields could also be a consequence of the ecology of current market participants. Choosing to not own these government bonds as an active allocation decision can (even with good cause due to their negative yields) carry risk for certain investors – e.g., the potential for higher tracking error to their benchmark or underperformance versus their peers. That said, as government bonds have an increased representation in many bond indexes that are used as benchmarks, holding these bonds to stay close to the benchmark also carries a cost: lower absolute returns due to a portfolio with an increasing component of negative return. Fourth, certain investors who have a preferred investment horizon may require a meaningful risk premium to buy bonds with maturities outside their preferred habitat. For instance, when investors with a shorter horizon are faced with short-term yields in negative territory, the steep slope of the yield curve and longer-maturity bonds might provide the inducement to buy longer bonds. Because they join other investors who invest regularly in longer maturities as part of their own preferred habitat, the ensuing higher demand could be a reason for negative yields on longer-maturity bonds, as was recently the case in Switzerland and Japan. And lastly, negative interest rates cause currency volatility and capital flight. By adopting a negative rate to weaken the currency, the true goal is to apply a haircut to government debt that is unsustainable as GDP growth stays anemic. The result is negative interest rates lead to one currency appreciating to super strength, namely the US dollar, while the rest of the world’s currencies depreciating by central banks printing money. The result of negative rates is the opposite from what it was intended; instead of a stimulus, it has led to deleveraging debt. The effect was first through the energy sector by causing distress in high yield markets that has now spread more broadly. Portfolio Strategy If one believes negative yields are primarily due to demand from passive or indexed investors, then an active investment strategy should tolerate the tracking error and take the other side of the indexing herd. Despite the profit uncertainty of investing in negative yielding bonds, there is a logical approach to constructing robust portfolios. First, control exposure to risk factors where the uncertainty of outcomes may be the most severe, for instance, by adjusting overall portfolio duration. Second, tilt portfolios in directions where relative asset valuation is more attractive, e.g. equity and bonds of companies with solid fundamentals. Third, look for sources of diversification, where the ultimate and eventual resolution of the negative yield conundrum is likely to create large trends and market movements. And finally, in very broad terms, aggressive central bank intervention with negative interest rates continues to underwrite risk taking. At the same, negative rates also cause volatility, currency depreciation and deleveraging of debt. So as more central banks jump on the bandwagon to drive rates more negative, an appropriate asset allocation of conservative, higher quality credit risk, floating rate exposure, and maintaining high liquidity remains prudent. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Stock Selection: The Top-Down And Bottom-Up Approaches

So, you want to trade a stock. Well, you’re not going to trade any stock, of course. So the question is: what stock are you going to trade? There are a lot of stocks out there and you’re going to need a way to narrow down your search. For this, there are two approaches you could take: bottom-up, or top-down. Click to enlarge TOP-DOWN In the top-down approach, you go from big to small. First, you take a look at the prevailing market trends in terms of what industries are experiencing favorable trends. Within those industries, you take a look at the sectors that are trending well. And finally, within those favorable sectors, you look at the specific stocks that are performing well. Some of the reasons that stock traders prefer this method of stock selection is because it allows them to approach the market with an open mind. Rather than trying to formulate a trading plan on the basis of liking a particular stock, it starts traders out on a path that lets them discover a stock that may work for them. Also, the practice of identifying strong sectors in and of itself can be useful for traders looking to get a good sense of the overall market. Some traders also favor this approach because it may help them discover opportunities for diversification . Again, instead of you saying, “I know lots of things about tech, so I’ll focus on tech,” it allows you to consider all sectors, as long as they’re favorably trending. On the other hand, some traders feel the top-down approach is not the best way of selecting stocks. This method forces the trader to be aware of the entire market, which can be challenging and requires a greater amount of research. But also, by ruling out entire sectors, some traders feel that they are missing out on many trading opportunities. BOTTOM-UP As you might have guessed, the bottom-up process is pretty much the opposite of the top-down approach. Here, you consider particular stocks that you believe are poised for growth, and then confirm that the sectors they are in are trending favorably, and that the industries that those sectors are in are also trending well. Some traders like this, as it allows them to investigate stocks one-by-one, rather than having to research the market as a whole. It may also allow traders to select stocks that they might have otherwise passed up in a bear market, when the top-down approach could make most sectors look unattractive. But mostly, it’s a stylistic choice: some traders are interested in a certain set of stocks, and it allows them to use those stocks as starting points. Of course, some traders eschew this method, as it may play too well into pre-conceived notions (if you’re already “rooting for” a stock, you may only find good things when you’re researching it). And, of course, by focusing on the individual stock, a trader could miss larger, macroeconomic trends and shifts, which could impact their trade down the line. Ultimately, no particular way is better than the other. But what both of these approaches allow you to do is be thoughtful and prepared as you formulate your trading plan. And that thoughtfulness and preparedness should not only give you an idea about what stocks to buy, but also at what point you should sell the stock. In other words, as you look at trends and the viability of a stock, don’t just think about buying stock; think about when the time comes to sell it, and what level you expect that will be at. After all, it’s all part of the plan. Important Disclosures Schwab Trading Services (formerly known as Active Trader or Active Trading services) includes access to StreetSmart® trading platforms, the Schwab Trading Community, and priority access to Schwab trading specialists. Schwab reserves the right to restrict or modify access at any time. Access to electronic services may be limited or unavailable during periods of peak demand, market volatility, systems upgrades or maintenance, or for other reasons. Past performance is no guarantee of future results. Investing involves risk, including loss of principal. Diversification and asset allocation strategies do not ensure a profit and cannot protect against losses in a declining market. The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. Examples are not intended to be reflective of results you can expect to achieve. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.