Anemic wage growth. A 7.9 percent national unemployment rate. An economy that expanded at a measly 0.1 percent annual rate in the last three months of 2012. Political paralysis in Washington, D.C. as the arbitrary budget cuts (better known as the sequester) kick in.
Hardly a recipe for a roaring stock market, is it?
Yet the Dow Jones industrial average has recently soared into record territory, capping a 128 percent rally that began back in March 2009.
Outlook for the Stock Market
Is this yet another misadventure on Wall Street, a manic euphoria that makes for a speculative bubble followed by a spectacular blow-off?
Certainly, after working my way through various stock market stories in recent days, I would say that the dominant mood currently leans toward another dangerous misadventure.
These two headlines give a flavor of widespread doubts about the durability of the stock market gains:
Dow record? Who cares? Economy still stinks! — CNNMoney
This is America, Now: The Dow Hits a Record High With Household Income at a Decade Low — The Atlantic.
The alarming disconnect between the finances of American households and an exuberant stock market is troubling enough. Among Wall Street stock pickers, the greater concern is that the rally reflects nothing more than an artificial, short-lived feeding frenzy stoked by the Federal Reserve’s low-interest-rate monetary policy. Stock valuations will crumble once the Fed abandons its easy-money policy, they say.
Personally, I think the economic fundamentals suggest that stocks still have a long way to go.
It isn’t just the 30 multinational corporations in the Dow that are up sharply. The S&P 500 index of 500 widely held U.S. stocks has risen 129 percent since the March 2009 low. The Wilshire 5000, the broadest U.S. stock market index, breached record territory in late January. The Russell 2000 small-stock index reached record ground in January, too.
No matter which index you look at, the story remains the same: Stocks have climbed because corporate profits and cash flow are healthy.
“Rather than an unsustainable sugar high, the current stock market is best portrayed by a very traditional, fundamental, profit-led bull market,” says James W. Paulsen, chief investment strategist at San Francisco-based Wells Capital Management.
Rosier Picture for U.S. Economy
The economy appears at an inflection point, too.
Business investment surged toward the end of 2012. Home prices rose in 88 percent of U.S. metropolitan areas in the fourth quarter of 2012, according to the National Association of Realtors. Household balance sheets began 2013 with $205 billion less debt than at the same time last year, calculates Moody’s Economy.com. The federal deficit has shrunk from more than 10 percent of Gross Domestic Product during the Great Recession to an estimated 5.3 percent.
Although the job market remains disappointingly weak, the economy added more than 2 million jobs in 2012, the best showing since 2005.
Market Volatility Is a Given
Of course, the stock market will almost undoubtedly take sudden, stomach-churning dips or stagnate for months on end. Once interest rates rise, as is inevitable, stock market volatility will take nerve-racking twists and turns. And market optimism could vanish if the Eurozone stumbles again or China’s growth rate dramatically slows.
How to Invest Now
But here we are. So what should you be doing with your retirement savings now that the Dow has set a record high? Should you cash in your stock market chips while the going is good? Go all in? I’d say: Neither.
No one can know what will sizzle and or fizzle in 2013 and the track record of Wall Street prognosticators is abysmal. Leon Levy, the late Wall Street investor, wonderfully cautioned: “There is a genius on one side of every trade and a dolt on the other, but which is which does not become clear until much later.”
My recommendation is to stick with investment strategies that don’t rely on forecasts or your gut beliefs. Embrace diversification, dollar-cost averaging and a balanced portfolio. Let me explain what I mean by each.
3 Essential Strategies
Diversification is all about spreading your investments among different assets, rather than putting all your money in the U.S. stock market. This way, your overall portfolio will hold its value if stocks zig and bonds zag. It also means owning some international stocks and, perhaps, foreign bonds.
Dollar cost averaging means continually putting the same amount of money into an investment over a long period of time. So, for example, you could set up a system where you automatically transfer $250 each month from your checking account to a stock mutual fund, regardless of what’s happening in the market. The real benefit of dollar cost averaging is that it takes the emotions of fear, greed and panic out of investing.
Regularly rebalancing — once a year or so — is a technique that prevents your portfolio from tilting more toward stocks or bonds than you want. You could have a much higher percentage in stocks than a year ago, for example, because the market has risen so much.
Rebalancing is a way of giving you a higher return with lower risk. In essence, by systematically rebalancing, you’re forcing yourself to buy low and sell high.
Let’s say you’re 50 and have half your retirement portfolio in a stock market index fund and half in a Treasury Inflation Protected Securities, or TIPS, bond fund. But due to the market run-up, your portfolio’s balance has shifted. Now it’s 60 percent stocks and 40 percent bonds. Should you accept the market’s judgment or rebalance your portfolio to get back to your original risk profile? My advice: rebalance.
As a rule, many financial advisers suggest rebalancing whenever your portfolio gets more than 7 to 10 percent away from your original asset allocation.
Workplace 401(k) and similar retirement savings plans often let employees go online and set parameters for automatic rebalancing. But considering the strong rise in stocks since last June, I think that if you have a 401(k), you may want to manually adjust your exposure to stocks now.
Put it this way: It’s fun to talk about the stock market making new highs. What should dictate your savings strategy, though, is the basics of your everyday life and your future plans.
The bottom line: Don’t tie your fortunes to the manic moods of Mr. Market.