A lot of ink has been spilled over the huge rise in equities in 2013. The year so far has been less surprising but not at all bad. The S&P 500 put on nearly 32% in the last calendar year and more than 5% year-to-date, despite the sharp dip in late January.
The inflation-adjusted S&P 500 is now about 100 points shy of its all-time high of 2045.09, set back in August 2000. (It blew past the nominal highs some time ago.)
The new, higher ground for stocks has prompted a few pundits to project a coming stock “meltup,” which is exactly what it sounds like — a rapid rise in stock prices in a short period of time driven by heady times and high investor emotion.
You might think that stocks are set up for a mediocre medium-term run. Mathematically, some reasonably argue, corporate earnings would have to rise quite fast to support another double-digit rise in shares, an outcome dependent in turn on a vastly improved economy.
(Yes, the Fed matters. So does whatever happens in Europe, China and the Middle East in terms of politics, finance, war or all three. But we don’t know how events will unfold and neither does anyone else, so let’s stick to earnings and the economy for now.)
While eminently logical, the assumption on the role of earnings growth leaves out a major contributing factor to investment performance: actual investors. And they apparently wouldn’t touch stocks with a 10-foot-pole right now.
Howard Gold did an interesting analysis of equity ownership in a recent column. The bottom line is that while people owned stocks in droves during bull markets such as 1968 and 1999, the most recent move higher for U.S. stocks has been marked by low interest in equities: Portfolios were just 37.7% in stocks in 2012, the latest year studied by finance researchers.
Compare that to around 64% during the booms and you can see that investors large and small have turned against owning shares in spite of the indexes busting to new, record highs.
Once bitten, twice shy, as Gold contends? Possibly so. Also, people seem to be finally accepting that idea that a portfolio should contain more than a simple split of U.S. stocks and Treasury bonds. Real estate, foreign stocks and bonds and commodities increasingly play a role in retirement portfolios, in part thanks to the ease of investing through ETFs.
But the amazing restraint of investors in the face of a rising U.S. market suggests two likely outcomes, out of dozens of imaginable outcomes and any number of unimaginable ones.
One is a potential meltup as retail investors wake up and smell the coffee. The other is a follow-on meltdown, as the so-called “smart money” quickly departs the rising stock indexes for safer ground. Some analysts refer to this quick up-and-down movement as a “blow off” and consider it a hallmark of bubbles.
It’s a convincing argument, yet one that remains 100% conjecture. As Yogi Berra said, “It’s tough to make predictions, especially about the future.”
So how much of all this pedigreed guesswork matters to you, the retirement investor? It’s easy. The part about owning a wider variety of assets than a simple stock-and-bond split.
Financial advisors have done a great job over the years of getting their clients off the roller coaster of emotions that comes from owning either too much equities or too much fixed income.
Risk-adjusted return
Forced into a two-asset model, wild-eyed stock addicts got some emergency brakes installed in the form of bonds. Meanwhile, nervous types who want to stick to bonds picked up some inflation protection through blue-chip equities.
The research is clear: Investors who own a broader selection of investment types, both U.S. and foreign stocks and bonds, plus real estate and commodities in small doses, get a lot of the upside of equities with much less volatility, what pension and endowment managers call “risk-adusted return.”
By rebalancing prudently, steady investors can beat the straight S&P 500 by a comfortable margin without sweating the ups and downs, research has shown. Lower volatility in a portfolio helps avoid panic selling in down markets while providing a programmatic way to steadily cash out gains through rebalancing.
No predictions needed, unless you care to handicap the World Cup.
