A year of soaring domestic stock-market valuations has left some investors wondering if there is any room left for stocks to run.
On the other hand, holding bonds is scary because prices are slipping.
And cash continues to pay just about nothing in nominal terms and less than nothing when you take inflation into account.
Since stocks and bonds are the securities most retail investors are comfortable owning, the financial markets are beginning to resemble the rock and the hard place.
Do you risk holding stocks that could be at a high-water mark only to watch them drop when the current bull has run its course? Or do you buy bonds and watch your portfolio lose value while the Federal Reserve System gradually lets interest rates rise?
The answer is none of the above, said members of the CFA Society of New Mexico during their recent conversation with Journal business editors and writers. This was one in an continuing, periodic series of meetings with chartered financial analysts to discuss the economy, financial markets and investment options.
Don Hurst of Hurst Capital Management acknowledged that investors without a long-term sense of where they want to be might be confused.
The trick, he said, is to get a long-term sense of where you want to be so you won’t be confused. Write up a personal strategic investment policy statement and stick with it.
“I have to get past all this temporary stuff,” he said. “When I look at my clients’ portfolios, I have to say to them that we’re in it for the long run. There are going to be some rough waters, but unless you need that money in a year or two, look out farther on the horizon.”
Decide the kind of portfolio you need to meet your own requirements (retirement, paying for college, etc.), then focus on building it and ignore market gyrations, manias and panics, Hurst said.
Peter Lehrman, president of Sandia Wealth Management, agrees.
“The key is to get yourself where you feel you need to be for the year, for the decade, for whatever your plan is, and not to worry about short-term things,” he said.
The analysts aren’t all that spooked by the run-up in stocks last year or the likelihood of falling bond prices in the coming year, either.
Daniel Yu, an operations specialist at REDW Stanley Wealth Advisors, acknowledged that some investors feel bonds are “scary.”
“The thing you need to remember is that bond bear markets tend to be a lot less severe than equity bear markets,” he said. “We have not abandoned fixed income as an asset class.”
Yu says high-yield bonds – those that pay a better interest rate because they have a lower rating – offer some better returns for investors who can tolerate more risk.
As for stocks, the analysts say domestic stocks aren’t necessarily all that expensive despite last year’s sizzling performance.
“We’re only just now reaching long-term averages” based on the ratio of stock prices divided by earnings, both historic earnings and projected earnings, Yu said.
The Dow Jones Industrial Average and the Standard and Poor’s 500 Index only have just now climbed higher than the rate of inflation over the past 13 years, Hurst said.
“I suspect the market will always make new highs,” he said. “That’s the nature of the stock market, though there are going to be a lot of bumps in the road.”
Given the run-up in domestic stocks, it might make sense to take your profits on those investments and consider investing in the stocks of other developed countries, Lehrman said.
People who can stomach volatility and more risk might want to try emerging markets, which have been doing poorly relative to U.S. stocks for several months, he said.
Closer to home, signs are the Albuquerque and New Mexico economies are picking up, said Brent Carey of Financial Strategy Group. Among other things, Carey values businesses that are for sale or that are planning to issue shares.
“There is more business activity,” he said. “Credit is still very difficult. I hear that from everyone. Credit is no more available now than it was a year or two ago.”
The reason, Carey said, is that lenders are still not sure what regulations they will face when Dodd-Frank banking rules are completed, so they are trying to minimize their exposure to risk.
“I see a lot of real-estate and construction-related activity. Most of the construction firms I know are seeing a pickup,” he said, though most of the commercial construction is renovation, not new construction.
“On balance, I see more of a sense that things have settled,” Carey said. “That doesn’t mean there isn’t uncertainty out there. There is a little more confidence, a little more sustainability.”
In a world of very low, albeit slowly rising, interest rates, investors who need income with some safety from their portfolios face special challenges, the analysts said.
Stocks that pay good dividends are “far more expensive than they were,” Lehrman said. He suggests investors look for stocks that don’t necessarily pay the best dividends but that offer a good rate of growth in dividend payout over time.
Hurst is advising clients who need income to buy high-yield bonds, preferred stocks and real-estate investment trusts.
“With those comes greater risk, but that risk may be digestible in the long run,” he said. Those risks might include a temporary decline in the value of your portfolio, “but maybe you can withstand that.”
Master limited partnerships
Income also can be found in master limited partnerships, Yu said. An investor who buys an MLP becomes a partner in a business. The MLP pays its partners a share of the taxable income that the partnership generates. There are also exchange-traded funds that invest in MLPs.
Most MLPs are in the energy business, Yu said. Many of them own oil, natural gas and gasoline pipelines, and storage facilities.
But be very careful when buying an MLP, the analysts said. There are many different varieties, and not all of them are in a business you want to be in as a partner, and not all of them are designed to pay you the kind of partnership share you might require.