By Isaac Bonnell
Two years ago, when the economy was sliding into this recession, the stock market was a daily topic of discussion. It offered a measured snapshot of something that is difficult to quantify, at least in real time.
When the Dow Jones Industrial Average dropped below 7,000, many investors had already lost a lot of money and some were pulling out of the market altogether. Since then, the Dow has made impressive gains and is back above 10,000, but investors are still leery.
“When you come out of a recession, the economy first has to climb a wall of worry,” said Brant Faulkner of Faulkner Investment Services. “Investors are still jittery — there’s a lot of disbelief in the market now. Investors want some clarity on where this market is going.”
When the market was at its lowest, there was a dramatic shift to safer investments, mainly bonds. Yields on bonds are generally lower, between 2 percent and 4 percent currently, but they are considered less risky.
That move didn’t surprise Egan Ludwig from Waycross Investment. From 1982 to 1999, the stock market had the best run in its history. And when it came crashing down, many portfolios just weren’t built to handle it.
“It woke a lot of people up to that fact that you can’t be blind to risk,” Ludwig said. “We’ve been through two bubbles in the last decade and I think people have become a little more cautious with their investments.”
Balancing risk
If this recession has taught one lesson, it is the importance of maintaining a diverse portfolio, Faulkner said. It’s human nature to become overconfident when the market is doing well and investors often take on more risk than they should.
“They put everything in hot areas that have performed the best over the previous 12 months,” Faulkner said. “Instead of putting togther a diverse portfolio that can weather the good times and bad, they put it all in one area.”
Panic is also a part of human nature, and it tends to take over when investors are losing money. It can lead people to go against basic investment strategy: they end up buying high and selling low instead of buying low and selling high.
“Then people tend to get back into less risky investments and they won’t quite see the gains that can be made when the market rebounds,” Faulkner said.
In fact, much of the gains from this recession have already been made, Ludwig said, pointing our that in the last year, the Dow has risen 50 percent.
“If you don’t have any stocks and you’re sitting there with cash, you’ve missed a huge chunk of this rally already,” Ludwig said. “The worst thing is when people see the market going up and they put money into it when the market has already had its run.”
Bond bubble?
The stampede to the bond market may have stabilized many portfolios in the short term, but it is creating another unstable situation, said Rick Joines, a financial adviser with Bay City Financial.
“The next bubble to burst is going to be the bond market,” Joines said. “Everybody has gone to the bond market looking for safety and really it’s creating a bubble in the bond market.”
The problem is that as interest rates start to rise and the stock market becomes more appealing, people who invested heavily in bonds will find that their portfolios aren’t gaining much value, Joines said. He recommends keeping at least a quarter of any portfolio in the stock market to keep up with inflation and balance risk.
This is especially important for people managing their nest egg or planning for retirement, he added.
“You’re looking for investments that are not correlated and having a small amount in the stock market will adjust your risk in the long term,” Joines said.
Emerging markets
One area of investment that has seen a lot of attention lately is “emerging markets,” countries such as India, China and Brazil that are rapidly becoming more developed.
While many American companies are still struggling through this recession, these emerging markets have rebounded and then some. For example, Brazil’s stock market is up almost 100 percent and Russia is up 160 percent in one year, Ludwig said.
“I believe in the emerging markets,” he said. “You have to make sure you protect yourself from what happens here in the U.S.”
Faulkner agrees, adding that emerging markets should definitely play a role in diversifying a portfolio. But that’s not to say that the domestic market isn’t going to bounce back.
“This year will be a transition year from the economy relying on stimulus to standing on its own two legs,” Faulkner said. “I’m pretty optimistic at this point — things are developing about as well as we could have hoped. I’m just happy that, by golly, we did avoid a big disaster.”
