Which may be a relief, considering the aftermath of earlier parabolics. Japan’s ““bubble market’’ of 1988-89 eventually surrendered 63 percent of its value. When gold broke in 1980, the bottom turned out to be 47 percent down. Then there was the Dow in 1987 and, um, 1929.
This history has to get your attention even if (like me) you believe in buying stocks and holding on to them. It’s one thing to be consistent, but quite another to be stupid. Nothing says that parabolas must end in tears, but that often appears to be the case.
Still, a market’s postparabola blues don’t necessarily last very long. The price of gold and Japan’s Nikkei average languish well below their peaks. But after Wall Street’s 1987 crash, stocks recovered in 16 months – a shorter-than-average bear market and no problem for people who stuck to their guns.
Interest rates are usually the spoiler. If they rise too high, stock prices fall. But no one knows what’s ““too high’’ today or whether that point will even be reached. With inflation so low and profits so good, stocks might deserve their current record valuation or something not very far below it.
Still, that parabola nags. Here are some ways of adjusting your investments, consistent with holding on to stocks:
Take short-term savings out of stocks. You can’t run the risk of investing with money you know you’ll need within three or four years – for example, for college or living expenses. Over that period, the market could drop and not recover by the time you need the cash. Stocks are for funds that you don’t plan to touch for four years or more.
Don’t mess with new issues. They’re for flipping – in and out of the stock in a couple of days – not for holding. Six months later, they’re often lower than their starting price.
Rebalance your tax-deferred retirement portfolio. Serious investors don’t buy securities haphazardly. They choose a specific mix, such as 60 percent stocks and 40 percent bonds. That’s the classic pension-fund allocation (stocks for growth, bonds for cushioning losses when the stock market drops). The more aggressive you are, the higher proportion you’ll keep in stocks.
But because of changes in market values, investment allocations don’t stay put. If you were 60 percent in stocks at the start of 1994, and have made no changes since, stocks now represent 67 percent of your portfolio (measured by Standard & Poor’s 500). Extra stocks mean extra risk. You should ““rebalance’’ back to your original 60 percent, taking money out of stocks and adding it to bonds. That reduces your exposure to this parabolic curve. It’s easy to rebalance with mutual-fund shares (harder with individual stocks).
With investments outside a retirement plan, you might owe a capital-gains tax if you sold some stocks. If so, rebalance by directing any new investments into the portion of your portfolio that’s low.
Look for ““value’’ investments (securities that appear to be underpriced).You cannot consistently identify market tops or bottoms. But you often can tell when a market is relatively cheap. If you buy such a market, the price may drop further before it recovers. But you’ll have locked in your shares at an attractively low price.
Bonds look like a ““value’’ play today. Taxable bond mutual funds are down 1.5 percent this year, compared with a gain of 13 percent for general U.S. equity funds. When interest rates rise, bond prices fall – so if rates rise further, bond funds will sink even some more. But eventually, prices will recover. ““Even if that takes time, bonds are paying a 7 percent yield on your money, which isn’t bad,’’ says John Hussman of Hussman Econometrics in Farmington Hills, Mich.
Another good value – for maybe 5 percent of your money – are diversified emerging-market funds. They focus on Asia and Latin America, and tend not to drop in tandem with American stocks.
International funds, by contrast, emphasize Europe and Japan. Japan should hold up if U.S. stocks drop, but much of Europe would follow the Dow industrials down, says Bill Sterling of BEA Associates in New York, which manages money for wealthy investors. Still, he thinks international stocks would rebound more quickly, so he has put more money there.
Diversify into commercial real estate. Even without inflation, real-estate values are rising in most parts of the country. There are 49 real-estate funds to choose from, reports Lipper Analytical Services. More than half are less than two years old, including an index fund just introduced by the Vanguard Group in Valley Forge, Pa. These funds buy real-estate investment trusts (REITs), which own and manage hotels, shopping centers, apartments, industrial parks, office buildings and other properties.
In the past, REIT prices rose and fell along with small-company stocks, so they offered no special diversification. But 25 big companies have gone public since 1993, and they tend to track real-estate prices rather than stocks, says Kenneth Rosen of AMB Rosen Real Estate Securities in Berkeley, Calif. If that trend holds, REITs could offer some shelter from stock-market drops.
I have to point out that just because something is logical doesn’t mean it works. But diversifying assets is smarter than trying to pick a market top.
