Investors see risk in rally

Column by Patricia Kummer

Posted

Hindsight is perfect vision. If investors knew we would be flirting with 15,000 on the Dow in April 2013, perhaps fewer would have panicked in May 2009 when the same market index was at 6,700. The broader market index as measured by the S&P 500 was at 696 then, and as of this writing is nearing 1,600 or a return of 130 percent. ¹

The lesson from this example and any other market decline is that recoveries typically follow declines. The problem always lies in the unknowns — usually when and how much. Therefore, many investors make long-term decisions based on short-term information. Two conflicting emotions often dictate how we behave with our money: fear or greed.

During the Great Recession, fear was the common denominator for most people tracking their retirement or college funds. Lately, greed has started to take over as more folks are wishing they had invested more and could be looking at over 100 percent returns by now.

There are several risk factors that continue to affect this recovery, and many people remain fearful despite the large returns. One obvious problem is that the economic growth has been so slow, hampered by unemployment and a stagnant housing market, that the recovery itself was difficult to recognize until after it occurred. The continued trajectory, according to the Federal Reserve Board minutes from early April, is that the slow growth is here to stay. No one is predicting any stellar Gross Domestic Product (GDP) bursts in the near future.

Slow growth transcends into another problem: Low interest rates. The low interest rate environment, designed to loosen the money supply, makes it difficult for retirees to get much yield on their fixed income investments. Since bond values increase when interest rates decline, the outlook for bond price appreciation is actually negative. Therefore it does not make economic sense to purchase bonds at record high prices for paltry returns.

Another longer-term risk to be aware of is the potential for inflation creeping back into the economy. There is significant potential that the consumer will experience higher costs on such staples as food, housing and energy, long before their salary will increase to compensate. Wages are held down as a result of high unemployment; however, food and energy costs are rising. This phenomenon of inflation before growth is very difficult to manage as an investor or a consumer.

The added volatility in the marketplace is a result of the above three major risks. The whipsaw attitude of when to add growth investments to the portfolio or when to be defensive has many investors' heads spinning. In stock market terms, this is called risk-on or risk-off. Those adding risk because they are now fearful of missing out (greed) are pushing stock prices higher. Those reducing risk by being defensive either due to age or income needs are sustaining a bond market that otherwise would naturally be declining.

These conflicting attitudes may actually create opportunity. Investors would be wise to revisit their long-term strategy with their advisor. Confirm you are diversified in the areas where you feel comfortable taking risk and that your time frame is appropriate for the investments you are holding.

Patricia Kummer has been an independent Certified Financial Planner for 26 years and is president of Kummer Financial Strategies Inc., a Registered Investment Advisor in Highlands Ranch. She welcomes your questions at www.kummerfinancial.com or call the economic hotline at 303-683-5800. Any material discussed is meant for informational purposes only and not a substitute for individual advice. Investing is subject to risks including loss of principal invested. The S&P 500 is an index investors cannot purchase directly and is used as a benchmark only.