The selloff in the U.S. stock market is dramatic enough to have most of us watching with a mixture of awe, dismay and indecision.
The S&P 500 has now plunged nearly 6 percent since setting its most recent record on May 21, before Federal Reserve Chairman Ben Bernanke first openly voiced the prospect of an end to quantitative easing in the coming months.
Most of the drop so far has been linked by market pros to hedge funds and other traders with shorter-term time horizons and whose investors are likely to be ultra-sensitive to any dent in either absolute or relative performance. But the longer this selloff continues, and the more technical barriers that market indices break on their way lower, the greater the temptation will be for individual investors to join the rush to the exits, if only to lock in some of the impressive gains they have earned from stocks so far this year. After all, we have just been through a long period without experiencing a setback of this magnitude – the longest such stretch since before the financial crisis, by some calculations.
But before you climb aboard the bears’ bandwagon, you might want to pause for a moment. Selling is just the first part of the decision that you’re about to make. The second part requires careful thought, and ultimately may force you to reconsider the instinct to sell: Where will you put the cash you realize from your sales?
A quick review of your alternatives makes clear just how tricky this choice is.
Cash: If you’re clear from the start that this is simply a short-term strategic move – taking money off the table in the expectation that you’ll buy back in after the S&P 500 and the Dow Jones Industrial Average stabilize at new, lower levels – well, that’s one thing. But why would you make an active decision to hold cash as an asset? Adjusted for inflation, you’d be losing money. And trying to time the market is a treacherous game. Unless you are worried about a repeat of 2008 and another financial apocalypse, you want to invest your capital somewhere that is going to earn a positive return.
Treasury Bonds: See above. True, after the recent selloff, yields (which move in the opposite direction to prices) are higher. Still, given that the stock market volatility is being driven by the prospect that Fed policymakers will allow interest rates to begin drifting higher once more, there seems little reason to own Treasury securities. Which would explain why they, too, have joined the market selloff.
Corporate Bonds: In the eyes of some investors, these securities represent a real bubble, the kind that makes the irrational exuberance of the Internet era look like a sleepy sideshow. As a result of investors’ hunger for yield in an environment of low interest rates, the risk premium has collapsed. Especially at the “junk” end of the credit spectrum, there is fear that the yields don’t reflect the risks of default. And as Treasury securities fall, corporate bonds either follow suit or become more expensive relative to their “risk free” bond market counterparts, presenting investors with a devil’s dilemma.
Emerging Markets: Really? These days, most of them are doing a better job of submerging. Take China: The Shanghai Composite Index is down 8.6 percent so far this year; markets in Hong Kong are even lower. Korean stocks are in the red, as are those in South Africa, Mexico and Chile. And as for Brazil’s Bovespa, well, that has fallen nearly 23 percent, while Russia’s RTX index is down 18.4 percent in U.S. dollar terms. True, you can chase a handful of these markets – Pakistan, for instance, or Dubai – but if you’re interested in curbing risk and volatility, these aren’t the stocks you want to own.
Japan: Yes, Abenomics remains (for now) the success story of 2013. But speaking of volatility, it wasn’t that long ago that the Tokyo stock market reminded us of just how precarious some of those market gains may prove if real gains in both economic growth and the structure of the economy don’t materialize. A drop in the value of the yen and an increase in exports can generate only so much upside, and investors in Japanese stocks may already have pocketed the lion’s share of that.
Europe: Do we really need to rehash the whole sorry tale? The region’s economic malaise is likely to weigh on growth for the foreseeable future. In contrast to the United States, growth in the economy and in corporate profits may appear anemic, at least on an overall basis. (There may be the chance for savvy stock pickers to find some individual companies with tremendous upside potential.)
Commodities: If you’re skeptical enough about the prospects for economic growth in the United States to steer clear of stocks, you really don’t want to own commodities. Most commodity indexes put a heavy weight on industrial metals, like copper, as well as energy products. While energy prices are edging higher, copper is hovering near a three-year low, while prices of other commodities like cotton are in freefall. Unless you expect the hot weather to trigger another Midwestern drought this summer – in which case you should be concentrating your buying on the agricultural commodities – this is another part of the market that appears to offer limited upside potential but plenty of risk and volatility.
Real Estate: Hmm, OK. Last month, the number of homebuyers snapping up existing homes hit the highest level seen since 2009. And prices are rising, too – enough to cause renewed talk of a bubble in some areas. But the problem with real estate – as many have found to their cost – is that it isn’t always as liquid as you might like. And while you may find some appealing REITs out there in which to invest, you probably don’t want real estate to represent an outsize part of your investment portfolio.
Whenever stocks start losing ground, it’s natural to be anxious and even pause to consider whether it’s time to take some money off the table. Are valuations out of line? Are analysts revising earnings growth forecasts lower? Is the economy turning sour?
Without positive answers to some or all of the above, however, doing anything dramatic may leave you with an even bigger problem on your plate than the one you faced.