The Federal Reserve’s ace policymakers made clear this week that they want to keep their options open. “Committee participants want to make sure that we have the flexibility — that the committee has the flexibility to respond to unfolding developments,” Fed Chair Janet Yellen said primly at her press conference this past Wednesday.
Indeed, much of Yellen’s analysis felt — logically enough — an exercise in “on the one hand; on the other hand.” What the Fed does with rates will depend on what happens to the economy: the better the growth rate, the faster the Fed will move to boost rates, and vice versa. Above all, Yellen argued, the Fed doesn’t want to be “locked into” any kind of forward guidance outlook.
That still leaves investors facing the potential twin terrors of a secular revolution in the bond market triggered by the Fed’s eventual decision to raise rates and a cyclical shift in the stock market after a long bull run. Unease about stock valuations is growing. “Everyone’s greedy,” venture capitalist Bill Gurley told The Wall Street Journal recently. No shocker there — this is the stock market, where if you’re not being greedy, you’re cowering in fear — but the amount of greed in riskier parts of the market, like fledgling biotech and technology companies, has risen to new highs. The IPO market, too, has been on a tear this year.
So what’s an investor to do? Well, if the Fed wants flexibility, you should too.
The first step might be to go back to basics and rethink it. Stop viewing it in terms of rigid asset classes that do certain specific things at certain specific times, and instead look for investments that have that same characteristic that the Fed itself prizes: flexibility.
So, avoid chasing high-yielding bonds and high-growth stocks that can only reward you in one way. Odds are that at this stage of the game, you’re buying one source of return at a premium price. Look around for alternatives.
Bonds: Bonds still have a role in any portfolio because, let’s face it, you can’t reinvent the wheel. You just won’t be able to expect quite as much from them. So, instead of counting on them for capital gains, look at them as a kind of cash cushion or a safe haven, and perhaps a source of liquidity down the road, as well as a way to get at least a little bit of yield. But keep durations toward the shorter end.
Master Limited Partnerships: MLPs have sprung to prominence as a result of the boom in shale oil and gas exploration and production and the use of “fracking” technology. Setting to one side the environmental issues associated with fracking, many of these new fields have been in areas that don’t have the infrastructure that is required in order to extract, transport and store all the new production. That’s where midstream companies — often funding their operations via MLPs — come in, creating investment products that have fared well even as energy prices have been volatile. While Kinder Morgan (NYSE:KMI) has taken the step of rolling up its MLPs into a corporate entity, analysts don’t believe that marks the beginning of a big trend: There are plenty of opportunities for investors in these high-yielding hybrid securities that offer a combination of growth and income.
Large-cap, high-quality stocks: On an inflation-adjusted basis, the S&P 500 is still trading below where it was in 2000, at the peak of the dotcom bubble. Does it matter that Charlie Munger, Warren Buffett’s right-hand man, hasn’t found a stock that he wants to add to his personal portfolio in more than 2 years?
If you’re willing to own a business for the long haul — Buffett style — and acknowledge that there will be ups and downs in the broader market, then there probably are some values out there. Look for earnings growth rates that are consistently higher than that of the broader market and a company that has a track record of increasing dividend payments. That way, even if the market turns turtle and you’re not collecting much in the way of capital gains, you’ve still got that dividend income stream. Remember, it’s all about flexibility.
Each of the three ideas above offer you different ways to profit from the same investment. An MLP can generate either income or capital gains, and so can a blue-chip stock. An intermediate-term Treasury bond can generate a tiny amount of yield, can be a safe haven in times of stress and can serve as a source of cash when you spot a great investment idea somewhere else.
Can the investment idea you’re pondering be that versatile? If not, it may be the wrong addition to your portfolio in the current environment.
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