Now that many stock ETFs and funds have risen as much as 125% since the March 2009 lows, and perhaps about 15% from the June 1, 2012 low, should investors add to their stock positions, simply do nothing, or perhaps take some off the table? This question becomes even more complicated in light of the Fed's recent statements which are, in part, designed to push investors into riskier asset classes, including stocks.
In my July 2012 Newsletter, I recommended what some might consider a high allocation to stocks -- 67.5% for typical (Moderate Risk) investors. Once again, right now, all I can do is report what both my interpretation of ongoing events and my long-standing research suggest to me: Stocks remain one's best chance of both earning positive, inflation-beating returns, and coming out ahead of alternative investment classes (i.e., bonds or cash). Withdrawing money from stocks in the hopes, perhaps, of returning at some "later" time is a lot less likely to be successful.
Naturally, every investor's circumstances are different. For example, some investors may either be approaching retirement or already in retirement. Within this group, some investors may appraise that, while they are where they currently want to be with regard to their total overall assets, a serious and necessarily long-lasting drop in stocks might put them in jeopardy of not having enough in the years ahead. Such individuals might well feel that the risks associated with stocks might not warrant taking too many chances going forward.
In other words, further gains, while perhaps on the horizon, are not as strong a motivating force as the risk of possible losses. But for those individuals who have many years before actually needing to tap their retirement funds, or who still need to rely on further growth in their portfolios to meet their long-range objectives, significantly reducing one's allocation to stocks at this time would seem to be a mistake.
Regardless of the effects of the Fed's actions on other investors' behavior, one needs to decide for oneself what makes the most sense for you. The following discussion reflects my new Model Portfolios for October 2012. It will try to shed some light on what I think will be the best directions for investors' portfolios over the next year or two.
If you tend to follow an asset allocation model for stocks, bonds, and cash, such as I present on my website every quarter, your percentages divvied up to each of these broad asset classes may have changed over the last year even if you took no action at all. This is because whatever you allocated to stocks has likely grown much faster than bonds or cash. For example, if you had 60% in stocks a year ago, 32.5% bonds and the rest in cash as we had recommended at that time, your current allocation to stocks might have risen to as much as 63% today, while your allocation to bonds would have gone down several percent as well. (If you held a large position in international stock ETFs/funds, your returns over the last year would be less, and consequently, your current stock allocation would have grown less as well.)
The following tables show where you might want to have your allocations now. As you can see, the only change from our last Model Portfolio is a slight upward adjustment in stock allocation for conservative investors.
For Moderate Risk Investors
Current (Last Qtr.)
For Aggressive Risk Investors
Current (Last Qtr.)
For Conservative Investors
Current (Last Qtr.)
Note: We realize that many conservative investors may recoil at our high recommended allocation to stocks. Obviously, there are many routes investors may elect, and only time will tell which allocation will turn to be the most ideal. And, of course, one must take into account one's comfort level -- not just potential returns. But investing in stocks will always require a certain "leap of faith."
Possible Effects of Fed Quantitative Easing on Your Investment Choices
On September 13, the Fed announced it would go further than it ever has to attempt to change the course of the economy, which has been stuck in low gear. So the question becomes what effect, if any, might this radically new policy potentially have with regard to creating an ETF/fund portfolio designed to deliver decent returns while always being mindful of the risks over at least the next year?
Is it reasonable to expect the new Fed actions -- also known as "QE3" -- to boost stock prices even further, as they did for the two previous versions of QE1 and QE2?
I believe that given that QE3 may go on for years, it is likely that it will serve as a prop under stock prices, since low interest rates almost always work as a stimulant to stocks. Not only is there the potential for stimulus, but many investors sitting on the sidelines are realizing more and more that they can't make a decent return in either cash or many types of bonds. Therefore, like it or not, they will essentially feel "forced" to take the plunge into stocks.
Not all types of bonds will necessarily suffer. Any ETFs/funds that pay a somewhat higher yield should be the main beneficiaries. These include high yield bonds, corporate bonds, and possibly, municipal bonds and emerging market bond ETFs/funds that have higher yields than government bonds, the latter of which include U.S. Treasuries. Investors should emphasize mainly intermediate, as well as some longer-term bonds, rather than short-term bonds whose yields are low and likely going even lower. (Lower bond yields can create capital gains, but such gains should be greater for longer-term bonds.) While we view the bond investor's enemy, -- inflation -- as still quite unlikely for the next several years, inflation-protected bonds (OTC:TIPS) are still a better way to go than Treasuries.
Since the Fed is specifically going to be buying mortgage-backed securities, we expect that bond ETFs/funds featuring them, such as Vanguard Mortgage-Backed Securities (NASDAQ:VMBS), may do somewhat better than expected, too. According to published data, the world's biggest and most successful bond fund over the years -- PIMCO Total Return Fund (MUTF:PTTRX) and its sister ETF (NYSEARCA:BOND) -- each now has close to a 50% position in mortgage-backed securities, suggesting this assumption is likely valid.
As far as the types of stocks, and therefore, the type of stock ETFs/funds that should profit most from QE3, we compiled a list from several knowledgeable sources, and here are those that we see frequently being recommended:
1. Income/dividend producing stocks
2. Natural resources, including precious metals, energy, and commodities
3. Real estate
4. Emerging markets
5. Cyclical stocks (i.e. those closely tied to the growth of the economy), including financial and consumer discretionary
6. International Stock ETFs/funds that profit when the dollar is weak
Of all stock ETF/fund categories, those with a Large Value orientation appear to have the best prospects going forward. This would also include ETFs in the Financial sector, such as Vanguard Financials ETF (NYSEARCA:VFH).
Incidentally, investors seem to have become much more confident that the eurozone is getting a grip on its problems lately with the European Central Bank having recently come out with a bond-buying program of its own. The region remains highly undervalued in our estimation, and we would, therefore, regard it as one of the best buys out there for long-term investors.
Disclosure: I am long VFH. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.