Investing in a time of
flat returns
Five strategies for advisors to
consider
This article was
written by John Caspar and reproduced from Forum Magazine, October, 2005
So if the market is prepared to pay
increasingly high prices for a given level of corporate earnings, stock prices
may rise even if earnings don’t, and if valuation levels are flat or falling,
stock prices may languish or even fall despite good underlying corporate
earnings. Consider that in the context
of today’s market – which is hardly busting out with sale prices – and the case
for a mean-reverting period of flat returns seems reasonable.
Now, this isn’t a particularly chipper line of thought, of course. Most folks love a party and many would prefer to believe the bull market will be back any old time now. There are lots of investors who were baptized in the fire of the 1990s bull market and, despite all the unpleasantness at the end, many of those folks still long for the kind of returns they experienced before they got burnt. This whole “lower your expectations” line of thinking isn’t really any fun. But fun or not, every investor needs to consider various probable outcomes and manage the risks associated with them. And if it’s possible or perhaps likely that equity markets may end up simply muddling along over the next few years, well, we need to have a strategy for that. Here are some things to consider:
1. VALUE. Yes, all the fun of the late, great bull market was in growth stocks. But remember the lesson of the pain as the bull market turned bearish. Value investors insist on having a margin of safety built into the price of the stock when they buy it and you should too. Yeah, uh-huh, growth stocks are glam in go-go markets but value stocks have outperformed growth stocks over most long-term periods. So buy ‘em cheap and you will reap, just like Warren Buffett.
2. INCOME. No, not from bonds. From stocks. Yes, capital gains are taxed at a better rate than dividends, so given your druthers you’d prefer the former to the latter. But dividends aren’t just for widows and orphans anymore. In fact, smart investors have always loved them. A big part of the historical return of equity markets have come from the reinvestment of dividends. (And, of course, in periods where there was little price movement in the market, dividends were everything.) If that isn’t enough of a reason to look for income, stocks that pay regular dividends tend to suffer much less when the market turns sough. And no wonder. Everyone loves a regular paycheque.
3. INCOME TRUSTS. Yes, yes, I know. They have had a hot run and there are many that don’t deserve your consideration. But the breadth of choice within this class of investment is growing all the time and there are good reasons to consider income trusts as a fixture in your portfolio. That being said, think of them as equities in terms of risk – and risk management.
4. BONDS. Yep, bonds. You’re certainly welcome to the conjecture that interest rates may rise, thus pushing down bond prices. Although there seems to be little obvious upward pressure on the horizon for rates right now, markets are fickle and that could well change. But simply staying on the short end of the yield curve and laddering your bond exposure will help you manage that risk – and ensure that you get some tasty income to reinvest in the meantime. Remember, if markets trend flat and don’t do much of anything, it’s gonna be all about the income.
5. DON’T INDEX. Yes, indexing can be a very useful strategy when markets are uniformly rising. But in a choppy market with a flat trend, it’s all about the stock picking. (And the income. Did I mention the income?)
If indeed the 2000s end up being a decade of payback for the roaring ‘90s, these are the strategies that you need to consider for you and your clients.
Other articles included this month:
Plan B: Critical Illness Insurance – More and more people are surviving disease, but life insurance only pays out when you check out.
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