Sunday 22 March 2009
How to prepare for the stock market’s coming rebound
It is difficult to think about the good times to come when the stock market is getting pounded day after day. But a savvy investor knows that overestimating the permanence of today’s conditions is a dangerous habit. Such reminders typically come when markets are climbing, but the concept is equally important when the atmosphere is dismal.
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How to prepare for the stock market’s coming rebound
Gregg Wolper
22 March 2009
It is difficult to think about the good times to come when the stock market is getting pounded day after day. But a savvy investor knows that overestimating the permanence of today’s conditions is a dangerous habit. Such reminders typically come when markets are climbing, but the concept is equally important when the atmosphere is dismal.
At some point, the stock market will stage a steady recovery. That could be a long way away, but it might arrive sooner than anyone thinks. But a nice, sustained rally is almost certain to come along. That is not just my opinion; you agree, don’t you? Those of you who have more than a pittance invested in stocks or stock funds - if you didn’t agree, you wouldn’t own them, right?
With that in mind, it makes sense to prepare your portfolio accordingly. For a variety of reasons, there is a good chance that your current positioning is not where you would want it to be if (I mean, when) the market recovers. Maybe your allocations got out of whack because stocks collapsed; maybe you were lucky enough to own stocks in Wal-Mart or Cafe De Coral and their stellar performance during the crash have made their weight in your portfolio much, much larger than it used to be.
You do not necessarily have to return your portfolio to its pre-crash allocations or own the same funds that you did then. Nor do you have to jump in immediately; encouraging mindless optimism is not the aim here. Rather, the point is: at a time when our personal investments are the last things that we want to think about, it is critical to force yourself to look them over. Think about what you want your overall portfolio to look like for the long term and remember that long term will probably include a recovery in the stock market. Then see how closely your current holdings resemble the framework you have in mind.
The values of all types of stocks have fallen so far, in comparison to cash and most bond funds, that even investors who simply stood pat no longer have the allocations that they once did. Late last week, the S&P 500 Index was down nearly 60 per cent from its October 2007 high. By contrast, cash is not down at all, and unless you owned the most disastrous bond funds, they held up much better than your stock funds.
As a result, your portfolio probably has a much lower allocation to stocks than it did before the crash. So, take a deep breath and decide if you still want the same allocation to stocks as you used to have. If not, fine - pick a new number.
Our research finds many top-performing funds during the downturn held fairly substantial cash stakes, but should we be glad to see portfolio mangers holding cash at times? Investors may indicate that they do want managers to have the flexibility to shift assets out of stocks - perhaps holding huge amounts of cash - if they cannot find enough stocks to suit them or if they expect a broad market downturn. And now, it is a good time to make sure that your funds have the policies you want.
When the market rebounds, funds with cash are quite likely to lag. You have to be comfortable with that being the trade-off for protection during declines. If your fund companies’ documents do not provide clear explanations of their policies in that regard, call them up and ask specifically how much cash the manager is allowed to own and what the levels have typically been over time.
At a time when the S&P 500 has lost more than half of its value, it is hard to believe the index has been an outperformer. But small caps and emerging markets have been battered even worse than the big stocks in the United States and Europe. If you did not have much exposure to either emerging markets or small caps during this crash, be thankful.
However, it is important to think ahead. If you want exposure to emerging markets and small stocks when times improve, you may have to take action. That does not mean that you must buy a separate fund for each. Most, but not all, broad international funds have some emerging markets stocks. Small-cap exposure is less common in most core stock funds, so an all-cap stock fund or dedicated small-cap fund might be needed if you want such exposure.
You don’t absolutely have to own emerging markets or small caps. But it is essential to know what you want and know what you own.
Sadly, many people have found out too late the importance of the guideline that stocks, and stock funds, are suitable only for money that they won’t need for many years. No one knows exactly how long a time horizon must be to make stocks the right vehicle. But we can be certain that it is extremely risky to put money into stock funds that you know you will need in a year or two.
So check your timetables again. Decide how much money you will need in which time frame, and allocate it accordingly. Of course, stocks could zoom over the next 12 or 24 months, but the chances are too great that they will decline, resulting in less money in your account than you need for a critical expenditure.
Gregg Wolper is senior mutual fund analyst with Morningstar
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