The Ignorant Investor

Ignorance Can't Stand in the Way of My Opinion

Monday, March 14, 2011

 

Which way is the market headed?

There's a lot of discussion in the financial press about whether the market will head higher or is about to tank. This is one of those decision points that come after a good runup in equity prices. Studies show that ignorant investors like me tend to feel most comfortable buying stocks after a long period of rising stock prices. We get in on the end of the rally just as the professionals are getting worried and moving out of them.

About two months ago I went from about 60% equities up to 80% equities, just as the trend line in the S&P 500 was turning sideways. I haven't made much money by making this move, and I've increased my exposure to a correction. So I'm acting in line with the expectations of behavioral economists.

The standard advice in dealing with this kind of decision-making is to pick an allocation among asset classes that fits a risk profile and then stick with it mechanically. This removes the need to make decisions that, at least in the case of ignorant investors like myself, tend to be mistimed.

The dilemma I'm in now goes to setting those basic allocations. We're in an unusual investing environment because of the Federal Reserve's policy on low interest rates, savings accounts and short term bonds offer almost no returns. Worse, the rates are lower than the inflation rate, meaning that every dollar left in a savings account is losing purchasing power as time passes. This has pushed up the equity markets, and it's difficult to fight the Fed on the issue. If they want to make stocks more attractive than bonds, they've got the power to do that.

Now the question is how long the Fed can maintain such low interest rates. Conventional wisdom suggests that when rates go higher, long-term bond funds will get hammered, and the stock market will lose the help of the Fed in pushing the indexes higher. So bond funds are at risk and stock funds are at risk. For the ordinary investor who doesn't have access to, or the familiarity with, exotic investment vehicles now in vogue with hedge and pension funds, there aren't many other options to choose from. A savings account will protect capital from loss, but while the money is on the sidelines its purchasing power is trickling away even in a time of low inflation. If inflation increases, it only gets worse.

So what's left? Real estate?





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