With the market managing to slough off events that would, in normal times, trigger substantial downdrafts, it makes sense to pause and wonder how much longer this might continue. If it makes sense to do some fine tuning of an investment allocation, it is best executed in the calming atmosphere of a bull market as opposed to waiting until we appear to be going to hell in a hand basket.
While stock prices remain in record-high territory, there is more than a toe-hold of rationale for why that good fortune persists — starting with a growing world economy, stock buybacks from corporate tax savings, record corporate profits and a consensus view that all of this will continue into the future. What could get in the way is something called “event risk” — the possibility of an otherwise unlikely event that we can’t predict today. Back in 2008, this was chronicled in a book called “Black Swan” by Nicholas Taleb, which illustrated the way that unpredictable events can come out of the woodwork to wreak havoc on our best-laid plans.
Take the banking collapse for example: Alan Greenspan and other political leaders at the time thought that regulations could be relaxed because “businessmen would never make decisions that would threaten their long-term self interest.” Little did they anticipate that short-term interest, otherwise known as “greed,” would become the operating principle of the investment banking industry — an industry promptly allowed to leverage themselves 30 to one. In other words, for every dollar of their own money, they suddenly could borrow $30. So if they lost just 3 percent, their equity was wiped out — which is exactly what happened.
Some recent comments from Bill McNabb, the chairman of Vanguard, caused me to pause when I read them recently. He suggests that over the next 10 years, bonds may actually pay a higher rate of return than stocks — an opinion based on what he feels are irrational market values today. Young people with years to retirement can ignore that opinion because lower prices over the next 10 years would be a good opportunity to be investing regularly, but older folks should probably think about hedging their stock bets with an increased bond component.
The question is, “Which bonds?” I have always been partial to high yield corporate bond funds that are at the conservative end of the high yield spectrum. The largest mutual fund companies all offer high yield products that meet that objective. The interest rates are currently in the 4-5 percent range and the share prices of the funds can fluctuate but revert to the norm sooner or later as bonds held by the funds reach maturity and are replaced.
Another source of higher yields can be found in emerging markets bond funds. These bonds are loans made in countries like Brazil, Russia, India, China, and about 20 other new economies. Yields can be higher than those of domestic high yield bonds. Again, however, these funds can experience fluctuations in capital value based on demand, currency exchange-rate changes and even geopolitical events.
As for black swan events, we need look no further than Washington for what may be the source of the next one. Trade wars, for example, are not “easy to win” as we learned back in the ’50s and more so in the ’30s. Moreover, they are difficult to end once they start. By the same token, a weak dollar is not a good thing for foreigners with investments in our debt or in U.S. assets of any type.
Beyond a lack of basic understanding of economic issues, those deliberately turning a blind eye to further destruction of our electoral system are creating a deep, dark black hole — a nutrient-rich breeding ground for the next black swan.