With the ups and downs of the stock market smoothed out, investors might be ignoring its inherent risk. Is this the lull before the storm?
They are worried that with the ups and downs of the stock market smoothed out, investors are ignoring its inherent risk. The stock market is high while its volatility is low, and bond yields are virtually nonexistent. Is this triad of information telling us something?
Indeed, some people think it is. They are worried that with the ups and downs of the stock market smoothed out, investors are ignoring its inherent risk. They are anaesthetized.
Additionally, there are few places to turn other than to stocks because bonds, the usual alternative, glean virtually no yield. This pushes investable money toward stocks while ignoring the danger of them.
Recently, all of this was brought home to me when I was forced into thinking about my own options regarding new money. My husband and I had cash from the sale of our New York City co-op, but deciding how to place it was a challenge.
Initially, I anticipated I could tap into some reasonable paying short-term bonds (hope springs eternal). However, after talking for some time with my bond broker from TD Ameritrade, I found this wasn’t possible unless I took more risk than with which I felt comfortable. Investing in a toppy stock market didn’t look so good either. This is how the conundrum was solved.
Our 2007 crisis was preceded by a decline in stock market volatility. So was the 1997 Asian financial disaster. My worry is that this could be happening again. This is especially true since the Fed and the Bank of England plan to lessen their efforts to bolster their respective economies.
Chart of the volatility of the S&P (VIX) from 2005 to present. Volatility is low now just as it was before the 2008-2009 financial crisis.
The stock market fear index is called the VIX (please see above). This parameter of anxiety related to the market could be described in clinical terms as an indication of the pulse of the market. When the VIX is down, heart rate and blood pressure are low and investors aren’t worried. When it is up, these cardiovascular measures increase and investors fret.
As long as nothing happens to increase the VIX (think a repeat of 9/11 or a similar event) the market will, in all likelihood, continue to go up. But, if there is an unexpected negative event, the VIX will increase and at least some investors will pull out of the market. Then, the S&P, Dow and NASDAQ will drop.
History repeats itself
In reviewing my past columns, I find that I went through the same machinations for new money in April 2013, roughly 14 months ago. At that time, I recommended stocks with generous fallback cash reserves offset by debt that also had inside ownership.
If a reader had invested in them, that portion of her or his portfolio would be up about 30% since (as is the general market). This demonstrates how it can be damaging to a portfolio to avoid risk altogether and stay out of the market.
The squishy decision
Given all these dynamics, rather than let our money lay fallow, I’ve decided to make a choice that incorporates extremes instead of making no choice allowing our cash to sit.
Half will be placed in the stock market and the other 50% will be assigned to safer, though low-paying alternatives. These include short-term municipal bonds and a money market. The latter will be waiting for the right occasion to be invested.
In doing this, I know I won’t be as rich as I could be if I were more bold and if the market continues to rocket forward. However, I won’t become as poor as I could if it tanks.
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