By Brian Boughner
Ned Stark definitely knew something when he declared, “Winter Is Coming.”
Is the same true today with our economy and markets? Is winter coming? And are you prepared for it? Global stocks and bonds are experiencing volatility right now and there is an unease starting to set in with asset prices.
Here are four important things we know:
Interest rates and inflation are on the rise. This is important because they have both been declining since 1981… 37 years! Most people who are alive today have never experienced what a rising inflationary interest rate environment even looks like and have no idea how to prepare for it.
We are in one of the longest stock bull markets in history without a meaningful correction. When the next correction happens, you will need a rules based risk management plan in place to ensure you don’t make emotional decisions at precisely the worst time.
U.S. Stocks are highly valued. While valuation is never an ideal timing tool, it has done a great job predicting forward returns over the next 5-10 years. With the current Shiller PE ratio of the S&P 500 at 30.72 which translates to 90%, history tells us that forward returns could potentially be in the 0 to 3% range.
FOMO as a strategy. FOMO, “fear of missing out,” is when an investor sees everything going up around them and says, “I have to buy something or I’m going to miss out.” This strategy has led to more declines in net worth as these investors pile on near the top with no regard to risk.
The truth is we can’t predict the future, but being prepared for a recession or market correction is a mark of being a prudent investor.
Here are 3 steps you should be taking today.
Implement a rules based risk management strategy. A rules based risk management strategy is where you create a set of rules to follow in a bear market to reduce your risk. These rules help reduce your market exposure while also preventing you from selling at the worst possible time.
Create some liquidity in your assets. Real estate prices have been moving higher here in the Upstate and we have seen lots of people buying in recently. The problem is that if most of their assets are in real estate when the market corrects, they will not be able to sell and have cash available to take advantage of new investment opportunities at lower prices.
Be truly diversified. True diversification means owning uncorrelated asset classes like stocks, bonds, real estate, commodities, and international. Most people who think they are diversified actually a majority of their portfolio with U.S. domestic large company stocks. This now happens to be one of the most expensive markets in the world.
Ask yourself, “Do you believe what has worked in the markets over the past 10 years will work for the next 10?” If you do, then keep on rocking with what you have. If you don’t believe that summer lasts forever and winter eventually comes, then take some of the advice above to heart and prepare wisely.
Brian Boughner CFA, CMT, Parallel Financial