The greatest problem confronting the investment community is what to do.
Investment advisors, if they are bright and have integrity, must acknowledge that they are baffled. Never before have the alternatives been so fraught with risks.
In general, the financial industry is optimistic. Stock markets in the developed world have been very strong for many months. The Canadian market has been laggard, in sharp contrast to the Japanese counterpart.
Foremost, the positive attitude appears to be based on the conviction of the expanding economy in the United States. That assumption is flawed.
First, it looks sluggish at best. The head of the International Monetary Fund has just stated that the economy is going through “a soft patch.”
History shows almost no correlation between GDP growth and equity returns. The strong gains in the U.S. market have been “sustained” by the slowest growth of all the rising markets since the end of the Second World War.
The reasons for the buoyant market are many. Notably, the huge amount of liquidity/funds supplied by the U.S. central bank, about $85 billion per month. Those funds are sloshing around the economy, searching for a place to go. Then too, the economy has not collapsed in the Eurozone, even though many of its members are in a precarious economic state. This has removed one worry.
Another explanation for the climbing stock market is that the other alternatives are so uninviting. Cash yields are tiny, and with inflation and taxes, the returns are negative.
Many investors have avoided the equity market ever since the 2008 Great Recession. Volatility has scared them.
Articles such as one in Maclean’s have proclaimed we are on the verge of a many-year bull market, rivalling the one in the decades following 1980 or even the market of the 1920s. Few seem able to resist the lure of a compelling argument, and speculators are even anxious to capitalize on a trend, even if it is a fleeting one.
Hedge funds have been dumping commodities as “last year’s story” so almost all commodities are significantly lower.
Conventional wisdom infers that inflation is dormant, but any objective observer would acknowledge that prices indeed are rising. Hence, the Federal Reserve will have to raise interest rates inevitably – if not imminently. This will hurt the equity market, which, in any event, adjusted for inflation is expensive.
This columnist has been a long-term believer in gold and now considers it a good time to invest there. Another alternative would be to begin to purchase dividend-paying stocks that provide some return, but many are overpriced.
Thus “caution” should be the watchword and cash reserves seem prudent.