FOR the second time in less than 18 months, the market has taken a steep plunge and the patience of buy-and-hold investors is being put to the test.
But if investors learned anything from the previous bout of acute volatility — when the Standard & Poor’s 500-stock index plummeted to a low in March 2009 before soaring 80 percent during the next 13 months — it’s that it often pays to remain in the market, even in frightening times.
That doesn’t mean investors must stand pat with their existing portfolios, especially if they’re not well diversified. While the sharp, 12 percent slide in equity prices since April 23 has yet to become an official bear market (defined as a decline of 20 percent or more), “the chances of this correction morphing into a new bear are definitely rising,” said Sam Stovall, chief investment strategist at S.& P.
Even after a strong performance last week, in which the S.& P 500 rose 4.8 percent, the underlying economic optimism that spurred the stunning rally last year seems to be subsiding. “I’m saying to myself that the economy is still getting better, but the healing is going to take a little longer than we thought three months ago,” said David H. Ellison, chief investment officer for the FBR equity funds. “So I’ve become more defensive and have more cash in my portfolio than three or four months ago.”
Raising levels of cash isn’t the only move that fearful investors can make. In fact, they can take several small, tactical steps to position their portfolios more defensively without significantly upending their overall exposure to stocks, market strategists and money managers say.
For starters, investors seeking more stability in their domestic equity portfolios should focus on shares of dominant, industry-leading large-capitalization companies, strategists say.
“When the seas get rough, it’s better to be in a big boat,” Mr. Stovall said.
To be sure, the Russell 2000 index of small-company stocks is flat this year, versus a decline of about 3 percent for the S.& P. 500 index of large-cap stocks. But ever since market volatility surged in late April, small stocks appear to have lost their edge. They’re down more than 15 percent since April 23, compared with the 12 percent decline of the broad market.
Mr. Stovall also pointed out that small stocks climbed significantly higher than large caps in recent months — up 111 percent between the bull market’s start on March 9, 2009, and April 23 of this year. So, he said, “small stocks may have more ground to give up.”
Safety-minded investors should also tilt their portfolios toward stocks that pay dividends and have the financial strength to raise those payouts consistently over time, said Thomas H. Forester, manager of the Forester Value fund, which was the only domestic equity mutual fund that made money in 2008.
That’s because dividends provide investors with modest protection against stock price declines. Indeed, since the start of the year, the SPDR S.&P. Dividend exchange-traded fund, which tracks the S.& P. High Yield Dividend Aristocrats index, is up 3 percent when dividends are factored in. That compares favorably with the 3 percent decline for the S.& P. 500 index including dividends.
Earnings growth for dividend payers also tends to be much more stable than for other companies, Mr. Forester said. That’s an important consideration for investors who fear that this latest economic hiccup could hurt what has so far been a positive period for corporate profit growth.
When it comes to one’s foreign equity portfolio, though, the advice of strategists and money managers can seem a bit counterintuitive.
For instance, given that the slowdown in Western Europe is weighing down the global economic recovery, many investors may be thinking of reducing their exposure to that region. But David R. Kotok, chief investment officer at Cumberland Advisors, has recently raised his stake in certain parts of Europe — namely, northern Europe, where debt worries aren’t as big and where economies are still relatively healthy.
Mr. Kotok points out that healthier countries in Europe, such as Germany and the Netherlands, would also stand to benefit from the plummeting euro, since their exports are now attractively priced for foreign buyers.
Rather than cutting one’s exposure to Europe, he said, investors might consider rebalancing their European exposure through a single-country fund, such as the iShares MSCI Germany index fund, that focuses on healthier parts of the region.
THIS may also be time to consider reducing one’s exposure to emerging-markets stocks.
That, too, may seem to run counter to conventional wisdom, since many investors now favor emerging markets like China and Latin America, where economies are growing much faster than the world economy as a whole.
But Jack A. Ablin, chief investment officer at Harris Private Bank in Chicago, said, “anyone who is bullish on the emerging markets currently is looking at the economies and not the markets.” He added that “there’s often a big disconnect between economic fundamentals and market performance.”
That has certainly been true this year. Stocks in emerging-market countries have tumbled more than 9 percent over the last three months, despite those faster-growing economies. And given that emerging-market stocks are historically more volatile than those of developed markets, it wouldn’t be surprising to see them fall further should global economic worries persist.
Mr. Ablin likens the plight of investors in this worrisome economy to a car riding on a spare tire. “If I’m driving on a spare, I’m not looking for maximum speed — I’m on the lookout for nails.”
Paul J. Lim is a senior editor at Money magazine. E-mail: fund@nytimes.com.
Read Full Article »