Safe Plays for Shellshocked Investors

Fear can make settling for low returns seem almost prudent. But seeking safety doesn't have to mean accepting sorry returns, especially at this point in the market cycle.

It's no secret that investor confidence is in the dumps -- again. The dramatic market tumble since April has driven another stake through the heart of America's love affair with stocks. Money has flowed into ultrasafe money market funds and bonds, driving interest rates to levels not seen in nearly 70 years.

I can't say I blame people. Fear and uncertainty abound. But buying safety by settling for low returns is exactly the wrong strategy while the economy continues to expand.

After missing the majority of the historic stock rally coming out of the March 2009 lows, investors finally started to put cash into stocks in March of this year, continuing into April. That was a big change. Individual investors had been net sellers of equities -- selling more than buying -- since the market lows, according to data from researchers at EPFR Global.

Unfortunately, April marked the beginning of a 1997-style foreign debt crisis and the start of a 17.1% decline in the S&P 500 Index ($INX). Just as investors decided to join the rally, the market gods unleashed another torrent. What a bunch of party poopers. Though the evidence suggests this is just a temporary setback on the path to higher prices, the episode added to the revulsion so many now feel toward stocks in general. Msn.Video.createWidget('PlayerAd1Container', 'PlayerAd', 300, 213, {"configCsid": "MSNmoney", "configName": "player-money-articles-16x9", "player.vcq": "videoByUuids.aspx?uuids=5a1bfbc1-35be-4bfc-99ef-613d6a0f4b63,59bdbdac-23e7-9cd7-fc77-e929fba9bbd2,2c93aaec-12b6-428d-a67c-464515e133df,a1a3b642-e0ee-42c8-86dc-057e20b0b2de,c8c30588-7f97-46ab-87f7-66d618c4d494,2a0be08a-2b1a-4ceb-bcc0-434a128fe051,9add67be-7fb0-4474-a8c3-628305a8a75d,e88a871a-cd95-4974-9797-30d758f16e2d,939d74f9-6831-40f3-905b-be9c257da632,15fd2cba-79e0-decd-edda-45e17ee679ac,a1c87324-a933-4100-de64-08e91f1a81bd", "player.fr": "iv2_en-us_money_article_16x9-Investing-Extra"}, 'PlayerAd1');Msn.Video.createWidget('Gallery4Container', 'Gallery', 304, 150, {"configCsid": "MSNmoney", "configName": "gallery-money-articles", "gallery.linkbackLocation": "bottom_left", "gallery.numColsGrid": "3", "gallery.categoryRequests": "videoByUuids.aspx?uuids=5a1bfbc1-35be-4bfc-99ef-613d6a0f4b63,59bdbdac-23e7-9cd7-fc77-e929fba9bbd2,2c93aaec-12b6-428d-a67c-464515e133df,a1a3b642-e0ee-42c8-86dc-057e20b0b2de,c8c30588-7f97-46ab-87f7-66d618c4d494,2a0be08a-2b1a-4ceb-bcc0-434a128fe051,9add67be-7fb0-4474-a8c3-628305a8a75d,e88a871a-cd95-4974-9797-30d758f16e2d,939d74f9-6831-40f3-905b-be9c257da632,15fd2cba-79e0-decd-edda-45e17ee679ac,a1c87324-a933-4100-de64-08e91f1a81bd;videoByTag.aspx%3Ftag%3Dmoney_dispatch%26ns%3DMSNmoney_Gallery%26mk%3Dus%26vs%3D1;videoByTag.aspx%3Ftag%3Dbest%2520of%2520money%26ns%3DMSNmoney_Gallery%26mk%3Dus%26vs%3D1"}, 'Gallery4');You can probably guess what happened next.

As equities spilled into fresh lows earlier this month, inflows into money market funds hit an 18-month high as people pulled their money out of stocks. This cash goes right into U.S. Treasurys, and, as a result, the yield on two-year Treasury notes moved below 0.6% -- a level not seen since 1942, when the Federal Reserve was subsidizing America's fight against Nazi Germany and the Empire of Japan by purchasing government bonds. Compare this with the high of 17% reached in 1981.

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Fear fatigue? Essentially, what this means is that people are so scared about the future that they are willing to give away their money. Inflation currently stands at 1.1%. Translation: Money socked away in two-year notes with a 0.6% return will lose 0.5% a year in purchasing power. Not exactly a solid investment. It's more like investing in quicksand.

And things could get much worse if interest rates climb, because bond prices fall when yields rise. Your actual losses could be much worse.

If this seems like irrational investing, well, it is. These investment decisions are being driven by emotion. You can see this in investor-sentiment surveys. The Rasmussen poll of investor expectations has fallen to levels not seen since last summer's stock market sell-off.

And the CBOE Volatility Index ($VIX.X), the "fear gauge" that is based on the cost of S&P 500 options, had a large jump from April to May as traders snapped up options to protect against stock losses. Aside from a late-2008 jump in the VIX that was associated with the crisis that followed the collapse of Lehman Brothers, this increase in the VIX was the largest on record since the indicator was created in the early 1990s. That's right: The recent panic level was higher than the fear that followed the 1998 failure of Long-Term Capital Management or the 2001 terrorist attacks.

Appreciating the fears many people have but mindful of the dangers of following the crowd into ultrasafe assets that lose money after adjusting for inflation, I recommend that cautious investors now focus instead on solid dividend-paying stocks. Not only do these offer more-attractive yields along with the potential for capital gains, but they are a better fit for where we are in the business cycle. The search for yield There are two important things investors need to know. The first is that, for now at least, it doesn't appear that the economy is tipping into a new recession. The 12-month growth rate of The Conference Board's Leading Economic Index remains in positive territory; company sales surveys in key industries such as airlines and temporary-help services remain elevated; CEO confidence relative to consumer confidence is high.

Instead, the European debt crisis has worsened what would have otherwise been a normal post-recession transition from a stimulus-fueled cyclical economic recovery to a slower, secular economic expansion. I've talked about this in my past few columns.

Continued: Still skeptical?More from MSN Money

Do CEOs know something we don't?

Why to buy stocks and houses now

Could the Dow fall to 1,000?

7 funds for 2010's second half

Wait! Was that the recovery?

 1 | 2 | next >

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Mr. Mirhaydari, I'm a big fan. If Congress were a company it would be in bankruptcy Court. Yet, we all know they will continue spending money we don't have for the foreseable future. We will be saddled with the debt and we really don't have the means to pay it. How do you think this will play out and won't that be a huge headwind for the economy? 

 

Can you write an article to address this topic?

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As equities spilled into fresh lows earlier this month, inflows into money market funds hit an 18-month high as people pulled their money out of stocks. This cash goes right into U.S. Treasurys, and, as a result, the yield on two-year Treasury notes moved below 0.6% -- a level not seen since 1942, when the Federal Reserve was subsidizing America's fight against Nazi Germany and the Empire of Japan by purchasing government bonds. Compare this with the high of 17% reached in 1981.

Fear fatigue? Essentially, what this means is that people are so scared about the future that they are willing to give away their money. Inflation currently stands at 1.1%. Translation: Money socked away in two-year notes with a 0.6% return will lose 0.5% a year in purchasing power. Not exactly a solid investment. It's more like investing in quicksand.

And things could get much worse if interest rates climb, because bond prices fall when yields rise. Your actual losses could be much worse.

If this seems like irrational investing, well, it is. These investment decisions are being driven by emotion. You can see this in investor-sentiment surveys. The Rasmussen poll of investor expectations has fallen to levels not seen since last summer's stock market sell-off.

And the CBOE Volatility Index ($VIX.X), the "fear gauge" that is based on the cost of S&P 500 options, had a large jump from April to May as traders snapped up options to protect against stock losses. Aside from a late-2008 jump in the VIX that was associated with the crisis that followed the collapse of Lehman Brothers, this increase in the VIX was the largest on record since the indicator was created in the early 1990s. That's right: The recent panic level was higher than the fear that followed the 1998 failure of Long-Term Capital Management or the 2001 terrorist attacks.

Appreciating the fears many people have but mindful of the dangers of following the crowd into ultrasafe assets that lose money after adjusting for inflation, I recommend that cautious investors now focus instead on solid dividend-paying stocks. Not only do these offer more-attractive yields along with the potential for capital gains, but they are a better fit for where we are in the business cycle. The search for yield There are two important things investors need to know. The first is that, for now at least, it doesn't appear that the economy is tipping into a new recession. The 12-month growth rate of The Conference Board's Leading Economic Index remains in positive territory; company sales surveys in key industries such as airlines and temporary-help services remain elevated; CEO confidence relative to consumer confidence is high.

Instead, the European debt crisis has worsened what would have otherwise been a normal post-recession transition from a stimulus-fueled cyclical economic recovery to a slower, secular economic expansion. I've talked about this in my past few columns.

Continued: Still skeptical?More from MSN Money

 1 | 2 | next >

Mr. Mirhaydari, I'm a big fan. If Congress were a company it would be in bankruptcy Court. Yet, we all know they will continue spending money we don't have for the foreseable future. We will be saddled with the debt and we really don't have the means to pay it. How do you think this will play out and won't that be a huge headwind for the economy? 

 

Can you write an article to address this topic?

Read Full Article »