The Three Smartest Ways to Reduce Market Risk

Jim Jubak MSN Money August 22, 2011

8/19/2011 7:16 PM ET

By Jim Jubak

You can't even begin to measure all the risk in global equities markets now. But you can reduce your exposure. The stocks that fit into 3 themes should rise even if the global economy stalls.

The past month has reordered global risk and reward.

It's not just that the Standard & Poor's 500 Index ($INX) fell 17.8% from its July 21 intraday high to the Aug. 9 intraday low. Or that the German index, the DAX ($DE:DAX), is down nearly 25% in the past two months. Or that emerging markets such as Brazil and Shanghai spent time in actual bear market territory.

But we've also seen eurozone leaders unable to put an end to the euro debt crisis. We've seen the Standard & Poor's credit rating of the United States go from AAA to AA+. (Fitch Ratings reaffirmed the U.S. as AAA on Aug. 16.) Japan has slipped back into recession. Inflation has topped official targets and has been stubbornly resistant to central bank policies. Economic growth has slowed or threatened to slow in most of the world.

Trends that investors depended upon to value stocks -- or to tell them where and when to chase momentum -- are broken, damaged or threatened.

Stocks are cheap in most of the world's stock markets -- if past trends reassert themselves after a short interruption. If the trends are truly broken, however, who knows? What's a Google (GOOG, news) or a Vale (VALE, news) or a Baidu (BIDU, news) worth if domestic and global rates of economic growth are about to drop by a percentage point or two -- or more?

Jim Jubak

You have the option of stubbornly insisting that things are headed back to normal. Or that growth and stock prices will revert to the mean. But that begs the question of what normal is and where the mean might be.

Unless you're willing to throw out the data on economic growth and performance of individual asset classes from the past decade (or more, I'd argue), it's hard to come up with a long-term trend that can be convincingly projected a decade into the future. And even then, your trend line would still have to come to terms with changes in global demographics and the global economy that, to me, indicate that the next decade will indeed be different.

To the degree I can, I prefer not to make investing a matter of faith or a gamble on alternatives with unknowable odds.

Latest on global recession fears

"To the degree I can" isn't a very large measure right now. For example, I think the most likely range of U.S. economic growth is somewhere between 1% and 2.5% for 2011 and 2012. Doesn't sound like much of a range? Just 1.5 percentage points? Certainly, but the swing is 150% from the minimum and 60% from the maximum. And, of course there's no guarantee that the actual outcome will fall within that "most likely" range. (We've got some recent experience with results that fall into the narrow tail of improbable outcomes, but that nevertheless turned out to be very real.)

And the United States is by no means the hardest economy to handicap right now. Brazil is inflating its own credit bubble, the government's will to restrain wage increases is questionable, and inflation is not under control. In the eurozone, the European Central Bank has seriously damaged its credibility, leaving the restoration of confidence to political leaders who won't lead and to a European Financial Stability Facility that isn't yet ready to go into operation. Indian politics make U.S. politics look like a model of rational discourse. And, while the Reserve Bank of India may be the last adult in the room, any parent will tell you that batting the children around doesn't usually produce good behavior.

I could go on. But I think you get the point.

3 themes for reduced risk

I don't think there's a magic method for bringing reasonable certainty to our projections about the global economy and about most national economies. We're stuck with the fact that these are uncertain times. The result of that, unfortunately, is that it's very hard to tell in most parts of the financial markets, and especially in the global equity markets, what the risk might be. You can calculate the reward but not the risk. That's the investing equivalent of dividing by zero.

Yet I do think there are three parts of the global equity markets where the risk/reward proposition more than just calculable, it's actually in the investor's favor at the moment:

No. 1: Dividend-paying stocks

If the global economy continues to slow, global interest rates will head down, and that will make dividend yields worth more. The value in a 3.5% -- or better -- dividend yield on a stock such as DuPont (DD, news) or Abbott Laboratories (ABT, news) when the 10-year Treasury is hovering near 2.1% should be clear to most investors.

The proposition becomes even more attractive when the dividend is paid in a strong currency such as those of Norway, Sweden, Switzerland, Australia or Canada. Take a look at the 5.1% yield from Norway's Statoil (STO, news) (STL.NO in Oslo). Australia's Westpac Banking (WBK, news) (WBC.AU in Sydney) pays even more, 7.5%. For more on this, see my recent column "How to pick stocks in an ugly market."

I can think of two kinds of downside risk with this strategy. First, the individual company may not be able to keep up the dividend stream. I think you can minimize this risk by buying shares with strong cash flows behind them. Second, the global economy might do better than expected, leading to higher interest rates and higher inflation, which would reduce the value of the dividends. That is why you're also looking to buy strong businesses. Shares of these stocks should go up if the economy grows more quickly than is now anticipated.

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The new normal? They haven't seen the new normal if they continue with this failed trickle down crazy insanity. The new normal, this is just transitive.

If trade is held the same way, it will eventually stabilize.

It will stabilize with the dow being worthless joke either with high super dooper stupid inflation or in case of deflation it just won't be funded anymore-- no one will want paper they can't even get a hold of to wipe their behinds with. And that's just wally world street. On the real world, unemployment 30% or more, and riots, and potential revolutionary wars, possible states succeeding and everything going out like one reverse 4th of July.

FIX our trade agreements, and start offering middle class wage.

I know wally street haters dislike that idea "oh no inflation" like you are so concerned about Brazil. But guess who will be on top for the most part compared to all other countries...drum roll.... Brazil. They have gone against conventional conservative nincompoops with their sugarcane fuel and now with ensuring wages do increase.

You all include jubaka all look like fools. But as time goes by, you are all starting to look like demons from some hell, who will look nicely thrown off a skyscraper or dismembered.

Have a nice day.

0 1ReportSpamMNomad7 hours agoAnd we're supposed to replace Social Security with this quagmire? 1 0ReportSpamSomeone (lo2) Sat 5:30 PMYou will never get wall street to stop computer trading. What has got to stop is short selling number 1 and most importantly! Also. these brokers are already emailing all their clients this weekend on what is going to happen during the week. That is the problem. They already know what the reports are going to say so their clients can get a jump on either the good news or the bad news. Brokers only care about one thing and that is to make money for their clients. They don't care what stock they destroy as long as their clients are happy and continue to do business with them. Call it insider trading or manipulation but that is what I feel it is. The government will not do anything that is going to put tax dollars in their pocket. And if you think that stock watch or the sec is going to do anything guess again. The brokers and traders are way too smart in knowing how far they can push the limit without being caught! We live in one sorry world where the almighty buck reins and people don't care how they make it whether by hook or by crook! 10 1ReportSpamrandall (randy47) Sat 8:47 AM

Wall Street and high speed computer trading has to be stopped on the spot by all economies. This type of trading is nothing more than a sure way to wreck our financial system in its place. At some point a news or event will happen and trigger an event and high speed trading computers will trade us off the map. It will happen so fast every economy will be dead in its track for years to come. The main most important thing is these computers lack the most important thing in there programming and that is common sense in world finances and events. It doesn’t have logic either. I also think it is an unfair advantage of an investor because it manipulates the markets it way only. You are not investing with a common competitor like another investor. You are competing against a machine made to out trade speed a normal human investor. The playing field is unfair!!! I am crying foul!!! Regulators have to step in and shut this type of trading down today. I would think every investor should put a law suit against the people who trade with these units and also Wall Street for uncompetitive business ethics. Investor plain and simple have been raped in the last few weeks!!

18 1ReportSpamFinal WordSat 6:40 AM

Plain and Simple... Now is not the time to do anything but sit on what you have.

...in other words: Buy Nothing! & Sell Nothing!

9 2ReportSpamSomeoneFri 11:29 PMAfter the Chinese Army basketball team - and nobody does anything without the consent of the Chinese Communist Party - beats up the Georgetown squad, after the Chicoms were allowed to study the remains of the US helicopter lost on the Bin Laden raid in Pakistan, after the Chinese train crash that revealed everything about the whole state run economy, after the way they steal overtly or through cyberspace all they can get there hands on and then slap a Chinese brand on it and sell it back to us through Wal-Mart, how can you in good conscience recommend anything to do with this state run "Terror of the Tongs." That's like recommending Coca-cola Stock for all the corn syrup slurping fat people in the US to invest in. 11 1ReportSpamAdd a commentReportPlease help us to maintain a healthy and vibrant community by reporting any illegal or inappropriate behavior. If you believe a message violates theCode of Conductplease use this form to notify the moderators. 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