Investment risk is going up for new equity positions and it’s mostly because share prices are strong. The stock market continues to trend higher, because earnings are good and because there’s a fair amount of hope for the future. We also have very accommodative monetary policy and a lack of alternative investment opportunities that can beat the rate of inflation.
But, I repeat; investment risk is going up and there are a lot of structural issues in the global economy that can derail all the recent progress in equity prices. The biggest issue remains debt—sovereign debt and the potential for currency havoc if there are country defaults. In a Bloomberg survey of investment professionals, a majority of those surveyed believe that Greece and Ireland will default on their sovereign obligations sometime this decade. With the exception of war, sovereign debt (abroad and at home) is the single greatest risk to capital markets and, make no mistake, if currencies begin to destabilize, so will your pocketbook.
The problem we continue to face with this issue is that the fixes so far have been for other countries to pool their resources and bail out the offenders. But these bailouts are occurring with borrowed money. So, we have a situation where bailing out poorly managed countries is being done so by piling debt upon debt without really addressing the other side of the equation—spending. It’s a real pickle, because no politician wants to tell the people that their pension benefits are being cut in order to control the deficit. This is an issue that has to be dealt with this decade, because the risk of not doing so is so great.
So, in an environment where investment risk is going up for taking on new positions, the good news is that there’s no rush to take any action. The key going forward is all about protection, not absolute returns. This means a conservative stance in equity markets and, yes, a healthy allocation to gold and other resources. And by conservative, this doesn’t mean that you can’t take some risks. But, recent history has proven that some of the best performers in the stock market have been from such unadventurous, high-dividend-paying companies like DuPont (NYSE/DD) and ConocoPhillips (NYSE/COP).
As you know, the price of gold has been modestly retreating of late and it’s because the dollar’s been stronger and institutional speculators have been taking some money off the table. I’ve got no problem with retreating gold prices. It only makes a new entry point that much more attractive.
There’s more chatter nowadays about the potential for a higher growth “super cycle” in the global economy. Whether this happens over the coming years is irrelevant. The most important thing to worry about now is risk, not expected return. This won’t change until the sovereign debt issue is gotten under control.