Does Risk Trump Returns in This Stock Market Environment?
Going by the choppy trading action this year, investment risk with equities is going up.
Recent shocks to the system include events in Ukraine and Crimea, Chinese economic data, and Citigroup Inc.’s (C) failed stress test.
This is a very uneasy stock market, and because the main indices are right around their highs, any shock has the potential to deliver a serious haircut to asset prices. The choppy, trendless action combined with full valuations is the reason why I’ve been advocating taking profits from speculative positions. This stock market is just plain tired out.
First-quarter earnings season is just around the corner, and while it’s looking like we’ll get more of the same from corporations (a meet-or-beat on only one financial metric, revenues or earnings) the stock market needs more than dividends and share buybacks in order for share prices to keep appreciating.
Blue chips, especially, have been coasting along, providing single-digit earnings growth on modest sales. The icing on the cake has been the rising dividends and share repurchases, which the stock market has eaten up over the last two years.
But sentiment is slowly changing regarding share repurchases. Big investors want to see more than these financial tools in the businesses they own. Rising dividends are always great, but you need underlying revenue and earnings growth to sustain the case. And in order to do so, corporations have to make new investments. They’ve been very reticent to date.
Healthy balance sheets are always desirable, but new business investment and innovation is what creates wealth over the long-term. Everything’s been short-term thinking the last few years, and companies themselves have been trying to please the stock market by providing easy financial enticements in what’s still a slow-growth environment.
I remain highly cautious about the stock market very near-term, until we get into the heart of first-quarter earnings season. You can just sense the nervousness in the trading action.
If anything, now is the time to keep or raise the cash component within equity market portfolios. There’s plenty of good companies in which to invest, but this stock market is long in the tooth, and it needs a bit of a reset.
We’ve seen biotechnology stocks cut significantly just over the last few days, and this is definitely a sign that speculative fervor has diminished. (See “Risk vs. Reward: Is It Time to Cash Out of This Bull Market?”) It’s also a realization by the marketplace that stocks can’t go up forever. Biotechnology has been one of the top-performing stock market sectors since the March 2009 low.
When the prices for financial securities drop, it’s a good reminder of just how important the role that risk plays is in a portfolio. Tactical asset allocation, meaning the ability to adjust your exposure to risk by attributing more or less weight to particular stock market holdings, is absolutely key.
Dividend-paying blue chips remain holds. But I would be reticent to commit new capital to this market in what clearly is an environment fraught with the potential for a serious revision in equity asset prices.