Get a Grip! How to Cope With Mounting Risk
Sometimes, as I cover the continuing trade war and its incessant round of tit-for-tat tariffs, I feel like Bill Murray in the 1993 movie Groundhog Day, where events keep repeating themselves ad nauseam.
The markets in recent months have risen and fallen according to the whims of trade negotiators. An encouraging press release sends stocks up; a belligerent tweet sends them down.
And so the familiar pattern started to occur again this week, as the markets cheered hints that maybe, just maybe, the on-again, off-again trade war was off again.
President Donald Trump on Monday said that the U.S. and China are “very very close” to signing a trade agreement. Trump went so far as to say that both nations “are going to have a signing summit.”
The suggestion that the trade rift between the world’s two largest economies might end has cheered investors.
Well, I’m gonna have to be the skunk at this garden party.
As an analyst and journalist, I’ve been covering the financial markets since the Reagan era. Over the years, I’ve witnessed all manner of folly on Wall Street. Maybe I’m getting too cynical, but I doubt this optimism on trade will last.
My informed hunch is that talks will again break down and the market will soon resume its manic-depressive ways. The White House is populated with determined trade hawks, the president wants to appease his base by appearing tough on trade, and the Chinese refuse to lose face in any way.
There’s another pattern at work here. The Trump administration is in the habit of announcing with great fanfare that a problem has been solved, but the problem was often caused by White House policy to begin with. Regardless of your political persuasion or party affiliation, it all adds up to one thing: chaos for investors.
It begs the question: How can nervous investors obtain greater peace of mind?
The question is especially relevant for investors in or near retirement. They’re looking for a safety net to protect their portfolios from unexpected gyrations in the stock market. Below, I provide four “defensive growth” measures you can take now. But first, I’ll give you a quick assessment of rising global risks.
A world of worries…
Rising geopolitical tensions, tit-for-tat tariffs, slowing global growth, political dysfunction in Washington, rising interest rates, stirring inflation, a looming U.S. recession — a glance at the headlines is enough to make investors reach for the Valium.
Chief among these concerns is the U.S.-China trade war. This week, progress appears at hand. But as I mentioned, haven’t we seen this movie before? One day the trade war is on. Next day, it’s off. Small wonder that the markets have been so volatile this year.
As we’ve seen so far this week, Wall Street succumbs to wishful thinking whenever a government official makes a soothing statement about trade. Days (sometimes hours) later, those hopes are dashed when the Tweeter-in-Chief posts a tweet that reverses course. Stocks plunge again. It’s a roller-coaster that can be dispiriting for even the most seasoned investor.
But it’s not just the trade war that’s keeping investors up at night.
This week, crucial economic reports are on the docket with the power to roil markets. This market-moving information includes congressional testimony from Federal Reserve Chair Jerome Powell, which concludes on Wednesday. Also on the docket are durable goods orders (Wednesday), weekly jobless claims (Thursday), and core inflation (Friday). Any whiff of negative news could send stocks reeling.
Inflation has shown signs of gathering steam, which has spooked investors. Inflation erodes your wealth. If Trump backs off on tariffs this week, it could keep inflation in check. However, historically low joblessness combined with wage growth continue to put upward pressure on prices.
The good news is that Fed Chair Powell has been sending dovish signals on monetary tightening. For really bad news, look overseas.
Britain’s negotiations to leave the European Union are a mess. The British government is trying to forge a Brexit agreement with the EU, ahead of the March 29 deadline. On Tuesday, British Prime Minister Theresa May and her cabinet debated an extension to the deadline, but the idea is unlikely to pass muster with Brussels.
Britain and the EU remain far apart on Brexit terms. The prospect of a “hard exit” (i.e., Britain’s exit from the EU without a detailed plan in place) is unnerving global investors. The consequences would be disastrous for Britain’s economy and sow uncertainty throughout the global economy.
Meanwhile, Russia and North Korea are flexing their military muscles in regional hot spots overseas, putting pressure on America to defend its interests. President Trump is meeting this week with North Korea’s leader Kim Jong-un. My take on the summit? Don’t expect more than theatrics and photo-ops.
Emerging markets are a worry, too. Developing nations are posting slower growth, as the strong U.S, dollar clobbers their export-dependent economies. Venezuela is coming apart at the seams and Brazil isn’t too far behind.
Far-right political parties are challenging the status quo in major European countries such as Italy and France. The Middle East remains as restive as ever, with Saudi Arabia courting global condemnation for its human rights abuses and Iran seething at the Trump administration’s scuttling of the international nuclear deal.
Oil prices have swooned lately, which unsettles the broader stock market because Wall Street interprets robust oil prices as a sign of economic strength.
See the comparison price chart of U.S. benchmark West Texas Intermediate (WTI) and international benchmark Brent North Sea Crude for the past 12 months (compiled with data from the U.S. Energy Information Administration).
Crude prices have tumbled over the past 12 months, although they’ve lately bounced back somewhat.
Then there’s the U.S. federal deficit. Individuals this tax season are seeing considerably smaller tax refunds, due to changes wrought by the tax overhaul signed by President Trump in December 2017. This nasty surprise is bound to weigh on consumer sentiment.
The sweeping reduction in corporate tax rates temporarily boosted earnings growth but the stimulus is wearing off. Indeed, the consensus projection is that earnings growth for the S&P 500 in the first quarter of 2019 will slow to just 0.7%, compared to the 26.6% pace posted during the same year-ago quarter.
Over the long haul, the rising federal deficits caused by those tax cuts will come back to haunt investors.
The annual deficit is on course to reach $1 trillion in 2019 and will remain above that level for the foreseeable future. We’re overdue for a recession and when it comes, policymakers will be bereft of tools to ameliorate it.
Deficits are a drag on the economy. Investors opt to buy government debt instead of making the type of private investments that generate growth and jobs.
Massive deficits are occurring during the latter stages of a recovery, not during a downturn when stimulus would make sense. When the next recession hits and tax receipts are in free-fall, rates will have to rise to entice investors into buying Treasurys to finance the federal government.
Four Steps for Portfolio Protection
Consider these four defensive moves. They offer portfolio protection, but they also keep you in the game.
1) Use Stop Losses When Buying Stocks
One of the most widely used devices for limiting the level of loss from a dropping stock is to place a stop-loss order with your broker. Using this order, the trader will pre-set the value based on the maximum loss the investor is willing to tolerate.
If the last price drops below this fixed value, the stop loss automatically becomes a market order and gets triggered. As soon as the price falls below the stop level, the position is closed at the current market price, which prevents any additional losses.
A trailing stop and a regular stop loss appear similar as they equally provide protection of your capital should a stock’s price begin to move against you, but that is where their similarities end.
The “trailing stop” provides an advantage over a conventional stop loss because it’s more flexible. It allows the trader to continue protecting his capital if the price drops, but when the price increases, the trailing feature becomes active, enabling an eventual protection of profit while still reducing the risk to capital.
Over time, the trailing stop will self-adjust, shifting from minimizing losses to protecting profits as the price reaches new highs.
2) Diversify Among Stocks and Sectors
Don’t put all of your eggs in one basket. Also be sure to diversify across sectors.
Despite the compelling case to diversify, many investors hold portfolios with assets concentrated in relatively few holdings. This common failure has its roots in lack of knowledge and just plain laziness.
We’re currently witnessing a transition in the market from overvalued momentum stocks to underappreciated value plays, with a focus on sectors that perform well during the late stage of an economic recovery. Now’s the time to follow this trend.
3) Spread Your Money Among Several Asset Classes
Don’t just stick to components of the S&P 500 or the Dow Jones Industrial Average. Spread your portfolio among value, small-cap, large-cap, growth and dividend stocks.
4) Spread Your Investments Geographically
Don’t simply focus on specific country or regional funds, or on emerging markets. The best course of action is to diversify throughout the world through international index funds.
How to beat the odds…
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