Investor Q&A: We’ve Got Mail

In classic movies, a montage of overflowing mailbags often represented the power of public opinion. Either that, or someone would run into the room and shout: “The switchboard is lighting up!”

The Investing Daily team gets lots of feedback, too. In this digital era, our letters mostly arrive in the form of emails, although from time to time we receive a hard copy letter via snail mail.

Here are my answers to a few recent emails that particularly caught my eye.

All that glitters…

“Good Morning John. Love your column. Look forward to it almost as much as my morning joe. You mentioned a 10% bond allocation as a stock hedge. If memory serves you have mentioned same in the last month or so. I’m curious as to why not gold, especially gold mining stocks. As I’m sure you are aware, gold has seemingly broken out and is on a tear. Maybe a barbarous relic no more. Thanks in advance.” — Gary G.

Thanks for your loyal readership. Actually, in recent months I’ve recommended gold as a hedge. The yellow metal is a time-tested safe haven against crises, which are multiplying with each passing day.

Hey, we’ve all seen the marketing pitches: Portfolio-destroying inflation is around the corner! Stock up the bomb shelter. Buy gold.

But here’s the twist: The perennial gold bugs are getting vindicated, as gold prices enjoy upward momentum. Inflation really does pose a threat. I can’t confirm the need for a bomb shelter, but I certainly advise you to gain exposure to gold.

During the Great Recession of 2007–09, the worst economic downturn since the 1930s, gold prices rallied from $840 per ounce at the end of 2007 to over $1,200 by the end of 2008, even though inflation over this period stayed in check.

The conditions that are favorable for gold will prove fatal for overvalued stocks that are looking for a trigger to tumble. The rule of thumb is that gold should make up 5%–10% of total portfolio assets, as part of your hedges sleeve.

Gold and other precious metals should shine as market volatility increases; mining stocks provide greater leverage as the underlying hard asset appreciates.

Hedging your bets…

“In your allocation model you say you have 25% in hedges. What do you consider hedges to be?” — Alvin K.

I define “hedges” as precious metals (see Q&A above), real estate investment trusts (REITs), and commodities, among other investment classes. Your choices depend on your investment profile and how much risk you’re willing to shoulder.

According to some financial industry studies, about 90% of portfolio performance is related to asset allocation. That’s an eye-opening statistic.

Of course, in a bull market, your allocation should emphasize stocks. In a bear market, you should lighten up on stocks in favor of bonds and cash. And in a transitional market that’s “in between,” you should strike a balance. At all times, your portfolio should steer clear of overvalued equities.

For general guidance on how to divvy up your portfolio under today’s conditions, take a look at the following chart:

These allocations provide a sturdy defensive growth posture that keeps you invested but doesn’t leave you too exposed.

An appealing hedge right now that often gets ignored by investors are assets linked to agricultural commodities.

By investing in plays that benefit from sweeping global transformations, you can settle in for the long haul and tune out the white noise about fluctuating indicators.

The confluence of four relentless trends — political turmoil, agricultural destruction, population growth, and an expanding global middle class — make agricultural assets effective hedges against inflation. For convenience and safety, consider benchmark exchange-traded funds that hold stocks of companies involved in agriculture.

As a direct hedge against inflation, consider Treasury Inflation Protected Securities (TIPS). These are government securities that pay interest, but also adjust the principal based on the Consumer Price Index (CPI).

Goldman Sachs (NYSE: GS), Morgan Stanley (NYSE: MS), and JPMorgan Chase (NYSE: JPM) are all predicting a sell-off in the stock market of at least 10% in the third quarter. Keep plenty of cash on hand, for the bargains that are sure to arise if and when the correction occurs.

Seeking value…

“Thanks for your July 29 article. It got me thinking of selling my large cap growth ETF to fund a large cap value ETF.” — Steve G.

Securities law prevents me from providing personalized advice. But generally speaking, I’ve recently written about the wisdom of re-balancing your portfolio away from overvalued growth stocks and toward value plays, especially in sectors that perform well during the late stage of an economic recovery (e.g., real estate, utilities, energy, and consumer staples).

Now’s a good time to pocket at least partial gains from your biggest winners; overvalued large-cap tech stocks are good candidates. Elevate the cash level in your portfolio to at least 15%.

And yes, now’s the time to emphasize value. By investing in value stocks, you’re essentially buying a built-in gain and/or a safety net. The smallest bit of good news can propel the stock up to a fair price. Even significant bad news doesn’t necessarily bring the price down. In many cases, the stock is undervalued because such bad news was already anticipated.

Overvalued stocks, or even some fairly valued stocks, are highly susceptible to bad news and don’t always respond as expected to good news. Surely, you’ve held a stock that released quarterly earnings that “met expectations” and proceeded to get hammered.

We’ve seen this dynamic play out during the current earnings season. In the subjective expectations game of Wall Street analysts, sometimes good isn’t good enough.

Questions or comments? I enjoy receiving and answering your letters: mailbag@investing

John Persinos is the managing editor of Investing Daily.