While the stock market may be trading near its all time high, the economy isn’t in such great shape. First-quarter GDP was weak given the Q1 contraction of over 2 percent.
Second, while the jobs data appears to be better on the surface, there is evidence to the contrary. For instance, while the unemployment rate is down, the percentage of Americans who have jobs has fallen as well as people who have dropped out of the labor force as Baby Boomers begin to retire faster than young people are entering the workforce. Furthermore, CNBC just posted an article that says that while people are getting jobs who lost them during the Great Recession, these jobs pay 23 percent lower wages than the jobs they lost.
Finally, we are seeing an escalation in geopolitical tension, and this is manifesting itself in economic sanctions. This hurts the economies of all of the players involved, and it even has a residual effect on other national economies.
While we haven’t seen these problems play out in the stock market yet, we are reaching the end of quantitative easing, which has supported the stock market throughout the past 5 years. Each time the Fed stopped its QE program, the market fell. With this in mind, it makes sense to take measures to protect yourself . Here are some tips.
1. Hold Cash
Cash isn’t sexy, but it gives you flexibility. Given that we have an inflationary environment, cash is losing value over time. But at the same time, if you have cash you can take advantage of a market opportunity should one arise. If you own 10 assets, for instance, there’s a reasonably good chance that one or two of them will correct meaningfully in the coming months. You don’t have to know which ones. You only have to know that the odds favor this. Consequently, it makes sense to have cash on hand in order to take advantage.
How much cash should you have? It depends on your situation and your preferences, but if you want the flexibility to make a large move if the opportunity arises, then it makes sense to have 15 percent or more of your assets in cash.
2. Think Globally
Too many investors focus on just the U.S. markets. But there is a whole world out there, and frankly, American stocks are among the most expensive in the world. They also pay very small dividends. Furthermore, while America is supposed to be the land of capitalism, we have extremely high taxes here and innumerable burdensome regulations that stymie business growth and investment. On the other hand, there are plenty of places abroad that have far more business-friendly policies such as Singapore, Sweden, and even Canada. I think that over the long-term, investors will do very well if they invest in these places, especially they take the time to find quality companies. There are plenty of foreign companies that trade on American exchanges through American Depository Receipts (ADRs), and you can trade them just as easily as you can trade American stocks while taking advantage of their governments’ business friendly policies.
3. Watch out for so-called defensive stocks
Defensive stocks are stocks of companies that have stable profits, large global businesses, and brand power. A good example is Procter & Gamble (NYSE:PG). As bond prices have risen — sending interest rates lower — these stocks have risen because their income is considered to be nearly as safe as bond income. The trouble is that these stocks have been bid up too high, and I don’t think they are defensive anymore. Many of these companies are not growing its profits, and yet they trade with price to earnings multiples that exceed 20, or even 25 in some cases. This is extremely dangerous, and if bond prices fall as quantitative easing comes to an end these so-called defensive stocks can lose you a lot of money.
4. Hold gold and silver
Gold and silver are widely misunderstood assets. They are also undervalued after experiencing massive corrections over the past couple of years. Given this correction, these assets are widely despised as investors are confident that stocks will continue to appreciate indefinitely. This, of course, is highly unlikely.
Gold and silver perform many portfolio functions. First, they are excellent inflation hedges. Second, they are uncorrelated assets, meaning that if stocks and bonds fall in value gold and silver will probably keep their values, if not appreciate. Third, they are excellent hedges against geopolitical conflict, which we are seeing a lot of nowadays. Finally, as the dollar becomes a less important part of the global economic system, many central banks are loading up on gold in order to diversify their holdings. This is going to provide a lot of support for the gold market.
With this in mind, every portfolio should have some gold and silver — at least 10 percent, if not more. Silver is more of an industrial metal, and it is also more volatile. Thus, it is more suitable for aggressive investors. Gold is a better fit for conservative investors.
Disclosure: Ben Kramer-Miller has no position in any of the stocks mentioned in this article.