To extend on my "Where To Invest 2007" series, the big economic picture continues to look bright as we finish the first month of the New Year, especially when viewed through the rose-colored glasses of media pundits. As you might imagine, I read a tremendous amount of daily, weekly, and monthly periodicals as well as websites and blogs dealing with investments, the economy, and personal finance. After pouring over all of the forecasts for 2007, I do not recall seeing a single one that is negative on the economy, its outlook or the direction for stocks. Hey, that's not so bad. Right? Not so fast. While the masses may be right most of the time, they can not all be right at the same time for long. Let's get into some philosophy and simple macro-economic observations to better explain just what I mean...
"No one goes there nowadays. It's too crowded." -- Yogi Berra
If you do not already know this, mass movements in one direction increases energy to move in the other. Think of your lessons in physical science -- a pendulum that swings back and forth. I do not believe that the market is currently "too crowded" as Yogi Berra quips, or that the pendulum is about to swing in the other direction as measured by the type of euphoria that signals a peak for stocks; but I do believe that the current overwhelming optimism over the direction for stocks sends the signal that the end of this Bull Market is closer than many of the talking heads will openly say.
Here are a few macro-economic observations that tell me defensive moves are prudent now:
- Margin Debt is Near Record Highs -- Margin (borrowing money to buy stocks) is not necessarily a bad thing. It only becomes a concern when it is higher than usual. As of November 2006, Margin debt was around $270 billion, which is just short of the record set in the year, 2000. Think along the same lines as your neighbor who moved in two years ago and used a three-year "interest only" adjustable rate mortgage to buy more house than he can afford. It's the kind of risk that may not be financially sustainable and it typically points to troubled times lurking around the corner, especially when that kind of hungry speculation becomes wide-spread.
- Day Trading is Up -- Schwab reported 242,300 trades in 2006 through the end of September. For the same period in the year 2000, the number was 242,000. Do you remember "day trading?" It became popular in the late 90's as newcomers and trading pros alike jumped on the irrational "new economy" exuberance of the last Bull Market. You know how that story ended...
- Optimism is High -- As I already stated and the title of my Blog entry suggests, nary a market pundit is calling for a decline in stocks for 2007. Personally, I will concede that a decline in stocks this year does not seem likely, given the current state of our economy and corporate profits. With that said, I will add that I am not in the business of market timing or making forecasts: I am in the business of giving prudent investment advice, which I believe includes smart, strategic, and sound asset allocation.
"Before the beginning of brilliance, there must be great chaos. Before a brilliant person begins something great, they must look foolish in the crowd." -- From the I Ching, traditionally viewed as written by Fu Hsi (2852-2738 BC)
Once again, we have not reached the level of euphoria that could be defined as "chaos." Additionally, true contrarian investing carries risks that the average investor should not partake in. After all, the "crowd" is right more often than not; however, I believe that smart investors should not be afraid to take strategic "baby steps" away from the crowd, given the right signals, even if they appear to look "foolish" at the time.
Economists, analysts, and other bloggers that are smarter than me can offer mind-boggling, quantitative analysis and macro-economic patterns but, being a philosopher at heart, I believe in simplicity. To put it simply, a prudent " baby step away from the crowd" would be a slight yet strategic increase in defensive sectors. I believe the "easy money" defensive areas such as real estate, natural resources, and precious metals are either priced too high, too volatile, or too complex for the average investor. I like the Health Care sector for a defensive and slightly contrarian move now. Along with technology, Health Care, as a sector, was among the worst performers last year and stock prices appear fair if not undervalued now. As the economy and Bull market slows, smart money gravitates to areas that are non-cyclical or defensive, which means that people still need the product or service regardless of economic cycles. People will still need their drugs; people will still need health services; and the baby boom generation will continue to age...
Look at my previous "Where to Invest 2007" posts for more of my thoughts on asset allocation but my model portfolio for a long-term, moderately-aggressive investor now looks like this for 2007:
- 45% Large Cap Domestic (A good S&P 500 ETF or Index fund will work well)
- 25% Foreign Large Cap (Actively managed)
- 10% Multi-Sector Bond (Actively managed)
- 10% Small-Cap (Actively managed)
- 10% Health Care (ETF or broadly invested actively managed fund)
- If you dollar-cost average, you may also consider beginning to build cash in anticipation of buying opportunities in the next 12 to 18 months.
I'll leave you with one more bit of philosophy until next time...
It is easy in the world to live after the world's opinion; it is easy in solitude to live after our own; but the great man is he who in the midst of the crowd keeps with perfect sweetness the independence of solitude. -- Ralph Waldo Emerson (1803-1882)
Kent Thune is the President and Owner of Atlantic Capital Investments, LLC (ACI), a fee-only, registered investment adviser based in Mount Pleasant, SC, near Charleston. ACI specializes in retirement, investments, and comprehensive financial planning.
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