Hedge your bets
We are living in uncertain times, and 2003 promises more of the same. If everything breaks right, it could be a terrific year for fund investors as stock markets turn around and equity values soar. But if events go wrong, we could be facing another year like the one we’re leaving behind.Unfortunately, there is no way of predicting the course of events. There are too many variables in play that could have a significant impact on investor fortunes, one way or the other. Here are a few of them.
Geo-politics. Fears of an imminent war in Iraq continue to escalate despite the fact that U.N. weapons inspectors have failed so far to come up with a smoking gun. U.S. president George W. Bush appears to be determined to knock Hussein off his perch one way or another and the whole Middle East situation will remain unstable until this is resolved.
As if Iraq weren’t worrisome enough, we now have North Korea injecting itself into the world’s consciousness and sounding more bellicose every day. Something will have to be done there too, but you can bet that Washington won’t move without China’s approval in this case.
Meanwhile, t revelation that Osama bin Laden is apparently alive sent shivers down the spines of many people. His audiotaped threats, which specifically included Canada on the list of target countries, make it clear that al-Qaeda remains a serious threat. Another major terrorism attack on the scale of the World Trade Center destruction would shatter already fragile investor confidence.
The U.S. economy. America has hit a “soft spot” says Federal Reserve Board chairman Allan Greenspan. Is it only that, or something worse? Not even Mr. Greenspan knows, but the Fed’s slashed already-low interest rates by another half-point in November and there is now speculation there may be yet another cut early in 2003.
Kyoto. The Prime Minister succeeded in his pledge to have Parliament ratify Kyoto before Christmas, but at what cost? No one knows and we are still waiting for a comprehensive implementation plan to emerge. If Ottawa fumbles the ball on this one, the results could be grave for one of our most important economic sectors, the energy industry.
The Canadian dollar. Despite the strength of our economy and the wide interest rate differential with the U.S., our currency is not showing the resiliency that many expected. World tensions get the blame right now. Last year, it was something else. Next year, the economists will find a different excuse. The underlying reality is that the failure of the loonie to gain ground at a time when conditions are ideal adds an undesirable level of uncertainty for investors.
On the positive side, we are starting to see spotty signs of an improvement in corporate earnings, a critical factor in any stock market recovery. Inflation is at higher-than-comfortable levels, but high energy prices are the main culprit and that situation should ease. Despite the fears that have been raised, deflation does not appear to be likely.
We also have market history working for us. U.S. stocks normally perform well in the year following a mid-term election. And never in the history of the Dow since 1900 has the index fallen for four years in a row. In fact, it has only twice had three negative years in succession: 1901-03 and 1930-32. The DJIA was down in 2000, 2001, and 2002. A four-year bear market isn’t impossible but it has never happened before, which means the odds favour an upward move in 2003.
All this suggests that you should hedge your bets in the coming year. Keep a decent percentage of your assets in equities, since the chances are that they will outperform bonds and cash over the next 12 months. But don’t go overboard. Here are my recommended strategies for the coming year. If events change the outlook in any material way, I will keep you updated.
1) Continue to take a long-term view but don’t lose sight of the short-term uncertainties. As this bear market has made clear, failure to adjust to short-term patterns can be costly. For example, anyone who loaded their portfolio with technology stocks early in 2002 on the assumption that they would recover quickly has paid a heavy price.
2) Be flexible. Conditions are changing rapidly. You need to be ready to adapt your tactics to new situations as they arise. This is most definitely not a time to “invest it and forget it”.
3) Don’t go to extremes. Although the odds are good that stock markets will recover in the New Year, don’t switch everything back to equities in anticipation of a big surge in values. It could happen, but nothing is certain in this world. Conversely, don’t cower in fear and abandon stocks. They offer the best opportunity to recoup any losses you’ve suffered.
4) Focus on value stocks. Although growth stocks offer the greatest potential if markets surge, value stocks provide greater downside protection in the event the bear lingers on.
5) Put your emphasis on North America. International stock markets will take their lead from what happens on Wall Street, not vice-versa. So while you should maintain some geographic diversification, your heaviest weightings should be in Canada and the U.S.
6) Hedge your currency positions. For years, I’ve been advising people to hold an appropriate percentage of their assets in U.S. dollars or other currencies. How much will depend on your objectives. If you plan to spend a lot of time in the States, you may want to have half your assets in U.S.-dollar securities. If Europe is more important, look for securities with heavy euro weightings.
7) Expect interest rates to remain low. It appears unlikely that rates will rise until at least the second quarter of 2003. Adjust your holdings accordingly. In the current low interest rate environment, premium savings accounts, no-load mortgage funds, and short-term bond funds should be considered for cash positions instead of regular savings accounts, term deposits, and money market funds.
Hopefully, these strategies will help you to maximize your return in 2003 while keeping your risk to a minimum if things go wrong. Happy New Year.
Adapted from an article that originally appeared in Mutual Funds Update, a monthly electronic newsletter of common sense mutual fund advice edited by Gordon Pape. Take advantage of a three-month trial subscription available to 50plus.com users for just $9.97 plus tax!