U.S. stocks danced around new highs in late August, a relief for investors after months below the record set in January. But by any standard the bull market is long in the tooth, and a big pullback would not be surprising.
So, for millions of investors, the question is what is the smart strategy when the markets are setting new records — put more in, play it safe or hold the course?
No one knows what stocks will do, of course, but experts do have some tips for life in the nosebleed section.
First is to keep some perspective, says Rick Wholey, managing director of Baird’s Wholey Poitras Group in Chicago.
[See: 9 Value ETFs to Buy for Stability.]
“New highs in the market aren’t necessarily a cause for concern,” he says. “Today’s new highs will seem low five to 10 years from now. The Dow Jones industrial average dropped 23 percent on Oct. 19, 1987, after peaking above 2,200 in August of that year.”
Now the Dow is near 26,000.
Paul Z. Shelton Jr. of Warwick Shore Advisors in Orlando, Florida, notes the stock market looks healthy despite high prices.
“The current fundamentals of the economy continue to show strength as highlighted in corporate earnings,” he says. “A healthy labor market with decreasing unemployment and moderately increasing inflation argues well for continued participation in the market.”
Other measures such as standard deviation, earnings yield and 200-day moving average also indicate the S&P 500 index, the gauge used by pros, is not as risky as before the market collapse a decade ago, though some concern is warranted, he adds.
“We do not believe that a recession will occur soon, however, [stocks] are in the process of forming the market top,” Shelton says.
“I’ve had some client’s express some concerns about the market’s highs and possible big drop soon,” says Edward Snyder, co-founder of Oaktree Financial Advisors in Carmel, Indiana. “I talk to them about how we look at their portfolio through the lens of their financial plan and what’s changed there, more than making any investment changes based off the current market.”
Though investing experts typically avoid recommending radical changes, many offer some tips for preparing for change that might come.
Snyder, for example, suggests clients build up cash reserves ahead of a potentially rocky period.
“They should ask themselves if there was a big market downturn, how long could they go without being forced to sell stock investments that would be down in value,” he says. “If the answer is less than five years, they should rebalance their portfolio to get more onto the fixed income side.”
Diversification is a common theme among investing experts, and Jordan Barkin, a real estate agent with Harry Norman Realtors in Atlanta, says investors should “consider investing in land. It rarely depreciates in value and has limited supply.”
[See: 9 Financial ETFs Rising With Interest Rates.]
Land and other real estate can hold its value when stocks fall, though that isn’t guaranteed, but investors should remember that raw land, unlike apartments, offices and other investment property, generally does not produce income.
“Most of my clients have done well with stocks and other investments and have chosen to diversify their portfolios with real estate holdings,” Barkin says. “It is all about balance, and nobody should have all of their proverbial eggs in one basket. The residential real estate trend in cities including Manhattan, Atlanta, and Los Angeles has been positive overall over the past two years.”
Some experts say adjustments to stock holdings may be warranted even if the investor wants to stick with a long-term plan
Michael Gauthier, CEO at Strategic Income Group in Chandler, Arizona, says, “With the U.S. markets at all time highs and with the economy nearing the longest expansionary cycle in U.S. history, we have made several changes to client portfolios and continue to make additional recommendations.”
That includes reassessing the investor’s risk tolerance, or their ability to withstand reversals.
“We have rebalanced out of equities with higher price-earnings ratios for those that are slightly below the market,” he says, referring to the ratio between share prices and the past-year’s earnings. A higher P/E means more risk. Stocks with lower ratios tend to pay less of their earnings as dividends, Gauthier says.
“This allows these companies to weather a downturn much better,” he says, referring to a company’s ability to continue paying dividends even if earnings dip.
His firm also offers clients an in-house fund that invests in real estate loans believed to be relatively safe because they are limited to no more than 70 percent of the property’s value.
Before pulling out of stocks, investors should realize the main alternatives, bonds, look pretty risky themselves, as rising interest rates undermine prices of older bonds that don’t pay as much, says Robert R. Johnson, professor of Finance at Heider College of Business at Creighton University in Omaha, Nebraska.
[Read: How to Say Yes to Investing Risk.]
The 10-year U.S. Treasury note currently yields about 2.8 percent, which equals a P/E of about 35, he says. That’s well above the P/E of 25 for the S&P 500.
As a result, even though the stock ratio is higher than its long-term average, Johnson says investors pay substantially less for every dollar of earnings with stocks than with bonds, making stocks a better buy.
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