Terry J. Diehl, The Daily Record Newswire
In thinking about how I would counsel my clients and friends looking forward into 2013, I would stress reviewing their overall asset allocation: Make sure it is appropriate for his or her current situation, and do some rigorous research that they haven’t unknowingly taken on too much risk in their portfolios.
If there is any lesson we should have learned after the Great Recession of 2008, it’s that nothing is off the table. Even money market and short-term instruments are not immune.
There were so many issues that we had to deal with in 2012. Just select one or two favorites: fiscal cliff, presidential election, China slowdown, European countries in recession, zero interest rate environment, war in the Middle East, lower corporate earnings estimates, unprecedented government debt, awash in liquidity, slow economic growth, high unemployment, etc., etc.
There is far more risk in the market today than there was 3 1/2 years ago. Let me share some of my reasoning why. On the equity side of the portfolio, as of Dec. 31, 2012, we are 1,393 days into this bull market. The technical bottom dates back to March 9, 2009. The average bull market for the past 100 years lasts 755 days. This is the fourth longest bull market since 1900. The S&P 500 would have to rise another 10 percent to get back to the October 2007 market high of 1565.15.
Corporations have not spent on capital goods and expenditures. The economy is very sluggish and in a very slow growth mode. Unemployment remains high, and until there are signs of end demand, corporations will not be hiring. A market correction is nothing more than a 20 percent downturn from the present levels. There is a very high probability that this is going to happen sometime in 2013. Hopefully this selloff will not be as deep as 2008 (S&P 500 — 37 percent).
On the bond side, one of the major trends in 2012 was stretching farther and farther in search for yield. We are currently in a zero interest rate environment, and the fed is on record stating that they will keep interest rates at these levels until the middle of 2015. Investors took this as an open invitation to look to riskier bond options-junk bonds, emerging market debt, mortgage-backed securities, investment trusts and limited partnerships.
According to The Wall Street Journal, 40 percent of the high yield bond funds issued in the fourth quarter of 2012 had fewer than usual protections for the bondholder. Barron’s one month ago ran a feature story on a Pimco High Yield Closed-End Bond Fund, managed by Bill Gross, that was trading at a 70 percent premium to its net asset value (break- up value). Who would pay 70 percent above the market value for any asset?
Let me give another example. When the 10-year Treasury note was yielding about 1.7 percent, a 1 point rise in yield would lead to a 9.2 percent decline in the value of the bond. Likewise for an investment-grade corporate bond index of five to 10 year notes, a one point rise in yield would reflect a 6.4 percent drop in price.
Risk may be the most misunderstood component in investing. As I mentioned above, there is significantly more risk today than 3 1/2 years ago for both the equity and bond markets.
Please examine your individual holdings. Make sure that your investments, mutual funds or investment advisors haven’t taken on too many of these riskier type investments in the quest for better performance or higher yield. Please make sure that your asset allocation is correct for you and that some of these riskier type investments have not made you more vulnerable in the event of a market selloff.
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Terry Diehl is a vice president for Karpus Investment Management, an independent, registered investment advisor. Offices are located at 183 Sully’s Trail, Pittsford, N.Y. 14534; phone (585) 586-4680.
