The first few weeks of January seem to have kicked off pretty much to plan. The FTSE 100 is up. In fact, it’s back to the heights it hit 14 years ago.
Yes, that’s right. The market is now trading at levels not seen since the days of the dotcom mania. But of course the index is only a number. You can’t compare the market now and then, it’s not a like-for-like comparison.
A lot has changed since those days. The companies in the index now are earning an awful lot more for shareholders than they did then. Not only that, but on average, company balance sheets are a lot healthier too. That’s mostly down to the aggressive deals and acquisitions which were going on back then.
And of course, today’s general financial environment is completely different. Trillions of dollars’ worth of money printing and rock-bottom interest rates have pushed savers into stocks in order to generate a return.
But I’m prepared to run with the equity markets, for this year at the least.
My stance has attracted a bit of criticism. And that’s fair enough. Today, I want to address reader’s concerns. Not only that, but we’ll look at how best to insure against two specific market threats that concern many readers.
The last bear
Let me just make one thing clear from the outset. I am still very much a sceptic about what’s driving the market. I think this house is built on sand. But at the same time, I’m a realist.
Savers can’t afford to miss out on stock market returns. 15% or so for the footsie last year. That’s a lot to give up, even for a sceptic. And anyway, given the fundamentals, stocks don’t actually look like that bad value.
The way I see it, you can have your doubts about stocks, but still invest in the market. If you’re not convinced, just lower the proportion of your portfolio that you assign to stocks. Staying out of the market altogether is just too expensive. And betting against it? Well, that’s proved to be even more expensive.
The first threat is a market crash. They can take the legs out from under you. If you were in the markets back in October 1987, then you’ll probably remember that one well. It was a shocker. Nobody saw it coming. And I’m guessing most readers will remember the dotcom crash.
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But the second threat we want to insure against is the ’2008 scenario’ – a financial crisis. I’m sure you’ll have noticed that 2008 was much more than just a stock-market crash.
After Lehman collapsed, the whole financial system was brought into doubt. Practically all paper assets took a bath. After all, what good is a paper promise when the signatories are no longer in business?
Now, using asset allocation to insure against a stock-market crash – the first threat I spoke about – is easy. A balanced portfolio will generally achieve that. In that scenario, cash, bonds and commodities can help steady the ship.
It’s amazing how few investors use asset allocation for protection. Most investors tend to be overly reliant on equities. But interestingly, over the years, bonds and commodities can be just as profitable for a portfolio. Cash rarely keeps up, but we hold that for its other unique qualities.
Stock-market crashes are inevitable, and markets always bounce back. You use asset allocation to make the most of things. That is, after a precipitous fall, you re-allocate more resources toward the asset sector out of favour. Of course, this is easier said than done. After all, the darkest hour is just before the dawn.
But even if emotion stops you from really making the most of a crash, the very fact that your portfolio is balanced will help.
How to cover yourself
Financial crises are different though. To protect yourself from a financial crisis you need to diversify into physical assets. And over the last ten or 15 years, physical assets have done very well.
To me, it’s interesting to see that gold has had a pretty solid start to the New Year too. Now, that should be so. After all, if gold is an insurance policy against a house built on sand, then it stands to reason that the insurance policy should get dearer the higher the roofline goes.
Then again, I’ve learned not to overthink the gold market. Yes, if you look over the long to medium term, there’s a fundamental logic to it. But short-term, gold just does what it wants to do.
Anyway, for me, 2014 will be more exciting for the gold miners. This year, it’s my intention to up the ante. I keep a close eye on the Market Vectors gold mining index, a New York-listed fund with exposure to the world’s largest gold miners.
Have miners found a market bottom?
Source: Digital Look
As part of my asset re-allocation, I’m looking to take advantage of what is, quite frankly, dire sentiment toward the gold producers. Later in the week, I’ll go into more detail about how and why I’m making my move.