How to cope with the market's mood swings
By
MoneyWeek Editor
John Stepek Jul 22, 2010
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Ben Bernanke disappointed markets yesterday.
The chairman of the Federal Reserve was pretty cagey about the prospects of any further quantitative easing (QE) or any other form of looser monetary policy. In his six-monthly written testimony to Congress, he said: "we remain prepared to take further policy action as needed."
However, he also reckoned that US GDP growth would pick up from between 3% and 3.5% this year, to 3.5% to 4.5% next year.
Markets slid. The Dow ended the day down more than 100 points.
But wait a minute. Isn't it good news that Bernanke thinks the economy is going to grow faster?
Not really. Not from the point of view of the markets in any case...
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Bad news is good news again for markets
The fact that Bernanke isn't planning to splurge more money any time soon disappointed investors yesterday. As Paul Ashworth of Capital Economics put it: "We suspect that equity markets were looking for a bit more than Bernanke or the FOMC [Federal Open Market Committee] is willing to offer."
For stock markets, we seem to be back in the "bad news is good news" mode. Bad economic news means that the Fed ends up under pressure to pump even more cheap money into the markets. So people buy in, anticipating further QE-inspired gains.
If Bernanke instead sticks to his script of economic recovery, then that means no more cheap money for now. Hence yesterday's deflated market.
But at least the economy's getting better, eh? Well, again we'd take that with a pinch of salt. Bernanke and central bankers in general aren't known for posting gloomy outlooks until it's blindingly clear that we're all in trouble.
We suspect the economic data will continue to deteriorate. And that Bernanke will be digging out his tool box to find new ways to try to prop it up before too long.
But with the market swinging from high to low, dependent largely on central bankers' actions and forecasts, then what can the average investor do with their money?
The markets have divided investors: what can you do?
My colleague Dominic Frisby noted yesterday that these are what he describes as "traders' markets". And Jeremy Grantham of US fund manager GMO makes much the same point in his latest quarterly update.
Grantham describes what we're in as a "fearful, speculative market." On the one hand, everyone knows that Bernanke "clearly belongs to the old Greenspan put camp". In other words, he'll keep interest rates low for as long as he can.
That's good news for the more short-term players in the market. "In such a world, aggressive hedge funds can leverage easily, and in their drive to make money, will emphasise more aggressive or speculative investments."
However, it takes more than low rates to help an economy recover (it could even be damaging, though that's a discussion for another day). And if you're an ordinary investor, then low rates "merely produce a feeling… somewhere between dejection and desperation."
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You might recognise this feeling yourself. British savers can't get a real return (that is, after accounting for inflation) on their savings anymore. Particularly not now that National Savings & Investments has pulled its index-linked savings certificates. (For more on this, and what to do about it, see my colleague Ruth Jackson's piece here: The sneaky way to beat inflation today).
So if you stick your money in the bank, with inflation where it is just now, you're certain to lose money. Trouble is, everything else you can invest in carries the risk of losing much more. We've been tipping big, blue-chip dividend payers as a good investment for months now. And if you're talking about your retirement fund, money that you're not going to need for ten years or more, then I think that's a good bet, as I'll explain later.
But if you're trying to save towards some relatively short-term goal, where you need the money on a specific date, and can't afford to take big losses, then stocks just aren't suitable. They're too risky for your house deposit, or your private school fees fund.
So the current market is a tussle between these two camps. For the aggressive end of the market, low rates are like a triple espresso. They're fired up on cheap money and moral hazard, and ready to trade. For the conservative end, fearful for the economy, their savings, and their jobs, low rates act more like a fistful of valium. They feel helpless and desperate for a safe place to put their money.
Stick with defensive blue chips for the long run
How do you invest amid this turmoil? Simple. Ignore the noise, and look at what's cheap. As Grantham points out, all the risky stuff, such as small caps and highly indebted companies – the sort of thing that the aggressive, short-term investors like – has been outperforming. The stocks that more conservative investors tend to favour – the high quality blue chips in other words – haven't done so well.
And it's possible that they'll continue to underperform for some time. But if we're wrong, and this recovery is genuine and the only way is up from here, then that'll be good news for big companies along with the others. Profits and sales will go up.
If we're right, and we're heading into another slump, then most shares will suffer, but defensives will bear up a lot better than the riskier stuff. At a recent Roundtable, we had a group of investment experts tip their top stocks for volatile times – subscribers can read it here: 13 stocks to protect your wealth in volatile markets. If you're not already a subscriber, get your first three copies free here.
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