By now, you've probably heard over and over again that the "secret" to a successful investment portfolio is diversification.
A Word of Caution to Retirees Tempted by Stock Market Records
Most people take this to mean buying bonds for stability and stocks for a better return. They might do small-, mid- and large-cap stocks or vary the duration of their bonds. But for a lot of people, that’s as far as they’re willing to take their mix.
Now, because of the Fed’s efforts to stimulate the economy — cutting the federal funds rate from about 5.25% to nearly zero and implementing quantitative easing programs to increase the money supply — that might not be enough. The government’s efforts to turn things around after the 2008 financial crisis may have put the two most popular asset classes on shaky ground. Here’s how:
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The Effect of Easy Money
When the central banking system made it easier for companies to borrow money at a very low cost, it allowed them to put cash back into their businesses and improve their profitability. Companies began expanding or, at least, shedding debt, which had a positive effect on stock prices. And consumers — who weren’t getting a good yield from more conservative investments — took notice.
At the same time, the drop in interest rates pushed bond prices up, because potential buyers could get more interest on existing bonds than on those that were newly issued. Yield was down, but values went up, and again consumers had a positive reaction.
A Potentially Dangerous Correlation
Historically, if there has been any correlation between stocks and bonds, it was negative. If one did well, the other did not, and consumers viewed them as solid hedges against each other. But for the past eight years, because of the Fed’s intervention, their values have risen simultaneously.
On March 15 the Fed announced it was raising its key interest by 0.25% to a target range between 0.75% and 1%. It was just the third time it has raised rates since the financial crisis. And so, as we find ourselves at the tail end of this long-imposed low-interest environment, it’s difficult to predict how the markets will react. But chances are it won’t be pretty.
There’s an old saying that when interest rates rise, stocks will die. Investors who were willing to take a risk when they could get only 2% interest on their bonds or CDs likely will go back to those more conservative investments once the yields increase.
In the same vein, because bond values have increased so much over the last eight years, as interest rates start to go up, the value of most current bond assets probably will go down.
Steps Investors Can Take
What should a wise individual consider to prepare for a possible double-bubble situation?
- Diversify. It’s still a good policy — just remember that diversification can be so much more than stocks and bonds. It can be commodities, international exposure, emerging market exposure, annuities, real estate and more. Consider additions that might benefit from rising inflation.
- Look into the possibilities of tactical vs. strategic asset management. A tactical wealth manager will take a more proactive approach, changing positions and allocations with your financial vehicles as the market dictates. Often your gains will be smaller, but so will your losses. And if you’re close to retirement or averse to risk, this may be a consideration for you.
- If you choose to stick with a strategic management style, consider your time horizon, make forward-looking decisions and then stay with them. Don’t panic! If you aren’t currently working with a financial professional, now is the time to start looking for someone you can trust. Don’t settle. Find someone who understands your risk tolerance and will communicate with you through good times and bad.
Hold On Tight to Get Through the Bond Market’s Bumpy Ride
Kim Franke-Folstad contributed to this article.
Disclaimer
This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
FAQs
The chart below shows the gauge for US stocks since 1900, expressed using percentiles. Simply put, the higher the reading, the more the indicator implies a market bubble. US shares are currently sitting in the 52nd percentile, despite a strong rally over the past months. This suggests that they're not in a bubble.
What is a double bubble in finance? ›
In the stock market, a "double bubble" can refer to a situation where a stock, or the market as a whole, experiences two separate periods of rapid price increases followed by a steep decline.
Is there a stock market bubble right now? ›
Despite comparisons with the market conditions of the late 90s, before the burst of the dotcom bubble, UBS strategists say "there's no bubble ready to go pop." TS Lombard, meanwhile, says the current bull market is missing one crucial ingredient required to be deemed a bubble.
What does it mean that stocks and bonds are relatively liquid? ›
Liquidity in stocks generally refers to how quickly an investment can be bought or sold and converted into cash. The easier an investment is to sell, the more liquid it is. Plus, liquid investments generally do not charge large fees when you need to access your money.
Are stocks expected to rise in 2024? ›
The Big Money bulls forecast that the Dow Jones Industrial Average will end 2024 at about 41,231, 9% higher than current levels. Market optimists had a mean forecast of 5461 for the S&P 500 and 17,143 for the Nasdaq Composite —up 9% and 10%, respectively, from where the indexes were trading on May 1.
Will there be a stock market crash in 2024? ›
Stock market investors may be anxious, but as the old saying goes, "There's no need to panic." "While we maintain a positive view on the U.S. stock market in 2024, there are a range of risk factors that could derail the current bull market," Dilley says.
How does double bubble happen? ›
When implants have too much volume for the patient's body type, downward may be the only direction for that volume to go. As a result, the implant pocket can become stretched below the natural inframammary crease, which causes a double bubble breast implant deformity.
What was the biggest stock market bubble in history? ›
The Nikkei 225. The two most famous bubbles of the twentieth century, the bubble in American stocks in the 1920s just before the Wall Street Crash of 1929 and the following Great Depression, and the Dot-com bubble of the late 1990s, were based on speculative activity surrounding the development of new technologies.
What is the problem with a bubble in economics? ›
Economic Bubbles
Because speculative demand, rather than intrinsic worth, fuels the inflated prices, the bubble eventually but inevitably pops, and massive sell-offs cause prices to decline, often quite dramatically.
Is it bad to invest in the stock market right now? ›
In other words, as long as you stay in the market for the long haul, there's never necessarily a bad time to invest. Even if stock prices plummet tomorrow, you're likely to see positive returns over time. The sooner you invest, the more time your money has to grow -- and the more you can potentially earn.
As for the stock market during Biden's tenure, it trended higher, but with significant volatility. The benchmark S&P 500 generated impressive returns of 28.7% in 2021 and 26.29% in 2023. Sandwiched in between was a bear market, as the S&P 500, at its low point, dropped 25% in 2022.
Is it OK to invest in the stock market right now? ›
With the right strategy, there's never necessarily a bad time to invest in the stock market. Regardless of whether prices surge or dip in the coming months, by investing in quality stocks and staying in the market for the long haul, you can maximize your earnings while minimizing risk.
What is the most liquid investment? ›
Cash on hand is the most liquid type of asset, followed by funds you can withdraw from your bank accounts.
What is the most liquid asset? ›
What Are the Most Liquid Assets or Securities? Cash is the most liquid asset, followed by cash equivalents, which are things like money market accounts, certificates of deposit (CDs), or time deposits.
Which asset has the highest liquidity? ›
Cash and Cash Equivalents
Cash is the most liquid asset possible as it is already in the form of money. This includes physical cash, savings account balances, and checking account balances.
Is the S&P 500 in a bubble? ›
During the three years leading up to bubble peaks, U.S. stocks have risen 100% or more. The S&P 500 is nowhere near that this time around. The S&P 500's torrid and top-heavy advance over the past year has convinced some bearish investors that U.S. stocks are in a bubble.
Where is the stock market headed in 2024? ›
As a whole, analysts are optimistic about the outlook for stock prices in 2024. The consensus analyst price target for the S&P 500 is 5,090, suggesting roughly 8.5% upside from current levels.
Is the US market overvalued? ›
Based on the latest S&P 500 monthly data, the market is overvalued somewhere in the range of 88% to 149%, depending on the indicator, down from last month's 92% to 154%.
How long can a market bubble last? ›
Data from the eight most prominent such events in history reveals that an economic, asset, market bubble lasts for about 5.6 years or about 67.5 months.
