Buy stocks to prosper. Buy bonds to sleep at night.
The Fed has been cautious, announcing it will start cutting its bond purchases but promising to keep short-term interest rates low for a while. But he might be forced to act faster if he feels inflation has gotten out of hand. The Fed’s intervention sparked the current bullish market rally in March 2020, and it’s not hard to imagine that the Fed’s intervention could end it.
Stock market valuations are stretched.
The stock market continues to rise, and until that momentum changes, it is dangerous to assume that the market will suddenly collapse. But its long rise has consequences: most stocks are no longer good deals. As Robert Shiller, the Yale economist, has pointed out, an important measure of stock market valuations, the cycle-adjusted price-to-earnings ratio (CAPE), hovered in a rarefied range, exceeded only in December 1999, during the dot-com bubble. .
The Shiller Index cannot predict short-term stock movements, but, like other valuation metrics, it suggests that stock returns over the next decade are likely to be lower than the last. Vanguard, for example, predicts that the US stock market will produce annualized returns of just 2.4-4.4% for the next decade, largely because prices are so high.
Other global stock markets haven’t risen as much lately, and partly for this reason, Vanguard expects them to outpace the US market by nearly three percentage points, on an annualized basis, over the course of the decade to come. This is a reminder that a truly diversified equity portfolio is a multinational portfolio, containing stocks from all major public stock markets (including those in China).
When the actions are terrifying.
The past is no guarantee of the future, but it does provide clues. Countless academic studies suggest that the key to prosperity for non-professional investors is to hold stocks for the long term and avoid market timing.
This implies that investors must be able to sustain large losses periodically as the stock market fluctuates, sometimes painfully, as it did last year. Recall that from February 19 to March 23, 2020, the S&P 500 fell 34%. More declines of this magnitude or more could occur at any time.
Does it make you uncomfortable? That bothers me.
A great strategy for absorbing losses and holding onto stocks, no matter what, has been to own bonds. This is because bonds and stocks have been inversely correlated most of the time: when one goes up, the other goes down.