Classically, a bull market’s first leg up produces the highest percentage gains. That’s the leg that market timers often miss. Their money remains in hiding because they don’t think it’s safe to buy back in. But those of you who invested steadily in 401(k)s might now have recovered most of the money you lost in the bear.
After some backsliding (a “correction”), bull markets have a second and maybe a third leg up, with lower percentage gains. Stocks should rise as long as investors expect future business profits to grow.
Much as I mistrust forecasts, I can’t help saying that business looks great. Every sector is expanding at a rapid rate. The leading indicators for jobs have also turned smartly up, says the Economic Cycle Research Institute, meaning that “overall job growth is about to increase notably,” despite its softness now. Our recovery is pulling the world along, with Asia booming, Japan improving and Europe edging up.
What’s more, contrary to conventional thinking, consumers aren’t drowning in debt. Total personal debt does stand at a record high. For the first time, consumer installment debt actually rose during a recession. But that doesn’t mean that the very same people keep going deeper into hock. Credit is now available to larger numbers of borrowers, which can raise the total without breaking anyone’s back. Record homeownership is a factor, too. More people carry mortgages–mostly at low, fixed rates and therefore immune to future interest-rate hikes.
Debt has actually gotten a bit easier to carry. Over the past two years, financial obligations (debt service, auto leases, homeowner’s insurance, property taxes and rent) dropped a bit, relative to income. Debt delinquencies are down. All told, voters should feel just dandy on Nov. 2.
The federal joystick steered us into this happy state, with tax cuts, low interest rates and massive deficit spending. All that loose money makes some pundits worry that inflation will soon rise. But core inflation (excluding volatile food and energy prices) fell in November, so disinflation remains in place. ECRI sees no problem over the next nine months, at least.
Whenever prices in general do seem ready to rise, interest rates will be rising, too. In the early stages of a business expansion, stocks and interest rates rise in tandem. The market normally doesn’t wobble until rates get “too high,” whatever that is.
For stock investors, the lessons of 2000-2003 should be pretty clear. You’re no darn good at predicting anything. You didn’t foresee that all stocks would crater (not just the speculative techs) and probably weren’t prepared for this year’s big bounce back. You may have sworn off international stocks owing to their poor performance–but thanks to the falling dollar, they’re now burning up the charts. Blue chips reigned in the late 1990s; last year smaller stocks shone. The only way to capture these unexpected gains is to spread your money across all the major stock groups, using mutual funds. Choose a core U.S. index fund (which follows the broad market) with satellite buys in REITs, smaller-stock funds and internationals.
When inflation and interest rates do rise, the value of bond funds will decline. Many of the pros are switching some of the money they manage into TIPS–Treasury Inflation-Protected Securities. These bonds protect your purchasing power by paying a fixed rate plus an annual inflation adjustment. (The adjustment isn’t paid in cash but is taxable anyway, so TIPS are for IRAs and other tax-deferred accounts.)
Two other things to watch for this year:
Mortgages. At a mortgage closing, you’re often hit with unexpected fees of $1,000 or more. To stop these unfair surprises, the Department of Housing and Urban Development has developed a new regulation (details yet unknown) requiring “bundled rates.” You’d be quoted fixed closing costs of, say, $2,500, covering all bank charges (appraisal, credit check, processing, title search and so on). That should make it easier to shop for cheaper lenders, which in turn should bring costs down.
Pensions. Companies expect Congress to change the pension calculation, so that they can put less money into their plans. Underfunded plans may become even more so. If they eventually fail, retirees will get less. That’s a strong case for taking your pension in a lump sum, if the plan allows.
The future will naturally surprise us, so prepare yourself for anything. There are always risks. I expect the best, but it wouldn’t be the first time I’ve been wrong.
