Optimism is on the defensive at the moment because the world is a dangerous place. Dangerous, and getting more so with each passing day.
Danger is hardly new, nor is the capital markets’ capacity for digesting and pricing peril a recent innovation. Crises come and go, and the markets reprice as events require. And still the disciplined long-term minded investor manages to make a buck. No less will be true in the future, but no one said it’ll be any easier than it has been in the past. In fact, it may get tougher relative to the already challenging standard that has been investing in the 21st century. Indeed, as one looks out over the escalating warfare in the Middle East, it’s hard to see an endgame in the near future that leaves investor sentiment on the mend.
We’re talking, of course, about the war between Israel and Hezbollah, the guerrilla group in Lebanon. The accelerating conflict is wreaking havoc in the two countries, and raising tension in a region that’s already tense from the ongoing state of chaos, otherwise known as Iraq. Adding to the bull market in instability is long shadow of Iran, which has become increasingly confrontational in promoting its anti-Western agenda. Iran, courtesy of its massive petrodollar-infused bank account, has the means to back up its inclination to run interference in the West’s (read: America’s) political agenda in the Middle East. That includes funding Hezbollah, which reportedly draws no trivial degree of financial help from Iran.
‘Tis easier to tear down confidence than it is to build it up. To the extent that such disorder and bedlam serve wider political objectives, pursuing turmoil and confusion is path that’s tragically easy to follow and difficult to repair. Investors the world over must understand this risk, even if it only informs only partly informs their decision-making process.
Yes, there may be a light at the end of the tunnel, but for the moment the aura from the Middle East is casting shadows of a particular hue on sentiment. A week is hardly a representative sample on which to base a long-term investing strategy, but given the events of the moment it comes as no shock to learn that commodities were last week’s big winner among the major asset classes. Oil and gold were particularly popular, rising 4.0% and 5.3%, respectively, in a week when the S&P 500 dropped more than 2% and Treasuries were only fractionally higher. Diversification, in other words, still carries more than a little weight as the only true friend in portfolio management.
All the more so once you consider that war and the threat of instability are only part of the obstacles facing paper assets. Valuations are hardly a screaming buy, or so one might reason. At best, equities and fixed income are fairly priced, but even that’s hardly the source for new round in the middle-aged bull market when bullets are flying in a part of the world that has a history of injecting havoc at times with America’s peace and prosperity.
The intrepid investor will no doubt keep an eye out in the weeks and months ahead to exploit Rothschild’s famous maxim to buy when blood runs in the streets. Alas, blood is running in the streets from the mortal victims of war, but paper assets have yet to suffer a wound of any magnitude. As such, grander bargains may await.
Rest assured, when and if stocks and bonds go on sale in dramatic fashion the pricing adjustment is apt to be accompanied by a dark sentiment coursing through the veins of the capital markets. The great risk, as always from a strategic vantage, would then be one of overlooking the bargains at a moment of maximum value. Human nature, being what it is, tends to minimize the allure of sale prices in the context of strategic investing. DVDs, shoes and cans of tuna fish fare better when it comes to opportunistic bargain shoppers. But thanks to the fear and greed syndrome, which burns brightest in the realm of investing, Joe Sixpack is disposed to overlook those exceptional junctures in history when valuations move to extremes.
True, the price-earnings ratio on the S&P 500 looks inexpensive by the standard of the past decade and the yield on the 10-year Treasury bond is the highest since 2002. As a result, minds may differ about what constitutes the most enlightened course in the here and now. But for our money, we’re inspired only to err on the side of caution. In part because after deducting energy earnings from the S&P 500, the index’s recent history looks less encouraging. And so, rar more comforting at the moment is a preference for assuming modest positions across the asset classes, waiting and hoping for more persuasive opportunities when and if they avail themselves.
Ours is a moment of great risks and middling valuations, an observation that informs our strategic outlook. There is a bull market lurking somewhere in the distance, but for the moment it’s not clear to our jaded eyes, and so we sit in above-average allocations of cash and related securities until confidence returns. We may, of course, be wrong, and pay a heavy price. Such is the art of investing, and the danger of embracing portfolio counsel that costs exactly nothing. Risk, in short, is rising, assuring that predictions will be among the leading victims.