Tags: risk | relative | absolute | markets | investors

Risk Is Relative, Not Absolute

Risk Is Relative, Not Absolute
(Dollar Photo Club)

By
Thursday, 14 September 2017 06:09 PM Current | Bio | Archive

What a difference a week makes! In just the span of a few days, Hurricane Irma went from being a huge threat to where I live in Florida to weakening significantly before hitting the populated parts—of the other side of the state.

To be fair, the state isn’t that wide, and it was a big storm. Despite being 200 miles from the eye of the hurricane, major winds downed power lines and caused light property damage. And I’m still without power at home. At least I was able to get out of dodge.

There’s something about a hurricane that makes me think about risk. As an investor, I spend a lot of time thinking about risk. As far as I’m concerned, it’s the most important thing. If you can handle the risk, the reward takes care of itself.

But here’s the thing: risk is relative. And there’s no guarantee that a low-risk asset today won’t become a high-risk tomorrow. Preparation is key. Like a hurricane, there are places where the danger is big and obvious. But there are also secondary and tertiary places where danger can lurk, even if it seems far from danger.

During the financial crisis, the sudden rush to liquidity meant traders were selling off everything—stocks, bonds, gold, you name it—to go to cash. A lot of quality names took a dive when they didn’t have to.

Also just like a hurricane, conditions can change gradually or quickly. Like bands of wind and rain that flare up and die off, periodic fears can wreak havoc in the markets. Sometimes that fear is manageable, like a company-specific fear—such as property insurers and cruise line companies last week.

Sometimes that fear is broader and more enigmatic, like fears of higher interest rates slowing the economy. Until that slowdown in growth starts to materialize, such fears tend to rise up and flare out.

Right now, the global economy looks pretty good. There are some broad risks. Overall stock valuations look high. But relative to the potential risks and returns of other assets, they don’t look too bad. Investors can buy stocks with 3-4 percent yields, and yields that will likely grow over time. That’s worth the risk relative to buying bonds with 2 percent fixed yields that won’t grow over time.

While most investors are still focused on the overall market, I’d say the fundamentals could be in for a future shock. We never addressed a lot of the core issues that led to the financial crisis a decade ago in the first place. There’s nothing to stop banks from lowering their lending standards again. Their only check right now is that they’re not as likely to be able to re-sell their loans to someone else. As long as they have to keep all their loans on their own books, they have a powerful incentive to continue to do so. That won’t last forever.

But we’re looking at the last crisis. Each crisis is different. There are many potential next crises that could flare up. Stocks could simply fall because they’ve been too expensive. The economy could start to see higher levels of inflation which would impact corporate earnings. We could simply see distrust in government reach levels that make some kind of social unrest likely. The possibilities are endless. We’re not near a turning point for the markets yet, but could be in a year or so. Chances are we’ll have a better idea where the dangers lie the closer we get to that turning point.

There are a few things investors can do to prepare for the unknown.

First, don’t chase stocks higher. Take advantage of opportunities to buy individual stocks on a big pullback. Even the big tech names that have led the market higher year to date have had them. And in the Braintrust, we’re always looking for great companies temporarily out of favor with the markets.

Second, consider some alternative asset classes. Gold posted a gain in 2016, and is doing about as well as stocks in 2017. Most investors have written off gold following its poor performance over the previous five years. That’s a mistake, especially if the economy starts to show signs of inflation. That’s where gold does best. There’s no need to buy too much gold, just enough as an insurance policy.

Speaking of insurance policies, cash. I brought cash with me when I evacuated out of Florida late last week. If the power’s down, we’re back to a cash economy for doing things because credit cards just won’t work. As an investor, keep some money in cash. That’ll take some of the sting out of the market’s bigger days, and it’ll also allow you to take advantage of the market’s opportunities.

Bottom line: risks are out there. It’s hard to define risks, even though most investment professionals think it’s possible. Something that doesn’t look risky could radically change. And something that was just a big risk might be a big opportunity if prices are now substantially lower and there’s a lot of fear out there.

But we don’t need to worry too much about risk. Over the long term, things tend to work out well for those who own stocks. Take advantage of bad days to buy shares. Keep some cash on hand to stay comfortable with your holdings. And consider other assets that are out of favor, such as gold.

Even if the markets continue on their gradual, upward course, these moves should ensure your safety if something goes wrong. The point of being prepared is to deal with expected difficulties that occur at unexpected times.

Andrew Packer is a Senior Financial Editor with Newsmax Media. He currently writes the Insider Hotline investment advisory, serves as investment director for the Financial Braintrust, and writes the monthly newsletter Crisis Point Investor.

© 2019 Newsmax Finance. All rights reserved.

   
1Like our page
2Share
AndrewPacker
Even if the markets continue on their gradual, upward course, these moves should ensure your safety if something goes wrong. The point of being prepared is to deal with expected difficulties that occur at unexpected times.
risk, relative, absolute, markets, investors
970
2017-09-14
Thursday, 14 September 2017 06:09 PM
Newsmax Media, Inc.
 

Newsmax, Moneynews, Newsmax Health, and Independent. American. are registered trademarks of Newsmax Media, Inc. Newsmax TV, and Newsmax World are trademarks of Newsmax Media, Inc.

NEWSMAX.COM
MONEYNEWS.COM
© Newsmax Media, Inc.
All Rights Reserved