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Stock Investors: Lack of Market Risk May Be Your Most Serious Threat

Stock Investors: Lack of Market Risk May Be Your Most Serious Threat
(Olivier-Le-Moal/Dreamstime)

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Monday, 08 January 2018 07:48 AM Current | Bio | Archive

On Friday we got once again good U.S. employment data.

Non-farm payrolls increased by 148,000 in December of 2017, below market expectations of a 190,000, the Labor Department said. Job gains occurred in health care, construction, and manufacturing.

In 2017, payroll employment growth totaled 2.1 million, compared with a gain of 2.2 million in 2016.

Wages increased to $22.30 an hour in December from $22.23 an hour in November. Wages in the United States averaged $10.94 an hour from 1964 until 2017, reaching an all-time high of $22.30 an hour in December 2017.

The overall tone to the Friday’s data was really not consistent with a “negative real fed-funds rate.”

Last week, St. Louis Fed President Bullard gave an interesting speech, suggesting that the relationship between employment and inflation had been broken by central banks and their credible inflation target.

“If the naming of a credible inflation target coordinates expectations and helps inform the macroeconomic equilibrium, then perhaps further coordination can be achieved by being even more explicit about the future actions of monetary policymakers,” he said.

It is usual that normal people care about central bank inflation targets. It also assumes normal people know that central banks have inflation targets and indeed it assumes that normal people will know what central banks do.

Interestingly in a survey last summer (July 2017) we learned that about half of Americans had no idea that the Fed raised rates a month earlier and most Americans had no idea who Fed Chair Yellen was.

Besides all that, we just got updated that the level of global debt rose in dollar-terms, but fell as a share of global GDP for the fourth consecutive quarter.

The ratio was 318 percent according to the Institute of International Finance (IIF), which is headquartered in Washington, D.C. and is the global association of the financial industry, with close to 500 members from 70 countries and that includes most of the world's largest commercial banks and investment banks, a growing number of insurance companies and investment management firms. Associate members include multinational corporations, trading companies, export credit agencies, and multilateral agencies.

In simple words, the world has borrowed about 3 times its income.

The focus on the level of debt is perhaps not terribly helpful.

The one question that really matters when thinking about debt is who you owe the money to. The countries where debt is owed internally, domestic lenders lending to domestic savers, debt is far less of a problem. In this case, the debt tends to represent an inter-generational wealth transfer. Time tends to reverse this transfer naturally through inheritance. This is why millennials could be one of the wealthiest generations ever.

Investors could do well keeping in mind that a scenario of rising U.S. yields and a stronger U.S. dollar is a real possibility and that would translate in a less benign backdrop for, for example, a lot of emerging economies.

No doubt, substantial change is on its way, which won’t please a lot of investors worldwide.

Now, if rates do rise, which I think they will, U.S. government or investment-grade debt will serve investors well, and if you, as an investor wants a buffer against rising rates, then hoarding cash and minimizing your holdings of long-term debt will likely be a more effective way of protection.

Meanwhile, for stock investors, and this is important, the apparent lack of risk may be a serious risk in itself.

The S&P 500, including dividends, has now gone up for 14 months in a row, which is the longest rise since 1928 (data Bank of America Merrill Lynch).

Remember, the catastrophic crash of Oct. 28, 1929 saw the Dow Jones Industrial Average plunging 13 percent, or 12.75 times its standard deviation. Technically speaking, the market has been so quite as of lately that it would only take a 5 percent one-day drop in the Dow to match the same extreme measure of risk from that historical day in 1929.

In this environment, even slight declines can provoke panic.

Investors will need to focus harder than ever on long-term returns in order to keep short-term losses not too distorting, but keep in mind that even long-term returns are likely to be distorted this year as well.

As a reminder, in September and October 2008, U.S. stocks fell respectively 9.1 percent and 16.9 percent.

Never forget, the safest place for real profits are profits in your pocket. With cash at hand, any investor can do what he/she wants to do when corrections take place.

Etienne "Hans" Parisis is a bank economist who has advised investors on financial markets and international investments.

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For stock investors, and this is important, the apparent lack of risk may be a serious risk in itself.
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2018-48-08
Monday, 08 January 2018 07:48 AM
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