Ian McGugan
Take heed, investors: Central banks are showing a new penchant for surprises – ones that can rattle your portfolio.
Over the past few days, the Bank of Canada and the Swiss National Bank shocked financial markets with unexpected moves, while the European Central Bank jumped into the game on Thursday with a commitment to monetary stimulus that was considerably larger than expected.
Savers, especially those nearing retirement, should brace themselves for what lies ahead. After six years of good times for Canadian and U.S. stocks, the bull market is showing signs of stress.
Pessimists can find plenty of reasons to be glum. Many central banks, for instance, appear to be engaged in a game of competitive devaluation. The Canadian dollar, the Japanese yen and the euro have all plummeted against the U.S. dollar and more losses seem likely, given the apparent willingness of many countries to weaken their currencies as a way to boost exports. This doesn't speak well for the strength of the global economy.
But what makes the stay-or-go decision tough for most investors is that many central banks also appear committed to driving up stock and bond prices as a way to encourage growth.
For instance, the strategy behind the ECB's new quantitative-easing program rests on a hoped-for chain reaction. The ECB will create money, which it will then use to buy vast amounts of government bonds. At that point, the sellers of those bonds will find their pockets stuffed with cash, and presumably use their new-found money to buy shares and other bonds. The rising prices of those financial assets will then drive down the cost of capital for companies, and that will encourage investment and growth. Or so the theory goes.
Those who don't feel so confident about the elixir-like properties of monetary policy cite three reasons for running for shelter.
The first is the age of this bull market. Jeffrey Gundlach, CEO of DoubleLine Capital LP, recently pointed out that U.S. stocks have never risen seven consecutive years in a row – and 2015 would mark the seventh year of this market expansion.
The second is valuation. While the average price-to-earnings multiple for the stock market appears robust but not unusually high, the picture changes considerably if you look at the median multiple rather than the average figure. This shift reduces the impact of extreme outliers and focuses attention on the most representative stocks in the market – with some interesting results. James Paulsen of Wells Capital Management says the median P/E multiple for U.S.-listed stocks is now 20.3, its highest level on record.
U.S. stocks also appear pricey if you compare their current prices to their earnings over the past 10 years. The so-called cyclically adjusted P/E is about 60-per-cent over its historical average, suggesting that a reversion to the mean could be exceedingly painful.
All of which leads to a third reason for investor caution: slowing growth just about everywhere in the world except the United States. Plunging prices for oil, iron ore and copper point to a global economy where demand is shrinking, not expanding.
But while all three reasons for caution are persuasive, there's an obvious issue for investors: Where do you run to? Bond yields are microscopic and many stocks now pay far more in dividends than safe bonds pay in interest payments. The only compelling reason to buy bonds is the hope that yields will fall even further, which would drive bond prices higher.
"Did you ever in your life believe you would see the day when investors would be buying bonds for the capital gain and equities for the income?" David Rosenberg, chief economist at Gluskin Sheff + Associates, wrote in a report Thursday.
It is highly unusual and suggests investors should think carefully about their own bottom lines. William Bernstein, an investment adviser and author, wrote a thought-provoking piece for The Wall Street Journal this week in which he argued that people should apply a simple rule: When you've won the game, stop playing.
After several years of bull-market gains, many investors nearing retirement have accumulated enough to fund basic living expenses for the rest of their lives. If so, Mr. Bernstein suggests, the smart move is to reduce your exposure to stocks. No one knows when this market may turn, but those who have already taken some money off the table won't be hurt when it does.
Ian McGugan