Taking Stock

Side-stepping the stampede: Why it's time to buy, not sell

The Globe and Mail

(Michael McCloskey/iStockphoto)

Anyone searching for signs of imminent financial doom didn’t have to look far last week.

There was the Philly Fed manufacturing index, which plunged to its lowest point since March, 2009, when the United States was in a deep recession. There was the unexpected jump in U.S. jobless claims. And there was – no surprise here – another batch of grim U.S. housing numbers.

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Confronted with growing U.S. economic gloom and continuing woes in Europe, financial markets went into familiar spasms: Gold soared to another record; the yield on 10-year U.S. Treasuries briefly sank below 2 per cent for the first time; and the stock market fell flat on its face. Again.

As if the economy didn’t have enough problems, consumers are suddenly feeling a lot poorer than they were just a month ago. According to Standard & Poor’s, from July 22 through last Thursday’s 4.5-per-cent rout, the S&P 500 shed $1.87-trillion (U.S.) of wealth. Globally, investors have lost $5.3-trillion on stocks.

Canada’s economy may be in better shape, but you won’t hear any cheering from Canadian investors. The benchmark S&P/TSX composite index, which has skidded about 16 per cent from its April peak, is only a few more bad days from meeting the definition of a bear market – a 20-per-cent drop.

If there was ever a time to dump your stocks and build a cabin in the woods with a two-year supply of Chef Boyardee, this must be it, right?

Not so, says William Bernstein. The Oregon-based money manager and author, whose books include The Four Pillars of Investing and The Investor’s Manifesto, thinks now is a good time to be buying stocks, not selling them.

“A general rule of thumb with investing is that the most uncomfortable thing to do is usually the best thing to do,” he says. “And the two most uncomfortable things to do right now are to be buying stocks … and buying [Treasury]bills that don’t yield anything.”

A former neurologist, Mr. Bernstein, 63, knows perhaps better than anyone that human beings are hard-wired for behaviour that is detrimental to their financial health. As social creatures, we buy stocks after prices have soared because that’s what everyone else is doing. And we sell in a panic when the herd is stampeding for the exits.

Buying high and selling low is a recipe for losing money, of course, but it’s an urge we find hard to resist – especially in uncertain times like these.

True, there are plenty of risks out there, from the European debt crisis to the growing possibility of another recession. But the market is already pricing in the bad news, Mr. Bernstein says. The S&P 500 is now trading at a trailing price-to-earnings multiple of 12.5, which is lower than the long-term average of 14.

“Historically, when you have bought stocks when they are fairly valued, you have done very well,” he says. Now, stocks are “fairly valued to cheap.”

That’s not to say you should jump into the market with abandon. He believes investors should choose a mix of low-cost stock index funds and fixed-income investments that suits their age and risk tolerance, and largely stick to their asset allocation targets.

“But there is nothing wrong in my books, if you are emotionally suited to doing so – and very few people are – to upping your stock allocation when things get cheaper.”

For the fixed-income portion, he recommends T-bills and government bonds with maturities of two years or less. The yields are almost invisible, but you’ll have the flexibility to roll into higher-coupon bonds when rates rise, or to take advantage of further weakness in the stock market. If you buy longer-term bonds and yields revert to their historical means, “you’re going to lose a truckload of money.”

Will stocks get cheaper? They might. But if things don’t turn out to be as horrible as everyone expects, the market could rise instead.

That’s why it would be foolish, despite the parade of depressing economic statistics, to follow your animal instincts and run to the perceived safety of cash. You’ll look like a genius if stocks tumble and you get back in at a lower price, but if you wait for a big drop that doesn’t come, “you may be in cash for the rest of your life,” Mr. Bernstein says.