The announcement last week that Hostess Brands, the maker of
iconic treats such as Twinkies and Ding Dongs, was going out of business
highlights the need for investors to have a solid risk management strategy.
As you contemplate making an investment, here are three things important to know:
1.
The rationale for the investment and
the research behind it.
2.
What constitutes “fair value” for
the investment.
3.
What would trigger you to sell the
investment.
Number three above is where many folks trip up – they don’t have a sell discipline.
Although Hostess Brands long ago ceased being a publically traded company, it’s
an example of how a company with well-known brands can run into trouble and
fail. To avoid riding an investment all the way down to zero, it’s critical to
have a system in place to monitor your investments and hit the sell button if
there’s a material change that makes the original investment thesis no longer
valid.
Sometimes a risk management strategy causes you to sell an
investment only to see it turn around and go right back up. While frustrating,
that’s better than not having any sell discipline in place and holding on to an
investment that drops dramatically and never comes back.
Viewed another way, it’s better to take a small occasional
loss than to hang on to everything forever and be exposed to a potential big
loss down the road on your irreplaceable capital.
Risk management is back in the forefront as U.S. stocks
continued their post-election slide last week. And, while we would all prefer
to see the market go up, we remain focused on our risk management discipline as
a key component of our overall portfolio management process.
ARE LOW INTEREST RATES GOOD OR BAD for the stock market? As you are
painfully aware, interest rates in general are very low. There are three main
reasons for this:
1.
Consumer
demand for interest-bearing products is relatively high.
2.
Business
demand for loans is relatively low.
3.
Central
banks in many developed nations are engaged in an “easy money” policy.
Source: The Economist
All three of the
above are associated with the fact that our economy is relatively weak. In
difficult economic times like today, central banks have a vested interest in
keeping rates low. The thinking is low rates will reduce the “hurdle rate” for
businesses to reinvest and, as a result, encourage them to expand and hire new
people. As businesses expand, the economy will grow and begin a new virtuous
circle.
So, let’s see if
this virtuous circle of low interest rates applies to the stock market, too.
Using data from the
Barclay’s Capital Equity-Gilt study, The
Economist took a look at U.S. stock market returns between 1926 and 2011
and sliced the data into periods when the real rate on Treasury bills (the rate
after subtracting inflation) was positive and negative. What they discovered
was startling:
“In
the 33 years where real yields have been negative, the average gain from
equities has been 2.3%; in the years when real yields were positive, the
average gain was 6.2%.”
As we all know,
data can often be presented in ways that support whatever position you’re
taking (just like in the past election cycle!). So, putting that aside, the key
is to interpret the data. Since we’ve been in a low rate environment for a long
time, stock prices have likely had time to adjust accordingly. The key now is
to watch for the turning point – the time when rates start a new rising trend.
When rates start to
rise, that could signal the economy is on the mend as businesses start
demanding more money for loans to expand and central banks pull back on the
easy money policy to avoid too much inflation. This would be a “good” reason
for rates to rise. Alternatively, rising rates could signal investors are
losing faith in our country’s ability to pay its bills. This would be a “bad”
reason for rates to rise.
We’re watching
interest rates closely for any sign of a new trend and, importantly, the reason
behind that trend. It’s just one of many indicators we monitor as we keep a
close eye on your investments.
Weekly Focus – Ode to an Icon…
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