The Globe and Mail, Report on Business
Published July 24, 2010

In my quarterly letter to clients I used the word “discouraged” to describe investor sentiment. In the few days since we published it, however, I’m starting to think a better word is “despair.” Too regularly I’m being asked whether it’s time to get out of the market.

The worry isn’t coming from portfolio returns in the first half of the year – balanced portfolios are down from zero to 3 per cent – but rather a deep concern about what’s going to happen in the second half and beyond. Investors don’t want to go through another 2008.

The despair seems to have common roots. It’s a news article about the world’s debt burden and its ramifications – higher taxes, unemployment and more “Greece-like” events. It’s the realization that growth is going to be tough to sustain after the government stimulation tap is turned off. Or it’s a gloomy economist pontificating on how we can’t get out of this mess without another debacle, or at least a very slow period of growth.

This stuff is hard to refute and I don’t try. I’ve been in the “bumpy road ahead” camp for a long time and have been counselling caution since last fall. But that doesn’t mean my nervous clients, friends and family will hear what they want to hear from me. That’s because my strategy doesn’t call for getting right out of the market. Far from it.

If I’m given time to respond to the question (and questioners don’t always want an answer), I start by reviewing a few basics. It goes something like this:

Remember, Susan, Mr. Market is well aware of the issues out there. Security prices are always trying to anticipate future events. Your fears are shared by many investors and may already be fully factored into market prices.

Whatever you do, don’t make radical changes at a time of maximum stress, or excitement for that matter. That’s when the biggest mistakes happen, mainly because the shifts are made to conform to the consensus.

Yes I know, the consensus can be right for a time, but believe me, it’s always wrong at the peaks and troughs. If investors are dead certain, then they’re certain to be dead wrong. Yes, I did just make that up.

I think you know that getting out of the market involves two decisions, not one. After you sell, you have to get back in at some point. Any expectation of precision on either of those moves would be misguided. There will be no alarms going off telling you the way is clear.

Scott, I remind you that the “all-GIC strategy” that your dentist was bragging about always looks good when the stock market is down, just as an all-equity strategy does in the good times. If you only need a 3-per-cent return before taxes and inflation to live comfortably in retirement, then a “sleep well” strategy like that is an option. For investors who need more return, however, the potential of missing an up market poses just as big a risk as catching the down.

Jake, I want you to think about your portfolio in terms of ranges around a long-term asset mix, one that reflects your long-term goals and the odds of you winning at the market-timing game. For example, if your strategy is to have 60 per cent in stocks (or other higher-volatility investments) over the long run, then you might give yourself room to move the weighting between 50 and 70 per cent. The less experience and time you have for investing, the narrower the range should be.

Then you need to look at three things to determine where you should be in the range. The first is your outlook, which in this case is negative. But don’t stop there. Next you look at valuation (pricing), because dire headlines don’t preclude investors from making a pot full of money. Indeed, if all the bad news is factored into the market already, then it might be time to buy, not bail.

And then you need to take a reading of market sentiment. Are other investors positive or negative? The market’s mood provides a good reality check, sometimes advising caution (when everyone is bullish) and other times pointing to areas of opportunity (bearish). It’s that consensus thing I was talking about. Are you alone, or running with the crowd?

Now the crescendo: Brad, I want you to make an informed decision based on those three factors, not just that article you read. Right now I would make sure your higher-risk holdings (stocks, commodities, high-yield bonds) are in the bottom half of your range. With you running between 50 and 70 per cent, that means 50 to 55 per cent of your portfolio in stocks. I say that because I agree with you that the big picture isn’t very pretty. But having said that, you should be getting prepared to do some buying because weaker markets have improved valuations and market sentiment is getting better (i.e. more despair).

If you have a specific need for money in the next year, set it aside in a high-interest savings account now. Cash management is always important, especially in a higher-volatility environment.

And Brad, be careful not to confuse economic forecasts or political ineptitude with the risks and opportunities for you in the market.