I am not suggesting that investors should abandon all of their risk assets. On the flip side, history tends to validate the adage, “the further they climb, the harder they fall.”
The media can try to pin all of the blame on China’s turmoil. As a catalyst, sure. Yet S&P 500 corporations with valuations at the 2nd highest levels in history are struggling to report earnings growth. Worse yet, revenues have declined for two consecutive quarters. If fundamentals matter, shouldn’t one expect some reversion to average price-to-sales ratios and/or average market cap-to-GDP ratios?
And then there’s the global economy. Currency devaluation throughout Asia, Latin America and Europe certainly haven’t helped the 50% of profits that are generated by S&P 500 corporations abroad. Worse yet, the London Interbank Offered Rate, or LIBOR, has been rising for the better part of the last 12 months. Might this suggest that banks in the UK (as well as banks that use LIBOR for mortgages) are growing concerned about lending to one another? Does it hint that the world’s reliance on central banks to keep rates unbelievably low is now in danger of creating another credit crisis?
From my vantage point, the evidence that has been building up for several months has strongly favored reducing the risk of loss in one’s portfolio. Should you run for the hills? No. Yet I continue to favor large-caps over small-caps, domestic over foreign. I continue to favor treasuries and investment grade over higher yielding bonds.
Most importantly, I have been systematically raising the cash level in client accounts for months. 20%, 25%, 30%, depending on client risk tolerance. Having that cash gives my clients the opportunity to buy high quality stocks at more attractive prices when a pullback, 10%-plus correction, or 20%-plus bear shows signs of abating. Specifically, when market internals/breadth as well as valuations improve, cash will be redeployed.
Gary Gordon is president of Pacific Park Financial, Inc.