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Peace of mind in a volatile market

“You make most of your money in a bear market, you just don’t realize it at the time”    

-Shelby Cullom Davis

A great quote but how do you have peace of mind in a volatile market such as we have been experiencing? We are faced with a difficult market environment and the threat of war and terrorism. Here are some strategies to keep in mind as you contemplate your financial future.

You need to identify your sleeping point. If you are laying awake at night worrying about your investment portfolio, you may make bad decisions. Each person has a different risk tolerance; many of these have changed over the past three years. There are market studies that show keeping 65-70% of your investment portfolio in equities should be enough to satisfy most investors’ long-term goals. Life is full of unpredictable changes, so having some of your money in cash or bonds allows you to live through bad markets without panic.

Understand the fluctuation of stock prices. Bull markets or a rising market do not last forever and neither does a bear market or a declining market. Still, when a bear market hits, it often comes on quick and can be violent - like a tornado or hurricane, it can do a great deal of damage in a short time. Of course, the recent bear market followed the greatest bull market of all time, capped off by the most flagrant financial bubble of all time. It was highly unlikely it would end quickly or gently. Investors become gloomy when a bear market comes along just as they become euphoric when a bull market is in full swing. It is important to keep your perspective. Don’t over-invest when things look too rosy nor under-invest when things look too pessimistic. I am a true believer in the market cycle.

Bear markets can lead to a better thought process. When you are riding high and overconfident at the top of a bull market, decisions are often more impulsive and, in retrospect, often turn out to be poor decisions. At the peak of the market in March of 2000, valuations were sky-high and widely dispersed among the S & P’s 50 largest companies - perhaps a tacit sign that many investors saw valuation as passé. Today, there is a far more narrow range of multiples. This doesn’t mean that the market is cheap. It may mean, however, that investors are paying far more attention to valuation than they did in March of 2000– an overall positive sign.

Valuation can be more of an art than a science. The average price/earnings multiple for the companies in the S & P 500 Index has historically been around 17 times projected earnings. But the swings in the price earnings multiple over the past 40 years have ranged from six times earnings to 30 times earnings. The price/earnings multiple in the technology sector stocks went much higher. One widely used valuation yardstick is the Federal Reserve’s valuation model. The Fed determines a fair value multiple for the stock market by dividing the yield on the ten-year

U.S. treasury bonds into 100 - with the current yield of 4.17 on November 22, a fair multiple should be around 24 times earnings. This model suggests the market may be undervalued. This model also predicted the overvaluation of the market in the year 1999.

Of course there is no perfect formula for predicting market behavior except hindsight. However, I believe, like many experts, that the market, as measured by the DJIA, should trade in a range of 10,000 – 14,000 over the foreseeable future. I am an eternal optimist and hope it will be sooner rather than later, but I am also a realist and believe in having a strict investment discipline based upon your goals, time frame and risk tolerance. Patience and a long-term approach to investing have always paid off in the end.

 

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Nancy Hadley

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