Where is the Risk?
This past year has left many investors scratching their heads and thinking, “Why all the focus on risk when the stock market keeps marching higher?” Though risk is something most people don’t ponder, every decision we make in managing our clients’ portfolios takes “risk” into account. The nature of risk is that many events could occur in the future, but not all events will occur. Over the past couple of years we have made portfolio adjustments out of concern over the following events and their potential to negatively impact our clients’ accounts:
Things that concern us:
– Slowing Emerging Market economies
– A double dip recession in Europe
– A real estate bubble burst in China/another global financial crisis
– Geopolitical risk in Ukraine and the Middle East
– The end of Quantitative Easing by the Federal Reserve
– Structural changes in the US labor market
– A lack of wage growth in the US
– High Price/Earnings ratios
Current widely held public beliefs:
– Central banks will keep supporting the markets because it is good for our economies
– Though other economies are slowing, that won’t have an impact on the US
– Current Price/Earnings ratios are justified because interest rates are so low
– I would like higher returns. Please give me more stocks
– Buy stocks whenever the market dips
These views are worrisome to us because of their implied apathy regarding market risk. Although our concerns have not materialized to date, does this mean that we should not have been proactive in trying to protect client assets against any adverse outcomes? We think the answer to that is a resounding “No”. The value of risk reduction is hard to see in a rising market. There will come a day when market sentiment and investor risk perceptions change, likely due to an “unforeseen” market moving event that causes wide spread investment loss. Like the flu virus which may or may not infect the patient, we will continue to focus on risk or “get the flu shot”, just in case. To quote Warren Buffet, “After all, you only find out who is swimming naked when the tide goes out” (Letter to shareholders 2001).
To learn more about Kenyon Lederer, view his Paladin Registry profile.
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