Our last article recommended that investors hold their positions, at this time we would like to issue an emphatic sell for all stocks. There are numerous stocks with very strong fundamentals, yet all they do is go down in price. Investors must take the following to heart: there is a time for all things. The time to buy stocks has passed with the climax occurring in May 2006. At this time, the best strategy is to create a laddered portfolio of short term government bonds.
Your editor has sold all stock positions at this time. We feel that both our positions in Sierra Wireless and Elan Pharmaceuticals had room to go higher. The problem is that when the entire market has gone down 1000 points in one month, you have to heed the obvious signs. Broker rates are at 6.75% showing that any type of rally will fall short. The major culprit of this precipitous drop is Fed Chairman Ben Bernanke and his raising rate strategy. It seems that he has taken rates higher too quickly.
The problem with raising interest rates so fast has hurt both the stock market and the real estate market. Home builder’s stock prices have been ravaged over the last month. An especially telling sign are the oil stocks. These stocks have tanked, to put it mildly, and there is no reason to believe that the fundamentals of this sector have changed. Investors must realize that higher rates will cut profit margins and make corporation’s cost of capital increase. When this metric increases it becomes harder to generate shareholder value.
Since higher rates will hurt stocks, we believe that they best strategy is to purchase short-term bonds. An astute investor should create a laddered portfolio of short-term bonds maturing in as quickly as one month to one year. The Fed will most likely continue to raise rates; this continuous rise will ultimately create an inverted yield curve. Currently, the flat yield curve illustrates the market’s uncertainty. Short-term rates will have to rise in order to induce long term bond investors to switch maturity. We believe that with a laddered portfolio, an investor can eliminate reinvestment risk. As your staggered maturity dates come due, you will be able to purchase more bonds because prices will have dropped and rates will have gone up. You receive a double bonus, a higher coupon rate and at the same time the difference between purchase price and maturity value.
It was easy and entertaining to listen to people like Jim Cramer who gives advice on his show Mad Money. The problem is that people like Cramer only advocate stock investing. Such a strategy is equivalent with financial suicide. Benjamin Graham, one of the most conservative and most successful investors, advocates a position of both stocks and bonds, with each portion ranging from 25 to 75% of the portfolio. With this in mind, we think that most investors should be allocated to 75% or higher in bonds. As the market goes lower, it will continue to follow the path of least resistance – stocks will follow suit. Remember a rising tide lifts all ships, but at the same time as the tide falls so will everything in its wake.
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