Wednesday, December 11, 2013

Stock Market Bubble

The word “bubble” is surfacing around the stock market as it marches to all time highs.  But is there rationale for that movement-or is quantitative easing (QEI, QE2, Operation Twist, QE Infinity) and a zero interest rate policy (ZIRP) drawing investors to riskier assets (stocks) since bond yields are so low?  The Federal Reserve personnel have been indicating a “tapering” of QE in late 2013 or early 2014; they are also saying that ZIRP will be around significantly longer.  A recent Federal Reserve research study indicated such a policy might continue until 2017.  So what do you do?

First, examine the asset allocation in your investment portfolio.  Is the proportion you hold in stocks, bonds, and money market reserve appropriate for your goals and objectives?  If there is a correction in the stock market, how will your portfolio be affected?  If interest rates rise, what will be the impact on your bond holdings (interest rates and bond prices are inversely related, so as interest rates rise, bond prices decrease).  Can you tolerate, financially and emotionally, the decrease in your portfolio that such changes might bring?

Second, examine your individual investments.  If there is another credit (lending) crisis, will your stock holdings be able to survive?  Companies with low debt and large cash positions on the balance sheet aren’t as dependent on the credit markets as highly leveraged companies.

Third, stocks are not equally susceptible to price changes in the general market.  Some stocks have a lower “beta” or movement relative to the general market than others.  Such stocks will decrease less in value in a general market correction.  A frequent advantage of such stock is they usually pay higher dividends to stock holders.

Fourth, examine your bond holdings.  As we noted, bond prices will decrease as interest rates increase.  That decrease generally will be less dramatic on shorter maturity bonds or bonds with higher coupons.  With interest rates at current (low) levels, it would appear that the next major move in interest rates would be an increase.

We at Paragon Financial Advisors will be happy to assist you in reviewing your portfolio to assure that it is consistent with your goals and objectives.  If you have unanswered questions or need additional guidance please call us.  Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas.  We offer financial planning and investmentmanagement services for clients.



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