Islamic Relief 2013 Qurban

Investments (V9-I48) Safe Havens?

November 21, 2007 by  


By Bob Wood, Muslim Media News Service (MMNS)

Where are the safe havens for today’s stock market investors?

There aren’t any! That, in a nut shell, is my answer to one of the most commonly asked questions in the financial media. The idea that investors will find stocks to buy and have those shares fare well — while the rest of the market falls — is patently absurd.

Stocks, by definition, fall into the category of ‘’risky assets.’’ And that means no guaranty that an investor will get back his initial investment. Buying financial assets offering higher potential returns than conservative investments like money market funds or CDs while assuming that some of these stocks offer a higher measure of safety is a ridiculous supposition.

Yet how often do we hear that technology stocks, consumer non-cyclicals or large cap multi-nationals (like General Electric) represent safe havens? Or that they will likely suffer minimal damage should the overall markets fall? I have even heard the opinion aired that stocks in emerging markets are today’s safe havens. Gimme a break!

Perhaps “safe haven” is an extension of the ‘’free lunch’’ concept that many in the financial media seem to see at every turn. And it’s a concept similar to the idea that the falling dollar is good for our economy. Sure, it’s a great time for exporters or American shops that cater to foreign tourists. But what benefit do the rest of us gain from seeing the purchasing power of our money falling so far, so fast, for the things we buy, whether it’s energy, food or imported goods from China?

For most, the falling dollar represents lost purchasing power, which is otherwise known as price inflation! While inflation might be good for some, it proves devastating for many others, especially savers and retirees living on fixed incomes. Investors need higher rates of return just to stay even, meaning they must accept a higher tolerance for risk in their portfolios.

Expecting the Federal Reserve to lower short-term interest rates again is another of those ‘’free lunch’’ wishes. Lower lending rates might look like a great idea, and, to some, it is, unless, of course, you are a conservative investor looking for decent yields in your fixed income and bond funds.

Thinking that ‘’safe haven’’ stocks exist may be the worst example of the “free lunch” concept that many of today’s market promoters rely on. Their premise is that those ‘’safer’’ shares offer upside potential if the stock market should continue to rise higher and still offer relative stability should the markets fall.

But this concept flies in the face of the most widely accepted academic theories used by investors, asset allocation and diversification. Adherents of these flawed theories freely acknowledge that one area of risk that cannot be diversified away is systemic market risk. If the stock markets fall dramatically, all shares will drop, though, to be sure, some will fall more than others.

Remember the bear market from 2000 to early 2003? While the technology heavy NASDAQ was taking a beating, losing about 80% of value from its early 2000 peak, stocks considered “safe havens” also lost considerable value. So called ‘high-quality’’ shares in Microsoft, Intel, Cisco and Dell took nasty beatings, albeit not as severe as many former high flyers that lost much more of their previous value and never recovered.

To be fair, yes, some stocks did hold up well during that bear cycle. Domestic large caps like 3M, P&G and J&J did well –and even rose higher — as a result of their better valuations and steadier business prospects.

But many of the ‘’safe haven’’ crowd are now counting on a repeat performance. They are expecting those same shares, which held their ground and rose amid the previous carnage (when the overall market fell by 48% as shown by the S&P 500 when used as a proxy), to hold firm once again.

But doesn’t that thinking suggest, with stock market gains barely higher for the year in mid-November, that too many investors are already parked in those “steadier” shares? Are they are pushing stock valuations higher in the process and capping further moves higher?

Another consideration is that some of those “safer stocks” are now feeling severe pressures from the housing depression affecting several parts of the country. Steady performers such as Starbucks, Fedex and Home Depot have warned in recent days that business is slowing down.

Were any of those companies considered “safe havens” in the weeks before warning of slowing sales and profits? The bigger question is how could anyone predict which shares will truly hold up well in a weaker economy and falling market? Which of these stocks would still be “under-appreciated” by investors as their prices are bid higher in anticipation of troubles ahead for the wider markets?

And would anyone be bold enough to suggest guaranties that these “safer” shares will not fall in value even if foreign owners, who are now large share holders, would finally bail out? They have remained in a market that has provided nearly nothing in gains, when repatriated into their home currencies over the past few years, while the dollar, metaphorically speaking, has been beaten into the dirt.

Let’s face facts here! How can any stocks be considered ‘’safe havens’’ at a time when traditionally safe investments like mortgage bonds are suffering steep falls in value? In the past week, several money market funds managed by Wall Street’s smartest organizations have required cash infusions to save them from falling too far in value or ‘’breaking the buck,’’ as it’s commonly known. Does anyone really think that, in an environment where even money market and bond funds are in peril, risky assets like stocks will offer a ‘’safe haven’’ refuge?

And what about real estate, where housing sales, once considered the ultimate safe haven, is so dismally soft and now offers the potential for large losses? How can any stock be considered safe in this climate?

A spokesperson for Wells Fargo Bank recently called the housing market ‘’the worst since the Great Depression.’’ Given how reliant our economy is on major manufacturing industries like housing and the ripple effects they have on the overall economy, how can this situation possibly bode well for risky assets like stocks?

And what about the idea that emerging markets may be today’s safe havens? Again, consider this food for thought: yes, other economies such as in Brazil, Russia and parts of Asia are growing while managed far more competently than our economy. These countries enjoy trade and budget surpluses and have paid off their external debts. But the crowd has caught onto those ideas and has been throwing record amounts of money into emerging market mutual funds for months now. And that may have less to do with better economic fundamentals than it does with typical performance-chasing by investors.

However, at the first sign of trouble in our markets, say a big one-day selloff, you can count on investors first rushing out of what are perceived as their riskiest holdings. No amount of promoting those shares as safer will be enough to counter decades of perceptions that emerging markets are more volatile and come with higher beta ratings than domestic stocks.

Until someone offers stocks that guaranty getting back your original investment when you want to sell, as bonds and CDs do at their maturity dates, all stocks must be considered risky assets. With Wall Street’s smartest people at the big brokers and investment banks taking massive hits on mortgage-related investments, the environment is surely as difficult and risky as any we’ve seen in recent years, the 2000 to 2002 bear cycle included.

Look at this another way: if the need for ‘’safe haven’’ stocks exists, given this much uncertainty about the overall economy and the potential for drops in the stock markets, why consider any stocks at all? History is full of evidence showing times like these to offer the worst risk/reward opportunities for investors. Who can recall the ‘’Nifty Fifty’’ shares of the early 1970s as yet another example?

In times like this, little safety is available. If I were to choose asset classes that look safer than most, energy and gold would surely rank at the top of my list. But stocks are stocks, and these too will suffer in a down market. That their underlying assets are strong offers comfort that the shares will rebound sooner than most, but they will still fall with the ebb tide that brings major averages down.

In an environment where you can’t even count on the safety of cash or bond investments, how can anyone say that risky assets like certain stocks offer “safe havens”? Heck if I know. I surely don’t see it that way! All asset classes represent more risk than reward today. Keep your eyes wide open before buying what others tout as safe. That free lunch has a hidden cost – just as all the others do.

Have a great week,
Bob

Bob Wood ChFC, CLU Yusuf Kadiwala. Registered Investment Advisors, KMA, Inc., invest@muslimobserver.com.

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