How to capitalize on the strength of the stock market
The market continued to go up the past few days despite the US Federal Reserve’s decision to cut rates by a larger than usual 50 basis points. Fed chair Jerome Powell justified the jumbo cut by saying the US economy was in good shape and they just wanted to make sure economic conditions would stay that way.
The strong share price action immediately following the rate cut convinced many investors the US economy is indeed doing well, and that the Fed will successfully orchestrate a “soft landing.”
Because of this, many believe that stocks will avoid a bear market and perform the same way it did during the 1995 rate-cutting cycle, where the S&P 500 ended higher 12 months after the first rate cut.
Although there are many reasons why I still think the United States is at risk from a recession and a bear market, I understand the importance of respecting share price action being a stock market investor for more than 20 years now. After all, the stock market can stay irrational for a very long time.
Given the prevailing situation where the market continues to go up despite the heightened risk of a US recession, investors can do the following to manage risk:
Raise some cash. Exiting the stock market while it is going up doesn’t seem to be the best decision right now as this would mean completely missing out on potential gains. However, the beauty of investing in the stock market is that you don’t have to sell everything. You can just sell a portion of your portfolio (around 20 percent to 30 percent) to raise some cash.
Raising some cash is a good compromise for investors who are worried about the sustainability of the ongoing rally since they would still be allowed to enjoy some gains if the market continues to go up. It will also allow you to buy back stocks at a cheaper price in case the market goes down.
Rotate to attractively valued stocks. At present, many stocks are no longer cheap after going up sharply the past few months. In fact, some stocks are already trading at a premium to their fair value estimates.
Stocks that are trading at more expensive valuations will most likely encounter difficulties going up further. They are also more vulnerable to sharp declines if the market goes down.
Consequently, it would be wise to sell these stocks and switch to other stocks that are trading at cheaper valuations.
In buying attractively valued stocks, prioritize those that have good first-half earnings but are just being ignored because they are not actively traded or are not part of the index.
It would also help to prioritize stocks that pay cash dividends. That way, it will be easier to stay patient in case the price of these stocks doesn’t go up right away.
Focus on defensive issues. As I’ve mentioned earlier, I’m still worried about a possible recession and a bear market in the United States. And while I’m not worried about the local economy and the health of our listed companies, the Philippines has always suffered from a contagion in the past. There is no guarantee this time will be different.
To protect your portfolio, focus on buying defensive stocks. These are stocks of companies that are expected to stay resilient even if financial markets become volatile and the economy weakens. Power companies, telcos, utilities and consumer companies that are focused on essentials are examples of defensive companies that should continue to do well no matter what. Most of them also pay huge cash dividends, making them good to own in a falling interest rate environment.
With these strategies, I’m hopeful that you can reduce the volatility of your portfolio. After all, reducing volatility is one of the most crucial elements in boosting the returns of your portfolio over the long term.
