Don't take excessive investment risks
Most investors credit the Fed's easy money policies for much of the stock market climb.
The Fed has been trying to encourage investors to take on more risk by holding interest rates very low.
This forces investors to enter the market to earn anything and more demand drives up stock values. It also allows companies to borrow at lower rates to reduce cost and increase profits.
Many companies have borrowed to use the cheap money to buy shares of their own company and thus increase the earning per share, which usually justifies a higher share price. For these reasons, investors watch carefully to see and even anticipate changes that the Fed may make.
There has been some anxiety because the Fed got a new chairwoman, Janet Yellen.
She is known to be a “dove,” so she is inclined to keep the Fed in a steady state. “Hawks” would be more inclined to raise interest rates to more normal levels. Yellen is chairwoman, but she only represents one vote among voting members who rotate terms.
Last week, Yellen testified before two congressional committees. The Fed is continuing to wind down quantitative easing. It had been purchasing $85 billion dollars of government long-term bonds each month. The Fed has been reducing its purchases by $10 billion per month down to the present level of $35 billion. Sometime this fall, the program will probably end. The Fed will continue to use other means to try to spur the economy.
A major concern of easy money policies is that inflation could explode.
This is when an individual's purchasing power is eroded by higher prices. Yellen said she does not think inflation is a concern. Apparently she has not gone to the grocery store lately. Meat prices are at an all-time high because the drought has forced farmers to cut back on herd sizes. Also, overseas demand has pushed prices higher. Produce prices and chocolate are hitting new highs. If you are doing home improvements, you are in for sticker shock. Most consumers believe inflation is increasing.
The Fed favors using the Personal Consumption Expenditures (PCE) index instead of the more traditional CPI or consumer price index. The PCE comes out lower because it considers that you will substitute one item for another. The theory is that if the prices of name brand groceries go up, a consumer will buy generic.
Yellen sees slack in the labor force. Despite the fact that the official government unemployment has been dropping, many people cannot find the type of job that they desire. The official unemployment report does not include all of the people who have given up looking for job.s It counts the many part-timers as employed even when many of these people would like a full-time job. The Labor Force Participation Rate report puts the figure at 62.8 percent of all adults working. This is the lowest level since the late 1970s. When the Fed does begin to raise interest rates, many are looking for a stock market correction of between 15 and 30 percent.
The stock market has performed much different in the first half of this year compared to last year.
Last year the S&P 500 were up 32 percent for the year. So far this year it is up 6 percent with recent increases in volatility.
Larger companies have seen larger increase than smaller ones. Energy companies have had some of the biggest increases because of the crisis in Iraq and the rest of the Middle East. This is one of the few sectors that benefits from fear when nothing really happens.
Junk bonds have fallen significantly from the beginning of the year.
Some investors have taken this additional risk trying to earn some yield. These could have dropped because many feared the weakness in the economy might lead to disaster.
Several weeks ago we discussed risky penny stocks. A week ago there was a great amount of news about a company with one employee and about $100 in the bank, seeing their stock valuation climb to a billion dollars. Thankfully the SEC stepped in and stopped trading in this stock. These companies are dangerous to the casual investor.
Only invest in things that you understand and do not take excessive risk.
Have proper allocation, because there is going to be a market correction at some point.
Young investors do not need to be concerned because they have time. Boomers must be careful because they will need to consume their assets during retirement. Do not get greedy or believe that it cannot happen to you.
Gary Boatman is a certified financial planner and local businessman who is president of the Monessen Chamber of Commerce.