Tuesday, July 31, 2007

An Investment Strategy For This Point In The Market Cycle

Last week's stock market performance was certainly one that tested the fortitude of stock investors. The unanswerable question is whether or not this is the beginning of a bear market or just another momentary setback for the equity bull market. At this point in time investors should review their broad asset allocation. Is there a portion of the equity portfolio that needs to be converted to cash within the next 12-18 months? Stock investments are a long term investment commitment, i.e., five plus year time horizon.

If the allocation between stocks, cash and bonds seems appropriate, what amount of fluctuation in equity values can one tolerate. If a lower volatility equity portfolio is desired, now could be the time to look at higher quality stock investments. Historically, large capitalization, high quality, dividend growth stocks held their value better in down markets.

Over the last five years, the better performing segment of the U.S. equity market has been small and mid capitalization equities. As noted in the charts below, although the small cap index (Russell 2000) has been one of the better performing segments of the U.S. equity market, it has been one of the worst performers year to date and last week. This is volatility.

(click on charts for larger image)

U.S. index performance chart YTD 2007
U.S. index performacne chart week 7/23/2007
One caveat is many strategist and investment professionals are telling investors a similar story. The result could be some downside equity returns as some investors find they need to take some money off the equity table. As long as the economic fundamentals remain in place, stocks should advance longer term--they have historically (see chart below of S&P 500 since 1950).

(click on chart for larger image)

S&P 500 chart since 1950

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