Here’s a headline from MarketWatch last week that really caught my eye: “Cash Beats Stocks, Bonds for First Time in 25 Years.”
2015 has been that kind of year. Globally, both stocks and bonds are down, while cash — earning virtually zero interest — has been flat. It has been a case of winning by not losing.
In a bear market, cash investments are king.
I could split hairs and point out that not all bonds have been losers this year. Treasuries have had a respectable year as yields have fallen. The 10-year Treasury started the year yielding 2.2% and now yields less than 2%, so in addition to the interest income, Treasury holders have seen a modest amount of capital gains.
But that’s really not the point. The key here is that virtually every asset class has taken its knocks this year. Stocks are down across the globe, with most countries either in correction or outright bear market. Commodities – most notably crude oil – have spent most of the year in freefall and are deep into a bear market. And most bonds outside of the U.S. had had a rough year too, particularly when you take currency depreciation into account.
Cash investments are the only thing that has completely escaped the volatility.
Should You Jump Into Cash?
So what do we actually do with this information? Take what’s left of our portfolios and invest in bunkers, canned goods and ammo?
Or more realistically, should we simply sell everything and sit in cash investments until the bear market runs its course?
There are pockets of value out there, and some indicators suggest that this bear market – or at least this leg of it – is probably over or close to over for now. If you’re willing to roll up your sleeves and pick individual stocks, I think you stand to do very well, bear market or not.
That was certainly the case during the 2000-2002 bear market, in which plenty of value managers posted solid, positive returns even while the S&P 500 lost half its value.
But looking at the broader market, you get the feeling that this might just be the beginning of a longer-term secular bear market. The cyclically adjusted price-to-earnings ratio is still at very toppy levels, suggesting returns over the next eight years of just 0.6% per year.
What’s more, it’s important to remember that much of the massive bull market since 2009 – and for that matter, since 1982 – has been fueled by falling bond yields. Stocks and bonds compete for investor capital, so falling bond yields make stocks more attractive and justify higher stock valuations. (I’ll spare you the technical details, but market interest rates affect the discount rate used to value stocks. Higher yields mean lower stock values and vice versa.)
Well, short-term rates are still at zero, and longer-term bond yields are close to all-time lows. So we certainly can’t depend on the massive tailwind of falling yields going forward. And in fact, modest headwinds from slightly rising bond yields are a lot more likely.
Smart Investing in a Bear Market
So, how are we to invest in this environment?
I’d start with a couple guidelines:
First, remember that while cash is king today, it has historically been a terrible investment, particularly if you look at the last period in which bond yields went from historically low to historically very high — the long 1968 to 1982 bear market. The stock market went sideways over that 14-year period, but cash lost 64% of its value to inflation.
Second, if capital gains are uncertain, getting paid in cold, hard cash becomes all the more important. Stocks that pay a competitive current dividend and — more importantly — aggressively raise their dividends are more likely to generate respectable returns.
I’ll throw out an example. I’ve written about Teekay Corp (TK) a lot recently, and in a lot of ways this is an ideal stock for this kind of environment. It sports a very competitive current yield of 7.1% and, more importantly, management has committed to raising the divided by 15% to 20% per year over the next three years.
Need another example? Try Enterprise Products Partners (EPD). This blue-chip pipeline operator yields 5.5% and has consistently raised its dividend about 5% to 6% per year for the past 10 years.
Charles Lewis Sizemore, CFA, is the chief investment officer of investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. As of this writing, he was long TK and EPD.