Where to Invest 2007: The Long & Short of Things

"All human situations have their inconveniences.  We feel those of the present but neither see nor feel those of the future; and hence we make troublesome changes without amendment, and frequently for the worse."  -- Benjamin Franklin (1706-1790)

To utilize the wisdom of Mr. Franklin's philosophy, we must leverage the short-term stock selloff ("troublesome changes") made by others for the benefit of our long-term ("future") investment objectives...   

Starting with the big selloff on February 26, investor sentiment took sudden shift from what I would characterize as overly positive to overly negative.  When investor sentiment shifts to negative, significant downward movement is likely to persist as investors tend to ignore positive news and overreact to negative news, pushing stock prices increasingly lower.  Conversely, when investor sentiment is positive, investors tend to brush off negative news and overreact to the positive, pushing stocks increasingly higher.

As I often preach, stocks are not a short-term (less than three-year) investment so I am speaking to long-term (more than 10-year) investors.  With that said, this environment can still be quite challenging.  The key ingredient to success here is composure. 

A logical review of some of the contributing factors to Tuesday's selloff suggest things are not so bad:  The primary trigger that created the initial selloff was the 9% drop in the Chinese market.  A domestic piece of the market's drop was due to the U.S. Commerce Department report that durable goods (cars, appliances, home furnishings) had plunged 7.8% in January.  Another contributing factor to the selloff was former Fed Chairman, Alan Greenspan's, comments that the US Economy may be headed for recession later in 2007.  We are now just three days past a major selloff and a revision of those factors should reduce concern: 

• The Chinese market selloff was primarily due to wild speculation and a warning from their government that the speculation has gotten out of hand.  At the end of the day, the price of U.S. domestic stocks are not directly driven by the Chinese markets, suggesting any related selloff in our markets was more due to emotion than logic.
• The Institute for Supply Management (ISM) report on March 1st showed a rebound for the Manufacturing sector in February, and their index for new orders, an indicator of future activity, rose to 54.9 from 50.3 (any reading above 50 suggests the sector is expanding).
• Current Fed Chairman, Ben Bernanke, stated just one day after the selloff, that the markets appear to be "working well" and he expects "moderate growth" for the Economy this year.
• Greenspan backpedaled a bit on his recession comment and iterated yesterday that an economic recession was not "probable" for 2007.

Now let's digest the short-term outlook for the remainder of the year for a moment and while keeping an eye to our strategic long-term positioning for post- 2007:

• While the market appears over-sold at the moment, we can take advantage of short-term dips while slowly positioning ourselves for leaner times that are likely after 2007.
• If you've built some cash, as I suggested in January, be prepared to buy into more dips as investors over-react to negative news and ignore the positive.
• If you're dollar-cost averaging, a prudent move would be to divert 50% of your future contributions to Large-Cap (domestic), Health Care, and Multi-Sector Bond funds, while continuing to build cash with the other 50%.
• If you want to stay aggressive, I suggest incorporating Mid-Cap stocks as a portion of your Large-Cap allocation.

If you've been following my "Where to Invest 2007" posts, you know that I've been moving slowly defensive (Health Care, Multi-Sector Bond), less speculative (more Large-Cap, less Small-Cap), and expecting buying opportunities (building Cash). To balance short-term conditions with a long-term objective, here's where my model portfolio will be by the end of March 2007 (Keep in mind that your allocations will fluctuate and this is only a model):

• 45% Large Cap -- ETF or Index (dollar-cost average or buy into "dips," Mid-Cap can be a part of this portion if you want to remain aggressive)
• 20% Foreign Large Cap -- Actively Managed fund (allow your allocation to fall to this level if you are higher than this now but don't be afraid to stay at 20% -- foreign stock is still important for diversification)
• 10% Small-Cap --Actively Managed
• 10% Multi-Sector Bond - Actively Managed (dollar-cost average into this to reach 15% by year's end)
• 10% Health Care - Actively Managed (dollar-cost average into this sector to reach 15% by year's end)
• 5% cash (continue to dollar-cost average here so you'll "build" cash to buy into dips)
• If you do not have time to actively manage your account, simply set your allocations now, rebalance accordingly every 12 to 18 months, and follow my posts...

You will notice that there is not a great deal of change in my model from the beginning of the year to now and there is good reason:  "Timing the market" is a self-defeating endeavor.  "Time in the market" is a winning long-term strategy; therefore, it is never prudent to make massive moves in reaction to short-term conditions.  Make small yet sure steps to balance short-term opportunities with long-term strategies...

 

TFPAuthor, Kent Thune, is the President and Owner of Atlantic Capital Investments, LLC (ACI), a fee-only, registered investment adviser based in Mount Pleasant, SC, near Charleston.  ACI specializes in retirement, investments, and comprehensive financial planning.