Volatility is way up. Your stomach, tied in knots by the drop in global equities and commodity prices, tells you that. Fear is back.But like everything else in the financial markets, fear moves in cycles, and that makes this a good time to remind yourself that fear is a short-term phenomenon. It has very little, if anything, to do with the long-term value of a stock or other investment. Fear doesn't change fundamentals, even if it can powerfully shift how much we're willing to pay for those fundamentals. It is dangerous to investors because it can make them forget long-term economic and market trends and abandon long-term winners at temporary bottoms. The best antidote for short-term fear is to run down your list of those long-term trends that you believe will turn some stocks into winners. And then use the short-term market overreaction to fear as an opportunity for building positions that will profit from those long-term trends. In this column, I'm first going to run down five long-term trends that I want to own in my portfolio. And second, I'm going to give you a tip or three on how to buy into these trends with the most safety while the stock market is still in the grip of fear. The odds are, I think, that we've put an end to a period of extraordinarily low stock market volatility that stretches back to 2003. The VIX, the Chicago Board Options Exchange index that tracks the volatility of the Standard & Poor's 500 stock-index options, shows a low reading when investor fear of volatility is low. So, in the complacency that preceded the bursting of the technology bubble in March 2000, the VIX had dropped to an average of just 22.7 for that month. The VIX numbers climbed after that in reaction to the market's bust, seeming recovery ... and bust again. By March 2003, the VIX stood at 30.6.
That turned out to be the high point for this cycle. In March 2004, the VIX averaged a reading of 17.7. By March 2005, the average was just 13.1. The first four months of 2006 saw VIX readings as low as 10.74. For the year through May 10, the beginning of the current selloff, the VIX averaged just 12. Investors had become accustomed to low volatility, and fear had dropped to levels even lower than during the run-up to the 2000 bubble. I don't think we're headed toward anything like a replay of the bust of 2000. Stock market valuations aren't nearly as stretched, future economic growth looks far better and market liquidity is relatively supportive. Instead, we're headed back to normal times, when stock markets and stock prices fluctuate with something like their average volatility. Given the recent abnormally low level of volatility, a return to normal is going to hit some investors hard. Abnormally low levels of volatility have led some professional investors to load up on debt in order to pursue risky investments. But as I look through my list of the five trends that form the backbone of my long-term investing strategy, I'll be darned if I can find a single instance where the return of stock market volatility to normal levels changes anything. I still want to own stocks that give me a piece of these trends over the next five years. What are these five trends? The developing world is growing richer. Oh, not all of it. But countries such as China, India and Vietnam -- more than 2 billion people just in those three, and many more in other developing nations -- are growing their economies at rates double or triple the 3% growth rate for the developed world projected by the Organisation for Economic Co-operation and Development. That will add hundreds of millions of consumers to the global middle class who will demand middle-class products and services, such as life insurance, home mortgages, hotel rooms and cars.
In a February 2005 column, I picked
12 Growth Stars That Shine in Foreign Lands . Nothing has changed my mind about the fundamental trends driving stocks such as insurance giant American International Group ( AIG), South Korean banking company Kookmin Bank ( KB), hotelier Accor Asia Pacific and Philippine beverage producer San Miguel. Demand for commodities will continue to exceed supply. A fast-growing developing world has created demand for commodities that global commodity producers in industries from oil to copper to coal to iron (and don't forget water) are having a tough time meeting. That has produced what some Wall Street investment houses are calling a "supercycle" boom in commodities prices. I gave a talk on the commodities boom -- and why it will last longer than the usual commodities boom -- at the Las Vegas Money Show in mid-May. You can find a link to the PowerPoint version of that talk here . In that presentation, I recommended stocks such as BHP Billiton ( BHP), Phelps Dodge ( PD), Newmont Mining ( NEM) and Companhia Vale Do Rio Doce ( RIO). We've seen the low in the inflation cycle. Although it will be a very odd kind of inflation, in that higher energy and commodity prices will bleed through into the core inflation rate. "Loose money" policies in China and the U.S. and the need to recycle petrodollars will keep the globe awash in cash, though not as much as at the peak in 2005-06. However, thanks to the surplus production capacity added to the global economy from China, India, et al., the prices of manufactured goods aren't likely to climb very fast. Official government measures of inflation are likely to lag subjective impressions of inflation and the measurable inflation in specific economic sectors that have scant competition from developing economies, such as education and health care. This kind of stealth inflation will keep the fire burning under trends such as outsourcing, especially of service-sector jobs, downsizing and contracting out to contain costs. Companies will invest in technology -- if it cuts costs. (Follow this link to another PowerPoint presentation from the Las Vegas Money Show on "Redefining Technology in an Age of $70 Oil.") Gold and other hard assets will remain in demand as hedges against inflation and because of the next trend in this list.
The world is getting older fast. And no country has saved enough for its retirement. The problem will hit first in Japan and Europe, the world's most rapidly aging societies, where the impulse to bust the budget to pay retirement costs is likely to be irresistible. But the problem may be worst in China, which will be as old as the U.S. by 2030, but nowhere near as rich. The dollar will continue to slide. Probably not as fast as the doomsayers now predict because Japan and the European Union have their own problems that will keep pressure on the yen and euro. But thanks to our huge trade deficit and the utterly feckless fiscal policy in Washington, the world isn't exactly clamoring to hold more U.S. dollars. The standard ways to hedge a weakening dollar are:
- Buy nondollar-denominated stocks, such as Nestlé.
- Buy U.S. stocks, such as General Electric (GE), that do big business overseas. They will sell more products with a weaker dollar, and that overseas revenue will be worth more when translated back into dollars.
- Buy gold stocks, such as Newmont Mining and Glamis Gold (GLG).
- If your portfolio is underweighted in any of your long-term trends, use weakness to bring your exposure up to your target level. So, for example, I'd like to have about 15% of my portfolio in gold, given my belief in the inflation trend. This equally weighted portfolio -- all stocks start out with the same dollar investment -- is fully invested at 33 stocks. Right now I hold 30, and three of those are gold stocks: Newmont, Glamis Gold and Anglo-American (AAUK). So, I'm going to add another gold stock by repurchasing GoldCorp (GG) to bring my exposure up to 13%.
- Don't buy randomly just because a stock is cheaper than it was, and don't load up on sectors just because they've taken big hits. Keep to your asset-allocation goals, whatever they are. An unbalanced portfolio is dangerous at any time.
- Within your asset allocations, use weakness to trade up. So, for example, with this column I'm going to sell my position in Sysco (SYY), the giant U.S. food distributor that has held up well in the selloff, but that recently announced disappointing inflation news, and buy Central European Distribution (CEDC), a Polish producer, distributor and importer of vodka and other alcoholic beverages that has been hammered by bad news on an acquisition attempt and by the selloff in the emerging markets. The switch increases my nondollar holdings in the food sector.