The Virtue of Contrarianism

Sometimes the best investment advice is to do the opposite of what everyone else is doing.

When the stock market was in free fall during the financial crisis, many investors who had hung on for as long as they could take it finally gave up. They sold their stocks, locking in huge losses and missing out on a historic rally.

Last summer, with the first hint that the Federal Reserve would taper its bond purchases, interest rates began to rise and investors sold bonds in record numbers. In many cases, investors moved more money into stocks, as the market continued to set records throughout 2013 after a brief drop fueled by taper talk. 

That’s proven to be a mistake, as bonds have so far outperformed stocks in 2014. In fact, Treasuries – represented by the iShares U.S. Treasury Bond exchange-traded fund (GOVT), up 2.4% year-to-date – have outpaced the Standard & Poor’s 500, down 0.02%.

We’ve suggested that investors not give up on bonds and likewise suggested that gold may shine again, in spite of its tarnished 2013 performance. Recent trends suggest that it’s worth repeating this advice.

First, consider the current state of the U.S. stock market. Sideways may be healthy for storing a bottle of wine, but it’s not a good direction for the stock market, even though it’s better than a bear market. Thus far in 2014, after the recent retreat from its Jan. 15 high and the past week’s bounce back, the S&P 500’s flat performance is uninspiring.

Of course, the Fed was the driver of market performance in recent years, and that may continue in 2014. Additional tapering is expected: Chairman Ben Bernanke’s final action was to reduce bond buying to $65 billion a month (down $20 billion from its peak last year). At a congressional hearing Tuesday, new Chairwoman Janet Yellen said she would keep that policy but added that the Fed could very well reverse course, if economic performance faltered.

Meanwhile, bond prices are better lately as yields dropped (the two move in opposite directions): 10-year Treasuries enjoyed a solid month of price gains, as yields fell from 3.0% to 2.6%. They nudged up again this week to 2.7% after stocks recovered from their swoon.

Yellen made it clear that interest rates will remain low for the foreseeable future, and mediocre economic news would reinforce that position.  “Mediocre” may be optimistic, considering that:

·         Fed Bank of Richmond President Jeffrey Lacker said he expects economic growth of 2% this year, which is less than the 2.8% median estimate reported in a Bloomberg News survey of economists.

·         Housing starts declined in December.

·         While the unemployment rate fell to 6.6%, the long-term jobless number still remains high.

·         Gold prices soared to record levels after the financial crisis began in 2007, but 2013 was not kind to gold. Prices dropped more than 25%, which was gold’s worse performance in more than three decades.

Analysts are making mixed predictions about gold’s 2014 performance, but the price of gold so far has rallied from $1,200 at year’s end to $1,290. Will the price continue to rise?

The precious metal’s future remains tied to Fed actions, although the next taper is likely figured into its current price.  A weak dollar means strong gold prices, and buying bonds or printing money weakens the dollar.  So for the same reasons that bond prices may continue to rally, gold prices may keep climbing. 

The clear lesson from this year’s market should be that it’s important to diversify.  Hedging is also an important tool, especially when uncertainty is high. Diversification combined with hedging can help you to manage risk, no matter what happens in 2014.

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Brenda P. Wenning is president of Wenning Investments LLC in Newton, Mass. 

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