Investing in stocks would be much easier if bull markets lasted forever.
Since that’s not the reality, the twilight era of strong market uptrends always raises the need to position defensively for flat or down periods.
Investors are now faced with such a task, according to Alicia Levine, the chief strategist at BNY Mellon Investment Management, which oversees $1.7 trillion in assets.
As a former investor, Levine understands the importance of always having dry powder in the form of cash that’s not vulnerable to the mood swings of the stock market. She’s now advising other investors beef up their holdings, based on her assessment of what markets are likely to do during the next few years.
“If you look at the returns over the previous 10 years for most asset classes, we simply don’t see those returns being maintained at that level,” Levine told Business Insider in a recent interview.
The past decade of lofty returns for the stock market coincided with a period of zero interest rates and quantitative easing. Both stimulative policies from the Federal Reserve helped prop up the stock market, especially because the yields on less risky assets were so low and unappealing.
Policy is now turning in the direction of higher interest rates and tighter monetary conditions. The very prospect of this shift stopped the stocks in their tracks in 2018, and was a key reason why investors just endured the market’s worst year since 2008.
In fact, some investors have never had a taste of this brave new world. They’re a cohort Levine described as “ZIRP babies” — those who came into profession in the bygone era of the Fed’s zero interest-rate policy.
“It’s good to remind investors that the returns will be more moderate,” Levine said.
“That doesn’t mean you can’t get positive returns, and we do see positive returns in equities and in emerging markets, for instance.”
She flagged US financial stocks as a sector that’s recently been beaten down even though its business fundamentals are strong. She also singled out industrials as a sector that should benefit for as long as the economy stays strong.
“We just think you have to start hedging, and you have to have an allocation to cash,” Levine said.
She’s advising that investors increase their cash holdings for the market environment that would prevail during the next 1-3 years. This dry powder serves as a hedge, and as an asset that can easily be put back in the market when needed.
“In a funny way, it’s a better place to be for an investor because you stop lulling yourself into thinking everything’s going to go up all the time, and you start introducing risk back into the system,” she said.