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John Manley

The risk of risk avoidance

AdvantageVoice® Blog—1-14-13
John Manley, CFA, Chief Equity Strategist

Bull markets climb walls of worry.”  Wall Street Adage

When I came to Wall Street 33 years ago, one of the first things I was told was that “Sometimes you buy stocks when they are down so you won’t get tempted to buy them when they go up.”  I think it was good advice.  It says that there are subtle risks in stocks that are just as real as the obvious ones. 

While academics define risk in terms of volatility, most investors that I know do not worry that the stocks that they own will go up too quickly.  Quite rightly, they worry that what they own will go down in price and that they will lose money.  Losing money is a painful thing and we all want to avoid doing it.  However, I am not sure that this risk should be avoided at “all costs.”

Many times, stocks seem to defy the rules of supply and demand.  With most things, higher prices mean less demand and lower prices more.   That is not always true in the capital markets. Sometimes the appreciation of an asset begets the belief in further appreciation in those who have not participated in the rise.  Non-buyer’s remorse can be even keener if the rising asset was avoided because of fears of losing money and the alternative (“lower risk”) asset offers little or no return to its holder.

In other words, it also can be painful not to own stocks as they are going up.  The feeling of missing the boat can bring one into the market at higher prices and set the stage for future losses.  I believe that investors should be risk averse, but I also believe that they should be aware of the multiplicity of risks that exist.  I think that the future is risky by nature.  You cannot avoid risk but you can manage it.  A diversified portfolio may mean that you are never entirely right, but you probably will not be entirely wrong either.  In my opinion, a 100% cash portfolio can cause almost as much angst as one that is 100% common stocks.

I would add that, even though stock prices have doubled off their 2009 low and are now at a five-year high, the S&P 500 is trading at only 13 times its consensus forward-earnings expectations.  This is below the historical norm and, in my opinion, when compared to yields on U.S. Treasury securities, fails to give the impression of the ebullience and “cash-holder capitulation” that has characterized past equity market peaks.

I think there is still room for appreciation.  While the world is still far from perfect and the perceived risks to stock prices still plentiful, I wonder if the least understood risk is the risk of no equity exposure at all.

The views expressed are as of 1-14-13 and are those of Chief Equity Strategist John Manley, CFA, and Wells Fargo Funds Management, LLC. The information and statistics in this report have been obtained from sources we believe to be reliable but are not guaranteed by us to be accurate or complete. Any and all earnings, projections, and estimates assume certain conditions and industry developments, which are subject to change. The opinions stated are those of the author and are not intended to be used as investment advice. The views and any forward-looking statements are subject to change at any time in response to changing circumstances in the market and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or any mutual fund. Wells Fargo Funds Management, LLC, disclaims any obligation to publicly update or revise any views expressed or forward-looking statements.

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