Tom Saler: If you abhor risk, here's a simple strategy for unpredictable times

Since buying my first share of stock in what now seems like the late Cretaceous period, I cannot recall a single stock market environment in which plausibly bullish and bearish scenarios were so implausibly balanced. 

For more than a year, bullish investors have ignored the generalized chaos of the Trump administration to focus on the metric that matters most to setting stock prices: the level of corporate profits relative to interest rates.

And despite the outbreak of downside volatility since February, stocks are still up by double-digit percentages since Donald Trump’s election as president and stronger than the historic average for a similar-length period.

Selloffs happen…

It’s easy to make the case for the recent correction being nothing more than an overdue pullback in a market priced for perfection. Though interest rates are rising, there are no clear signs of recession, and 20% drops in broad-based averages (the common definition for a bear market) are rare without an accompanying economic downturn.

Citing the $1.5 trillion tax cut enacted by Congress in December, the International Monetary Fund boosted its forecast for U.S. economic growth this year to 2.7% from 2.3%. According to the IMF, the outlook for global growth is brighter still, with the world economy projected to grow by 3.9% through 2019. 

Even in markets grown complacent, those projections — unreliable as they often are — could eventually lead to higher stock prices after the nervousness subsides.

The bearish case is more speculative, but no less compelling.

In recent weeks, Trump has weaned his administration of voices that have argued for restraint on trade and military matters. In fact, the president now finds himself in animated conflict on at least four fronts: with business leaders over politics, with legal institutions over Russia, with China and various allies over tariffs, and with Iran and North Korea over nuclear proliferation.

John Bolton, Trump’s third national security adviser, is on record as having favored military strikes against Iran and North Korea. 

It seems naive to believe that none of those fights will matter to the economy, even if it is impossible to know when or how something might go wrong. 

Puff and bluff?

Of those risk factors, tariffs are the most immediately worrisome for investors.

A best case template for avoiding a trade war is Trump’s 2007 comment about the Iraq War, in which he said — with little regard for truth — that the U.S. should simply “declare victory” and leave. If applied to trade, such factually challenged tactics could result in harsh threats followed by insignificant concessions, leaving the trade deficit largely unchanged but his base somehow placated by the aggressive rhetoric.

Meanwhile, the credit markets are flashing yellow.

The Treasury yield curve — the spread between short- and long-term interest rates — has narrowed by about a half percentage point this year, possibly foreshadowing an economic slowdown. There also are unexplained stresses in European credit markets, much like those that appeared in the months prior to the global financial crisis in 2008.

Besides the loss of market leadership from a tech sector now under threat from greater oversight, seasonal factors are unfavorable as well. Jeffrey Hirsh of the Stock Trader’s Almanac notes that stocks usually struggle during the second and third quarters, and those struggles tend to be most pronounced during mid-term election years, like this one. 

Investors looking to take risk off the table have options, though none will make them rich.

Based on research from the Bespoke Investment Group, the median return of gold, long-term bond futures and the U.S. dollar has been modestly positive over the six bear markets since 1980.

None of those sectors, however, represents anything close to a sure thing. Utility stocks offered scant downside protection, falling by an average of 20% over those six market downturns.    

Risk-averse investors are probably best served to keep it simple.  

According to Ned Davis Research, three-month Treasury bills returned an average of 5.6% over the 19 bear markets it counted since 1956, beating the S&P 500 by about 28%.  

In the current low-rate environment, cash might not seem like an attractive option. But if events spiral out of control in Washington and elsewhere, no one’s likely to complain.

Tom Saler is an author and freelance journalist in Madison. He can be reached at tomsaler.com.