The “New Goldilocks”….. Not

In our last post, we discussed the “new goldilocks” economy. But it may be “goldilocks” for the wrong reason. Why? It may be “goldilocks” (not too hot, not too cold) for investors in financial assets (for a while anyway), but it remains a pretty cold bowl of lumpy porridge for many people who are either struggling to make ends meet or find a new job. The economy is operating well below its theoretical potential because of slow consumption and companies’ reluctance to ramp up new hiring because of this slow growth. In our last blog, we talked a bit about why, in this “new goldilocks” economy, money is shifting to equities from bonds in a search of higher yield. This is raising systematic risk because equities are inherently more volatile than bonds. To the extent more people are relying on higher volatility investments to provide more of their retirement income, the risk of many people falling short of requisite retirement capital is increased.

 So the point is, while it may be a “goldilocks” environment for stock investors right now, it is not “goldilocks” for the economy. We are still mired in a very slow growth environment which is part and parcel of a de-leveraging environment following a massive 30-year credit binge. It’s like a “hangover” and this is the “payback”. In the meantime, as long as global central banks maintain their super-easy money policies (which they appear to be doing), the “goldilocks” environment for stocks will also probably continue as excess liquidity is channeled into higher yielding equity securities.  But it does raise systematic risk and is unlike anything we’ve seen in the post-World War 2 environment. How does one protect themselves in this environment of increased systematic risk? Diversification of investment portfolios by both asset class and market sectors. Diversification provides the insulation or “shock absorber” when markets become more volatile or decline because assets that are not highly correlated to stocks may hold up better or actually increase when stocks decline. Diversification is probably the only “free lunch” in investing; it is one of the ways to obtain portfolio “insurance” without having to pay for expensive hedging or alternative investment strategies.