As mentioned above, we think investors should be wary of most US stocks and bonds going into 2018. Growth and tech stock values are very stretched, pulling indexes to frothy levels. US bonds are increasingly at risk of big value drops as the Fed and much of the world continues monetary tightening and interest rate increases. While we don’t expect this latter to happen quickly, bond investors face a real frog-in-pot danger. Going into 2018, here are our choices for most attractive asset classes.
1. International stocks. These are usually categorized as “non-US, non-emerging” which means established, “first world” economies. Think Canada, Germany, Japan, Australia, and so on. For instance, the forward price to earnings ratio for Europe currently stands near 14, significantly cheaper than the US’s 18.
2. Emerging markets stocks. These are also non-US, but with economies that are far from mature., Brazil, Russia, India, and China (the “BRIC” countries) are great examples. But it also includes countries like South Korea, which is quite economically advanced. As with most categorizations, there is a spectrum, with players at both ends of the development progression. Emerging markets have done quite well for 2017 – up 34% compared to the US S&P 500 at 16%, better than double – but still are quite cheap with a forward price to earnings ratio of 12 compared to the S&P’s 18.
3. Frontier markets. These are countries where citizens are just coming out of the huts, as it were, and represent tremendous potential – and risk! This bucket includes many sub-Saharan African countries, as well as places like Laos and Cambodia. Vietnam is a more advanced example, knocking on the Emerging Markets door.
4. US value stocks – while we do think the US stock markets are on the whole quite frothy, bargains are to be found for those who look carefully. Remember – our concern with the US market right now is because of overvaluations, not because we fear a recession or a plunge in corporate profits in the next year or two. Good deals in overvalued markets are still good deals, and better insulated from corrections since there’s not nearly so much hot air to vent from them. This view, by the way, is the essence of our methodology for our individual stock portfolios – Columbia, Viking and Strong Stock.
5. Strong US high dividend stocks. By this I mean US companies paying relatively high dividend yields and with strong financials and prudent payout policies. We believe stocks like these are still the place for income investors – with interest rates just beginning what we think will be a long climb higher, mid- to long-term bond investors risk big capital losses for what is still paltry interest income. We think strong dividend stocks will hold up better, pay more, and offer a much better inflation hedge than fixed income. That pretty much goes double for tax free muni bonds, by the way.
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