After more than a year of steady stock market gains, complacent investors have been rattled by a long-overdue correction, and a spike in price volatility. They would do well to reconsider their strategies, Barron's reports, given that the macro environment also is changing: rising global GDP growth; unemployment rates in advanced OECD economies that are the lowest since the 2008 financial crisis; fiscal stimulus from sweeping tax reform in the U.S.; building inflationary pressures; and a major turnover of leadership in the Federal Reserve, among other key forces.
Russel Kinnel, the director of research at fund-rating service Morningstar Inc., suggests four investment strategies for investors to consider going forward, in remarks to Barron's. These are: small cap value stocks; high dividend stocks; inflation protection; and risk reduction. Investopedia's 27 million readers worldwide recently have been indicating extremely high levels of worry about the securities markets, as measured by the Investopedia Anxiety Index (IAI). (For more, see also: Stock Investors Should Fasten Seat Belts for More Plunges.)
Large-cap growth stocks have outperformed small-cap value stocks by the biggest margin since 2007, Kinnel tells Barron's, noting that there also was a comparable performance gap in 1999, during the Dotcom Bubble. Just as then, he believes that it's time for tech-obsessed investors to change course right now. He particularly likes the Royce Special Equity Fund (RYSEX), noting that it "holds its own during market rallies but shines in downturns," as Barron's puts it. Kinnel's other top picks are the Vanguard Small-Cap Value Index Fund (VSIAX) and the American Beacon Small Cap Value Fund (AVPAX), which tracks the index fairly closely, he says. (For more, see also: Stock Pickers Are Shining Amid Market Turmoil.)
The tax cut has increased the prospects for dividend increases, and bond yields are still low, despite being on the rise, Kinnel observes. He could have added that, while the coupon rates on most bonds are fixed, dividend-paying stocks offer the prospect of rising payouts over time. He says that the American Funds Washington Mutual Investors Fund (AWSHX) holds up well in market declines, with a high-quality portfolio of investment grade companies that have track records of dividend increases. The American Century Equity Income Fund (TWEIX) also is defensive in nature, and Kinnel rounds out his picks with the Vanguard Dividend Appreciation Index Fund (VDADX). The current yields on these funds are, respectively, per Barron's, 1.74%, 2.31% and 2.14%. (For more, see also: 10 Banks With Soaring Dividend Payouts.)
Investors with large holdings of bonds are vulnerable to capital losses imposed by a combination of inflation and the interest rate increases that inflation spurs. Kinnel does not recommend making inflation protection a big part of a portfolio, and warns that his picks are not tax-efficient, so they should not be held in a tax-deferred account such as an IRA or 401(k). The Pimco Commodity Real Return Strategy Fund (PCRDX) also holds inflation-linked bonds, and has a hefty yield of 8.54%. The Vanguard Short-Term Inflation-Protected Securities Index Fund (VTIPX) has a lower yield, 1.5%, but also a much lower expense ratio, 0.15% versus 1.19% for the Pimco fund.
The Vanguard Short-Term Tax Exempt Fund (VWSTX) yields 1.32% and Kinnel considers it one of the lowest-risk funds around. The Vanguard Wellesley Income Fund (VWINX) yields 3.26%, and is a balaced fund that includes both high-quality bonds and value stocks. The FPA Crescent Fund (FPACX) yields 1.48% and has a total return of 7.26% over the past 52 weeks. "Over the long haul he's [Steve Romick, fund manager since 1993] been adept at mixing defensiveness with aggression," Kinnel tells Barron's, adding "Returns land in the top decile over the trailing 10- and 15-year periods." (For more, see also: Stock Sell-Off Has Worrisome Similarities to 2008 Crisis.)